China's a Bad Debt Centipede

10/30/2013 8:00 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

The world waits for the next shoe to drop, in regards to the long, drawn-out China bad debt issue, writes MoneyShow's Jim Jubak, but the shoes just keep dropping.

It sort of feels like maybe we're dealing with a centipede. You know, the joke, of course, about centipedes is that, well, you always wait for the second shoe to drop, except if you're dealing with a centipede, they keep dropping, so that's what we're looking at in China.

What we've been worried about in China for a long time is the level of bad debt in China. We know it's going up. We know it's not really reflected in the statistics at places like the big banks, and recently, as in on October 22, we got news out of China that basically said that the level of bad debts—this is recognized bad debts—by China's big five banks had tripled in the first half of 2013, from the first half of 2012. It's still a very low amount. We're talking about bad debt levels being like 2.5%, 2.6% of assets, but no one really believes those numbers, and so, what you're looking at here is a question of, "Okay, so is this a good sign?"A good sign that the Chinese banks are getting realistic about their bad debts, or is it really a bad sign because it means that Chinese banks would be trying to, sort of, clear the decks, because they're going to see a lot more bad loans in the future, so they want to get these off the books now?

One of the real problems is the Chinese system is set up to delay the recognition of bad debts as long as possible. Banks have to actually ask the Ministry of Finance for permission to declare a debt a bad debt, and in most cases, they have to wait until the company has been judged bankrupt, which is a very long process in the Chinese courts, before they can even apply to the Ministry for this.

In 2010, there was a major change in the rules that said that relatively small companies—we're talking about loans of less than five million yuan, which is about $800,000—didn't have to go through this process, and banks could declare those as bad debts after they'd spent a year trying to collect. So, what that tends to suggest is that if we're seeing a rise in bad debts right now, it's really not a reflection of the bad debts that are at the level of enterprises connected with local governments; we know those are in deep trouble. It's not at the state-owned companies; we know those are in deep trouble, but it's probably at the lower end, the smaller end of the Chinese economy.

We know there's lots of stuff out there at the bigger end. It's probably not in the system yet, so the question is how much further are we going to go, and what size the write-off's going to be, and that, at this point, we simply don't know. The Chinese banks start to report earnings for the third quarter at the end of October. Industrial Commercial Bank, I think, is the first one on October 27. That'll give us some better sense of what the trends are, but still, because the system has so many legs, so much delay, I don't think we'll really know until really the bad debt hits the fan.

This is Jim Jubak for the MoneyShow.com video network.

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