Asia/Pacific November 08, 2018 / 04:01 pm UTC

China Banking Rescues: Lessons from 1997-2005

By Mike Gallagher, Jeff Ng
  • The level and pace of increase in Chinese banks’ debt-to-GDP ratios is causing rising concerns about over-indebtedness leading to a 2007-08 style crisis for China’s banking and financial system in the coming years. China is fortunate, however, that the debt is between domestic creditors and debtors in yuan, with a large portion of major debtors state-owned and the financial system heavily influenced by the Chinese authorities. 
  • Bottom line:Rapid credit growth since the global financial crisis threatens a rising tide of non-performing loans (NPLs) in the Chinese banking systemMultiple lessons from the 1991-96 credit boom and subsequent aggressive Big 4 bank bailouts can provide some guidance as to the likely reaction of the Chinese authorities. It is also worth noting that China allocated 10% of its U.S. Treasury holdings in 2003 as part of the Big 4 bank clean-up process, which may be an option again. 
  • Prompt action to support the financial sector may avoid amplifying debtors’ distress from any major credit deterioration. For now, though, the government is muddling through. It is doing so by engaging in a clean-up exercise in second-tier banks and the shadow banking system, combined with tactical macro policy easing. Still, significant risks remain, and we will watch carefully for signals of distress (systemic news, financial system rescues or bailouts, deterioration in domestic corporate earnings and policy mistakes) in 2019. 
  • Market implications: Rising NPLs in China will likely produce jitters about the Chinese financial system, economy and export prospects for commodity producers to China. Aggressive action by the Chinese authorities for the financial system would soothe, but not end, concerns over the banking system. Finally, the consolidation of China’s debt problem onto the government balance sheet will likely inflate the government debt-to-GDP ratio in future years.

Figure 1: Main Measures To Recapitalize Big 4 Banks, 1997-2005 

Year
1984Creation of Big 4 banks from existing state entities
1998$33 billion government injection into Big 4 banks; reserve requirement ratio (RRR) cut from 13% to 8% 
1999$170 billion NPLs sold by Big 4 to four asset management companies; RRR cut from 8% to 6% 
2003-05$45 billion of U.S. Treasury holdings transferred to Big 4 banks from PBoC FX reserves. At the time, this was 10% of China’s FX reserves.
2004$33.7 billion China Construction Bank and Bank of China NPLs sold to asset management companies at 50% discount
2005$15 billion government injection into Industrial Commercial Bank 
2005$85.5 billion Big 4 NPLs sold to asset management companies at discount via Ministry of Finance/PBoC

Source: Continuum Economics, BIS

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Analyst Certification
I, Mike Gallagher, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.