NPL disposal a concern in banking reform
By Hu Yuanyuan (China Daily)
Updated: 2004-11-29 09:51

The commitment to open the banking market to foreign competition in 2006 under the World Trade Organization (WTO) agreement is bringing into sharp focus progress in banking reform. This has raised increased concerns about the disposal of non-performing loans (NPLs), widely seen as a core issue of the reform.

Much attention is centered on the pace at which the NPLs are being disposed of by the four asset management companies (AMCs) that were established in 1999 by the government to tackle the problem. The issue, complex as it is, has sharply divided opinions of bankers and economists, China Daily reported Monday.

While they all seem to agree on the magnitude and urgency of the matter, they differ in the setting of priorities. Some criticized the AMCs for moving too slowly in auctioning off the NPLs while others have expressed concerns about dumping State-owned assets at too low a price.

The debate is helping to focus public attention on the issue and reflects government resolve in reforming the banking system.

"The banking sector, weighed down by a massive amount of NPL, is the Achilles' heel of the otherwise robust economy," says Fred Hu, managing director of Goldman Sachs (Asia), a unit of the leading Wall Street investment bank.

In an exclusive interview with China Daily in Beijing, Hu, who is also a professor of economics at the prestigious Tsinghua University, says that the NPL issue must be seen as an integral part of the government's overall banking reform programme. As such, the reform that is widely seen as critical to the future competitiveness of the domestic banks will not be effective without a significant reduction in their NPLs.

Total NPLs of the major Chinese commercial banks are valued at 1.7 trillion yuan (US$204.7 billion), representing about 13 per cent of their combined loan assets, according to the latest figures published earlier this month by China Banking Regulatory Commission. The NPL ratio, it said, was 4.39 percentage points lower than that at the beginning of the year.

Despite the trimming, many economists are known to believe that the progress has been too slow. Hu attributes the apparent foot-dragging in the disposal of NPLs to official concerns about being shortchanged in the process.

"There is an obvious need for a change in mindset before we can see some swift actions (in NPL disposal)," Hu says.

However, there is an equally strong argument, mainly by domestic bankers, for caution. At a NPL seminar held in Beijing earlier this week, several representatives of major domestic financial institutions complained that previous NPL auctions conducted by the AMCs were dominated by foreign investors, mainly the major US investment banks. Too few players, they said, have the effect of depressing the bidding prices. They call on the AMCs to break down the parcels for auction into smaller batches more palatable to domestic bidders.

"The pricing of NPLs is a touchy issue," says Wang Haijun, director of investment banking department at China Cinder Asset Management, one of the four AMCs. "We are taking great efforts to get as much money back as possible, thus minimizing the loss to the state," he says.

The government has taken numerous concrete steps in tackling the NPL problem by transferring a large part of the NPLs to several asset management companies (AMCs) established since 1999. In addition, the government earlier this year injected a total of US$45 billion of its foreign-exchange reserves into China Construction Bank and Bank of China, two of the nation's four State-owned banks. The asset injection is seen as a necessary step in strengthening the banks' balance sheets in preparation for stock market listings.

But the transfer of NPLs augmented by capital injections is seen as the first and relatively easier step in addressing the issue. The tough decision lies in the recovery of the residual values of those NPLs through the sales of the underlying assets, Hu says.

"Come to think of it, NPLs are NPLs," says Hu. "There is no way you can hope to recover the full amount through asset sales," he says.

What's more, the vast majority of the NPLs are "uncategorized" loans to the State-owned enterprises, Hu says. These NPLs are not tied to any particular piece of assets. For that reason, it is "much harder to recover those loans," he says.

The primary objective, Hu says, is to "maximize the residual value of the assets" and to "minimize losses to the banks." To achieve such an objective, the government must move fast in disposing of those assets because they are like "icebergs" in the summer: "the longer your keep them there, the more their value will melt away," Hu says.

Five years have passed since the first AMC was established, he says. But "whatever is being done is far from adequate," he adds.

AMCs are supposed to dispose of their entire NPL portfolios by 2009. But what they have done so far mostly involves debt rescheduling, discounted borrower payoffs and collateral sales.

But "how fast is fast," asks Wang of China Cinder. "We are satisfied at our pace of disposing NPLs," he says.

Wang says there is no way of gauging "quickness" or "slowness" in disposing of such a huge amount of NPLs because of the many other factors that must be taken into consideration.

Other than the pricing, a chief concern is the social consequence arising from the disposal of assets that could lead to the closure of enterprises, Wang says.

"Another thorny problem is China's under-developed social security system," Wang says. "We have to gain a balance between efficiency and social stability."

Disposal of NPLs can lead to the closure of the borrowers, many of which are the State-owned enterprises. The re-employment of thousands of workers who lost their jobs as a result is a major concern to the AMCs.

"If those SOEs are shut down overnight, how can the workers find a proper job to support them as we don't have a sound social security system yet?" Wang said.

Hu, on the other hand, says that international investment banks, such as Goldman Sachs, Morgan Stanley and Merrill Lynch, can play a much more "significant" role in helping the government resolve the NPL problem. These financial houses have both the capital and the expertise to recover the residual values of the NPL assets at fair market prices, he says.

"We can help in many different ways," Hu says. For example, investment banks can act as principals in buying NPLs directly from the AMCs. "We can come up with the up-front cash to do that," he says. But the government "must give more flexibility to the AMCs" to sell directly to foreign investors, he adds.

But the reluctance by the authorities to release the assets for fear of selling too cheaply is "not particularly encouraging" to market participants, Hu says. Only a small portion of those assets has been auctioned so far, he adds.

Such cautiousness seems excessive to some international investors because they believe that the biddings at the auctions are always "proper and transparent," Hu says. For that reason, he says, the prices offered for those assets are a reasonable indication of what the market is willing to pay.

"If I were running the show, I'd love to see foreign investors, both foreign and domestic, buying those NPLs make good money," Hu says. This will have the effect of attracting more demand, resulting in higher bids in future auctions, he says. "You've got to create the excitement for an otherwise highly liquid market."

However, there seems to be no lack of business opportunities in China to keep international investment banks busy, Hu says. Goldman Sachs, for instance, has been active in investing, corporate restructuring, mergers and acquisitions and underwriting.

Hu says that his firm has built up a solid track record as an investor in Chinese companies. "We invested in companies such as Ping An and SMSC, which are all doing very well," he says.

The firm is a leading manager in nearly all the IPOs of major Chinese enterprises and, according to Hu, it has established "excellent" relationships with many leading companies and financial institutions in China.

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