So how many bad loans have China's banks made? And when will the bill come due?

11/24/2009 1:05 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

There’s no free lunch. Not even for China.

The Beijing government has used its state-controlled banking system to provide much of the financial stimulus that has powered China to 8.9% economic growth in the third quarter of 2009.

And now the bill is coming due.

China’s big five lenders extended a huge $688 billion in loans in the first nine months of 2009. That dwarfs the government’s official stimulus program, announced in November 2008, of $586 billion in spending spread over two years.

Think about those numbers for a moment. Bank loans $688 billion in nine months. Government stimulus spending $586 billion in two years.

For months as the loans piled up, the worry has been that banks couldn’t possibly be lending at this speed and volume if they were paying any attention to the credit quality of the loans they were making. At $4.3 trillion (2008 estimate from CIA World Factbook) China’s economy is still just one-third the size of the U.S. economy (at $14.4 trillion 2008 estimate). No banking industry could throw $688 billion in loans at a $4.3 trillion economy in just nine months without making a ton of loans that will rapidly go into default. (Or would if China had a bankruptcy system.)

On November 24, the China Banking Regulatory Commission started to turn that worry into some sort-of real numbers.

The big five—Agricultural Bank of China, Bank of China (BACHY), Bank of Communications (BCMXY), China Construction Bank (CICHY), and Industrial & Commercial Bank of China (IDCBY)—have been ordered to estimate their potential capital deficits in 2010 based on their own forecasts for loans and loan losses, and to submit plans for raising any necessary capital.

Complicating the plan—and any attempt by outside investors to figure out how much capital the banks will need to raise—are uncertainties about what capital standard the China Banking Regulatory Commission intends that banks should meet. Last year the regulator raised the minimum capital ratio to 10% from 8%. Bloomberg has reported that the commission intends to raise capital requirements to 13% in 2010, but on November 23 the commission denied the Bloomberg story. However, he Wall Street Journal has also quoted an unnamed official at China Construction Bank saying the commission will raised capital rations in 2010. As of September 30, capital ratios at the five banks range from 12.6% at Industrial & Commercial to below 9% at Bank of Communications.

So how much capital will the big five banks need to raise in 2010? Estimates I’ve seen range from $15 billion to $5 billion. That’s on top of the $24 billion that these banks have already raised in 2009 by selling subordinated debt.

Of course, if the quality of the loans that these banks rushed to make to fulfill the government’s plan for economic recovery are as bad as I think they are, this $15 billion to $45 billion will be just a down payment on the final bill.

Unless the Chinese government does what it did in the aftermath of the 1997 Asian currency crisis and lets the banks sell off their bad loans at full value to specially created entities. By the way, those non-performing loans from 20 years ago are by and large still sitting on the books of those bailout vehicles.

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