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Here’s How China Hopes to Solve Its Corporate Debt Woes

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An elderly man walks past the People's Bank of China in Beijing on August 12, 2015. China cut the yuan's value against the US dollar for the second consecutive day on August 12, roiling global financial markets and driving expectations the currency could be set for further falls. AFP PHOTO / WANG ZHAO (Photo credit should read WANG ZHAO/AFP/Getty Images)Photograph by Wang Zhao — AFP/Getty Images

China’s central bank is preparing regulations that would allow commercial banks to swap companies’ bad loans for equity in those firms, in another effort to tackle the country’s mountainous debt problem.

Two sources with direct knowledge of the new policy told Reuters that the release of a new document explaining the regulatory change was imminent.

On paper, the move would represent a way for indebted corporates to start afresh after a borrowing binge responding to the country’s fiscal stimulus program in 2008/9 and the availability of dirt-cheap dollar funding as the Federal Reserve slashed interest rates in the wake of the Lehman crisis. Corporate debt has risen from 98% of Chinese gross domestic product in 2008 to 160% of GDP now, according to Standard & Poor’s Ratings Group.

For the banks, converting debt into equity would reduce the number of non-performing loans on their books, although it wouldn’t release them from the burden of hefty write-downs in many cases. As with many of China’s statistics, most analysts doubt that the actual level of NPLs is a healthy as official data suggest. One particularly bearish U.S. hedge fund manger, Kyle Bass, argues that the latent losses in China’s banking system could be four times those of the U.S. subprime crisis.

Official data from the China Banking Regulatory Commission shows Chinese banks held NPLs and “special mention” troubled loans in excess of 4 trillion yuan ($614.04 billion) at the end of 2015.

Recapitalising the corporate sector would theoretically create some balance sheet space for fresh lending for investment in the new wave of infrastructure products and factory upgrades that the government hopes will rejuvenate the Chinese economy.

 

The sources said the new regulations would be promulgated with special approval from the State Council, China’s cabinet-equivalent body, thus skirting the need to revise the current commercial bank law, which prohibits banks from investing in non-financial institutions.

In the past Chinese commercial banks usually dealt with NPLs by selling them off at a discount to state-designated asset management companies (AMCs). The AMCs would turn around and attempt to recover the debt or resell it at a profit to distressed debt investors.

The sources did not have further detail about how the banks would value the new stakes, which would represent assets on their balance sheets, or what ratio or amount of NPLs they would be able to convert using this method.

The People’s Bank of China did not respond to requests for comment.