China’s programme to lower corporate debt levels and reduce bank NPLs moves ahead

BOFIT Viikkokatsaus / BOFIT Weekly Review 2016/17

Chinese officials this spring have been formulating a programme to ease corporate debt problems and reduce the stock of non-performing loans (NPLs) held by banks. The arrangement lets companies swap their equity for bank loans and banks could also bundle the NPLs for sale at a discount. Similar arrangements were made in the wake of the Asian crisis. The programme’s contents have yet to be specified, but media reports suggest some of China’s big banks are experimenting with the bundling and sale of NPLs. Media reports suggest that the ceiling of the equity-debt conversion programme will be 1 trillion yuan ($650 billion). The first swap took place in March, when the Hong-Kong-exchange-listed shipbuilder Huarong Energy announced it had reached deal with its creditors on restructuring $2.7 billion in debt.

This week, three IMF economists released a technical note on the debt-equity conversion and NPL securitisation programme. In their view, the programme needs to be carefully designed due to the real danger that debt restructuring will simply give non-viable “zombie” firms extended time to fail and increase the overall cost to the state. This insight specifically concerns the restructuring of inefficient state-owned enterprises. The authors further note that banks generally lack the competence to turn around money-losing businesses and that bank involvement in non-bank businesses involves moral hazard issues. The IMF economists propose that firms be carefully vetted before admission to the programme, banks retain the right to replace corporate managers and directors as necessary, debt-equity conversions be based on actual market price of the shares, and that the percentage of a bank’s stake in a participating firm be limited and temporary. In addition, the regulatory framework should be geared to improving bank risk management and require banks to report their problem loans in greater detail.

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