Speculation is rife after China's central bank governor, Zhou Xiaochuan, said to Xinhua in Mexico that "China has decided to reform its financial system, including reducing non-performing assets and increasing capital input to banks." The number of loans that are not being paid back is notoriously hard to measure but estimates put the figure as high as 50 percent of China's GDP, or about RMB 5.5 trillion this year. The governor's statement was taken as an indication that China is preparing to rescue the 'big four' state-owned banks, which continue to struggle with a non-performing loan (NPL) ratio of about 20 percent. The eventual plan is to list the big four banks on domestic and international stock markets but this is impossible unless the banks can bring their NPL ratio down below the 10 percent mark. Of the four, the Agricultural Bank has been described as a "cesspool" of bad debt and no one seriously expects it to be listed any time soon. The ICBC is the biggest bank in China, the Bank of China has the greatest international experience and has already listed its Hong Kong subsidiary and the Construction Bank has the lowest ostensible NPL ratio so these three are all candidates for listing as long as they can get rid of some of their bad loans.
In 1998 China bailed out the big four banks by injecting RMB 270 billion of new capital and carving out RMB 1.4 trillion of bad loans and transferring them to four asset management companies (AMC) – Cinda, Huarong, Great Wall and Orient.
"That was supposed to be the last free lunch," according to Arthur Kroeber, managing editor of research publication China Economic Quarterly. He says that a fresh recapatilization is expected within the next six months but analysts are unsure what form that will take.
The minimum effective bailout package to fully clean up the banks would need to be about RMB 2.8 trillion according to UBS economist Jonathan Anderson, but he estimates the actual bailout being contemplated at the moment is probably no more than RMB 1 trillion.
According to Kroeber, the central bank and the China Banking Regulatory Commission (CBRC) are both pushing for a cash injection while the Ministry of Finance is reluctant to foot the bill because it would involve the government taking on additional debt. China's government deficit has quadrupled over the last four years.
There is research showing that the government could afford to take the NPLs off the banks' books in their entirety but the most likely outcome will probably be a compromise similar to that of 1998 and will include another transfer of bad loans to the AMCs. These companies are still burdened with roughly RMB 600 billion of bad debts from the 1998 transfers but in a perverse way they may actually welcome a fresh batch of bad assets to sell off.
Recovery rates on bad asset disposals have fallen, from about 30 percent initially, to an average of 15 to 20 percent now as the better bad loans run low. With a new delivery of problem loans will come a fresh injection of better assets, which will allow the AMCs to maintain and improve their relatively high recovery rates.