‘Bad Banks’ Spread Across China

Nearly 40 asset-management companies are vacuuming up bad debts, but it’s more like sweeping problems under the rug

By Anjani Trivedi

China is going back to basics when it comes to bad-debt management.

Beijing has unveiled a slew of tactics to clean up the dud loans in its banks—from debt-to-equity swaps and bad-loan securitizations to over-the-counter selling of bad assets. It is also reverting to a strategy of cleansing the system of nonperforming assets: so-called bad banks.

Part of a pilot initiative in 2013, there are now 35 such local asset-management companies, as they are called, with enough capital to absorb almost $200 billion of assets. Meanwhile, regulatory relaxation late last year allows two such institutions per province—up from one—and more leeway around how to manage bad loans, including selling the loans onward, which was previously banned.

They operate alongside a quartet of asset-management companies that were set up by the Chinese government in the 1990s to free the country’s banks, which were also then stuffed with bad loans.

Those original four institutions remain leaders in the business of buying up bad loans. But with assets deteriorating faster than they can handle, they have taken to aggressive capital raising. China Cinda Asset Management on Monday announced $3 billion of new bonds, following $3.2 billion of perpetual preference shares to bolster capital last year and an equity placement to a Chinese shipping conglomerate.

Yet the amount of bad debt to vacuum up isn’t slowing. The balance sheets of the big four asset-management companies have ballooned, up 400% between 2012 and 2016. Bad-debt receivables of nonfinancial companies, created by the asset-management companies rolling over credit to companies, have risen more than 100% compounded each year since 2012, according to UBS estimates.

So in step these new local asset-management companies. Zhongyuan Asset Management, for instance, says one its business goals is to exempt or reduce debt repayments to “revitalize the creditor’s assets.” The risk is these deals just keep alive inefficient companies.

The problem is that these bad banks serve more as warehouses of bad debt rather than eliminators of the stuff. The newer crop of asset managers is fully financed by bank loans—so while they help repay loans extended by banks, they themselves turn to banks for funding.

Many of the asset managers also maintain stakes in the local banks they are meant to help clean up.

The four large asset managers, too, rely heavily on banks, but have added other forms of funding, including capital markets, and have even bought up banking subsidiaries. The new local bad banks will probably do the same.

The rotation of bad assets around the financial system will alleviate and delay the impending pain—but it won’t make the problems go away.

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