The China Banking Regulatory Commission (CBRC) has emphasized the role of asset management companies (AMCs) in the campaign to reduce bad loans, and expressed support for foreign investors in participating in China's distressed debt market.

"Although asset management companies have some problems in their system and operational mechanism, we need to note that... their level of professionalism has been improving continuously, and their disposal work has been fairly smooth," CBRC Chairman Liu Mingkang told China Daily.

China created four AMCs in 1999 to take over a total of 1.4 trillion yuan (US$168 billion) of non-performing loans from the Big Four. As of September last year, they disposed of 415 billion yuan (US$50 billion) of bad loans, retrieving 86.2 billion yuan (US$10.4 billion) in cash, 20.75 per cent of the assets disposed of.

Although AMC officials have said such a performance was comparable to their foreign counterparts, they have long been dogged with such accusations as being inefficient and having undervalued assets they auctioned.

And the growing direct involvement of commercial banks in the NPL market last year has cast further gloom over the future of AMCs as the nation's specialized NPL managers, analysts say. The Industrial and Commercial Bank of China signed a memorandum of understanding with Goldman Sachs last year to form a joint venture to dispose of part of its bad loans, but little further information has been disclosed so far.

Liu said the government is considering new AMC policies in the areas of operational mechanism, performance evaluation and incentive measures as well as "external environment" to further improve their efficiency.

The four AMCs have estimated that most of their disposal work could be finished by the end of 2006, he said.

The official said his commission encourages foreign investors to participate in the disposal work, and co-operate with both AMCs and State-owned commercial banks.

The two forms of co-operation, he said, however, are either foreign investors and the AMCs setting up joint ventures, or the AMCs and the State-owned commercial banks selling packages of NPLs to foreign investors.

"In the future, we may also consider disposing of non-performing assets through securitization,'' Liu added.

Foreign companies including Morgan Stanley and Goldman Sachs set up two joint ventures with China Huarong Asset Management Corporation, one of the four AMCs, in 2002, but have not formed joint ventures with any of the Big Four.

NPL-reduction campaign

Liu's commission faces a herculean task set by the government to bring the Big Four's non-performing loan ratio, at 21.4 per cent at the end of last September, or a staggering near 2 trillion yuan (US$240 billion) in outstanding volumes, down to 15 per cent by 2006, when the banking industry is completely opened to foreign capital under the nation's World Trade Organization commitments.

And last year's rapid increases in loans have raised concerns that new bad loans are in the pipeline, with some worrying that banks have been, to a large extent, increasing lending to dilute their NPL ratios.

That phenomenon did exist, but was far from being a major reason, Liu said. "We believe the relatively rapid growth of loans was the result of a combination of factors," he said.

A strong recovery in the demand for fixed asset investment fuelled by fast economic growth had bolstered business borrowing needs, while last year's rapid monetary growth, largely the result of the central bank's purchases of excess US dollars that simultaneously amplified liquidity at commercial banks, provided sufficient supplies of loans, the official noted.

Growing exports and expectations of a stronger yuan, the local currency, have driven up US dollar inflows into China last year, forcing the People's Bank of China to buy dollars with the local currency as a way to consolidate a range for the yuan's exchange rate. As a result, China's foreign exchange reserves jumped by 34 per cent from the end of 2002 to US$383.9 billion at the end of September.

And the risk-averse banks, which had been reluctant to lend in previous years, have adjusted their lending strategies to take advantage of the surging borrowing needs, Liu said.

But he added: "Of course, aside from those major reasons, we do not exclude the possibility of a few banks, especially their lower-level branches, blindly increasing loans to dilute (the ratio of) non-performing loans.''

Financial institutions, including overseas ones, extended 2.6 trillion yuan (US$313 billion) in renminbi loans in the first 11 months of last year, exceeding 2002's total of new loans by 40 per cent.

The new loans were mostly concentrated in the areas of infrastructure construction, technical upgrades and real estate. "The structural problem of bank loans' sectoral concentration is fairly noteworthy," Liu said.

Other problems in surging loans that may lead to financial risks, he said, include commercial banks' rapidly-growing business of commercial paper discounting, which "is unstandardized and has a considerable risk," and the problem of "malicious" loan guarantee.

"Given the fast growth of loans, banks' capital inadequacy problem has worsened, which makes it difficult to achieve the effective restraint of capital," Liu said.

According to the CBRC website, all of China's banking institutions, except one of the Big Four and a couple of joint-stock commercial banks, currently fall short of the minimum 8 per cent capital adequacy ratio requirement, which spells another major hurdle to their reform and IPO plans besides bad loans.

Seeing the potential risks, the CBRC has urged banks to enhance loan management and stepped up loan inspections.

But the official said last year's rapid loan growth was basically unrelated to a rebound in NPLs recorded last October. The banking sector's total NPLs as well as the average ratio had been on a downward trend since late 1999.

The CBRC said on its website late last year that bad loans at some banks rose at the end of October, an unusual phenomenon it vowed to monitor closely.

The fact that the Chinese loan classification is based on the length of time after agreed repayment date makes it difficult to examine the underlying reasons behind October's NPL rebound, he said.

The commission has, however, he said, identified two general reasons -- loans granted in previous years but matured last year, and a slowdown in commercial banks' disposal of bad loans last year as the commission strictly prohibited banks from granting borrowers new loans to pay back their old loans.

"Currently, we are promoting the five-category loan classification so as to more accurately and truly reflect the quality of loans," Liu said, referring to an internationally-accepted loan classification method. "We are going to monitor the situation closely."

By the five-category classification, China's banking sector averaged an NPL ratio of 18.74 per cent at the end of last September, down 4.37 percentage points from the end of 2002, while the total outstanding volume fell by 96.6 billion yuan (US$11.6 billion).

Effective bank supervision

Liu's commission has been striving to build a bank supervisory regime that is up to international standards. It has been closely following developments in the international bank regulators' community, and has set up a board of international advisors to bring in best bank regulatory expertise.

Last year, it completed a preliminary self-assessment report by collating with the Basel Committee's Core Principles for Effective Banking Supervision in an effort to identify weaknesses and deficiencies.

"The China Banking Regulatory Commission, after its establishment, has done a lot of basic work in changing regulatory mentality, specifying regulatory targets, formulating criteria of sound supervision, revizing the legal framework and promoting regulatory system innovation, which has played a very important role in closing the gap between China's banking supervision and what the Core Principles require," Liu said.

"But due to the short period of time (after the commission's establishment), such work has not had a noticeable effect," he said. "There does exist a certain gap between China's banking supervision and international standards."

The report shows the gap in a variety of aspects, Liu said, including uncertainties like a structural imbalance of the economy and high employment pressure that may affect the preconditions of effective bank supervision, factors that constrain the independence of regulators, and problems like incomplete corporate governance structures at banks that affect prudential surveillance.

The CBRC has formulated an action plan to improve the regulatory regime, Liu said. The moves include improving supervision on market entry, enhancing the effectiveness of site inspections, establishing early-warning and risk-rating systems and building a supervision information network.

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