Fending off Toxic Debt

01

Fending off Toxic Debt - A Closer Look at the Two Asian Giants’ Deteriorating Asset Quality

Dushanthi Silva, Sri Lanka Analyst Team

The banking industries in India and China are challenged by growing asset

quality concerns amidst a rise in the volume of bad loans worth billions of

dollars to politically allied and heavily debt-ridden borrowers, who are now in

trouble. Consequently, non-performing assets (NPAs) in public banks have

sharply increased, with aggregate banking system capital nearing regulatory

minimums. The deteriorating financial health of banks has in turn increased the

systemic risk of the sector, threatening the stability of the banking system.

Indian authorities have stepped in aggressively, compelling lenders to recognize

the full extent of bad loans and clean-up their books, while supporting the

banking system through a series of capital infusions. Our analysis, suggests that

the Indian banking system will continue to remain resilient unless NPAs more

than double their reported levels.

However, counterparts in China, faced with a similar dilemma, seem to still be

ignoring the full extent of the problem. Given the banking system’s importance

to the global economy, a stronger response by the government is warranted

despite the ability of the economic powerhouse to withstand the reported

deterioration in asset quality.


20160928

02


Accommodative Monetary Policy - a Prominent Theme in India and China

The Indian banking sector plays a pivotal role in the equitable distribution of

credit in the country’s economic development. As per the Reserve Bank of

India (RBI), the banking sector is adequately capitalised and well-regulated,

which was reflected in it being resilient even during the global downturn in

2008. As of 2015, the country’s banking system was valued at USD 1.9 trillion

(in terms of assets) (90% of GDP), and ranks as the fifth largest in the Asia

Pacific. However, the sector contributed a mere 1% of global banking assets in

comparison to China - which accounted for nearly 20% of global banking assets

as of 2015.

The Reserve Bank of India (RBI) has adopted an accommodative monetary

policy stance since 2013, with the RBI easing or delaying tightening. The

monetary easing came with a deceleration of inflation (to 5.9% in 2015 from

9.3% in 2012) on the back of a sharp drop in oil prices and softening

commodity prices, strong economic growth (GDP growth increased to 7.6% in

2015 from 5.6% in 2012) and an improved fiscal situation (fiscal deficit reduced

to 4.1% of GDP in 2015 from 5.7% in 2012). The debt fueled stimulus was

aimed at accelerating a trickle-down effect through the Indian economy by

making more cash available at a lower interest rate. Since January 2013, the

RBI has cut interest rates by 150 basis points (bps) to 6.5% in 2016 from 8.0% in

2013. Further, as part of liquidity enhancement initiatives, the cash-reserve

ratio was lowered to 4.0% in 2013 from 5.5% in 2012, with the rate on the

marginal standing facility reduced by 250 bps (in several steps) to 7.0% in 2016

from 9.5% in 2013.

03


Source: World Bank national accounts data, and OECD National Accounts data files, RBI

Note: 2016 (E) GDP growth rate is based on the IMF forecast; however, the lending interest rate and deposit interest rate are actual figures

Source: RBI

Similarly, China, the largest banking system in Asia Pacific, adopted an

expansionary monetary policy stance for a prolonged period since 2008, in a

bid to defy any external shocks in the aftermath of the global financial crisis

(GFC). Accordingly, interest rates which stood at 5.3% as of 2008 reached a

record low of 4.3% as of 2015.

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 (E)

Benchmark Repo Rate Maintained at a Five-Year Low of 6.5%

GDP Growth Rate Lending Interest Rate Deposit Interest Rate

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

Rep

o R

ate

Date of Change

150 bps cut in Repo Rate by the RBI over the Last 18-Months

04


Source: World Bank national accounts data, and OECD National Accounts data files

Top 15 Asia-Pacific Countries by Total Banking Assets

Rank Country Asset Base as of 2015

(USD trillion)

As a Percentage of Global Banking Assets as

of 2015

1 China 34.0 20.2%

2 Japan 8.2 4.9%

3 Australia 3.0 1.8%

4 Hong Kong 2.4 1.4%

5 India 1.9 1.1%

6 Malaysia 1.5 0.9%

7 Taiwan 1.4 0.8%

8 Singapore 0.8 0.5%

9 Thailand 0.5 0.3%

10 Indonesia 0.4 0.2%

11 New Zealand 0.3 0.2%

12 Vietnam 0.3 0.2%

13 Philippines 0.2 0.1%

14 Pakistan 0.1 0.1%

15 South Korea 0.1 0.1%

Source: BMI Research, UZABASE

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

China Lowers the Benchmark Lending Rate to Revive Economy Post Financial Crisis

GDP Growth Rate Lending Interest Rate Deposit Interest Rate

05


Despite Monetary Stimulus, Credit Off-take in India Continues on a Downward Spiral

Regardless of policy rates continuing to be well below historical norms, Indian

banking sector credit growth has slowed since 2012 to a CAGR of 13.3% during

2012-15. This displays a significant deceleration compared to the credit growth

CAGR of 23.2% during 2006-11, largely owing to demand and supply-side

constraints. On the demand side, key sectors such as infrastructure (35% of

bank credit in March 2016), demonstrated less credit-intensive growth due to a

high number of stalled projects. Accordingly, credit off-take growth in the infra

sector slowed to a record low of 4.4% YoY in March 2016 from 37.2% YoY in

March 2011. Similarly, the power sector - the biggest drawer of bank credit

within infra, recorded the sharpest deceleration in credit growth to 4.0% YoY in

March 2016 - a fall from 41.9% in March 2011. Further, a large portion of the

decline was also attributed to moderating credit aggregates, thereby

constraining supply in the wake of banking sector risk aversion.

Source: RBI, Source: World Bank national accounts data, and OECD National Accounts data files

0%

5%

10%

15%

20%

25%

30%

35%

0

10

20

30

40

50

60

70

80

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

YoY

Gro

wth

INR

bill

ion

Credit Off-take Growth Slowed to 9.7% YoY in 2015- a Fall from 18.1% in 2012

Loans and Advances Lending Interest Rate Loans and Advances Growth

06


Source: RBI, Planning Commission- Government of India, Ministry of Statistics and Programme Implementation

Source: RBI

In contrast, China saw a rapid expansion of bank credit owing to a prolonged

expansionary monetary policy by the People’s Bank of China (PBOC), with

banks being compelled to boost credit to state owned enterprises (SOEs) and

local governments for major infrastructure developments. Accordingly, on the

back of a healthy credit growth CAGR of 17.5% since the global financial crisis

(during 2008 -15), banking sector tripled to USD 34 trillion against a GDP of

USD 10 trillion (340% of GDP).

0%

5%

10%

15%

20%

25%

30%

0

20

40

60

80

100

120

140

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

YoY

Gro

wth

INR

bill

ion

Banking Sector Asset Growth Slows Mirroring Credit Growth

Aggregate Banking Assets Asset Base Growth

0%

5%

10%

15%

20%

25%

30%

Infrastructure Power Roads

Cre

dit

Gro

wth

Yo

Y

Decelerating Credit Growth in Infrastructure Sector

As of March 2012 As of March 2013 As of March 2014 As of March 2015 As of March 2016

07


Upsurge in Banking Sector Assets in China Amidst an Expansionary Policy

Source: IMF, CEIC, UBS Estimates, SNL Financial, People’s Bank of China,

China Banking Regulatory Commission Annual Report 2013

Note: Assets data include consolidated assets of banking institutions within and outside China

Rising Non-Performing Assets in Public Banks Resulting in Stricter Credit Control

Seasoning of the loan book amidst a credit cycle of rapid expansion (in 2006-

11) led to a credit deadlock as a result of less stringent credit appraisals and

competitive credit disbursals. Consequently, the gross non-performing assets

(NPAs) in the Indian banking system rose at a CAGR of 30.8% during 2010-15 -

significantly above the credit growth CAGR of 16.1% recorded for the same

period. Accordingly, NPA as a proportion of total advances increased to 4.3% in

2015 from 2.5% in 2010, while further deteriorating to 7.6% in March 2016. As

a result of the weakening performance, the Indian bank shares became the

worst performing shares in Asia (ex-Japan), over the past year with 11 banks

reporting losses for the quarter ended-December 2015.

Moreover, the RBI expects gross NPA to worsen to 8.5% by March 2017 under

its baseline stress test scenario. Furthermore, according to the RBI financial

stability report June 2016, given the most adverse conditions, the gross NPA

ratio may further worsen to 9.3% by March 2017, hampering the banking

sector’s overall performance.

0%

5%

10%

15%

20%

25%

30%

35%

0.0

50.0

100.0

150.0

200.0

250.0

2007 2008 2009 2010 2011 2012 2013 2014 2015

YoY G

row

thCN

Y tr

illio

n

Aggregate Banking Assets Asset Base Growth Credit Growth

08


Ballooning Non-Performing Loans Curtail Credit Growth

Source: RBI

Public Sector Banks Record Low and Declining Returns

Source: RBI

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

2010 2011 2012 2013 2014 2015

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

NP

A R

atio

(%

)Yo

Y Gro

wth

(%)

NPA Ratio Loans and Advances Growth Gross NPA Growth

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%

2.0%

ForeignBanks

PrivateSectorBanks

PublicSectorBanks

All SCBs

Ret

urn

on

Ass

ets

(RO

A)

2013 2014 2015

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

ForeignBanks

PrivateSectorBanks

PublicSectorBanks

All SCBs

Ret

urn

on

Eq

uit

y (R

OE)

2013 2014 2015

09


Majority of NPAs Reside on the Balance Sheets of State-Owned Banks under the Weight of Politically Driven Decision-Making

Public sector banks, which account for 70% of the Indian banking system have

performed the worst since 2012, with stressed advances (the combination of

restructured standard advances and non-performing loans) clocking in at 13.5%

in 2015, compared to 4.6% in private banks. Moreover, public banks’ gross NPA

ratio registered at 5.4%, compared to the industry average of 4.3% in 2015,

while rising to 9.3% of total advances in March 2016. The RBI further estimates

that this ratio may worsen to 10.1% by March 2017. Moreover, according to a

report by Credit Suisse, at state-owned banks, the un-provided NPAs are now

at 30%–75% of their capital and un-provided problem loans (loans which are in

trouble and could turn into NPAs) are at an even higher level of 65%–200%.

Sectors including power and iron & steel formed a large part of the stressed

assets, predominantly on the back of an overestimated demand and supply

position (industry overcapacities), inflated project costs and poor project

appraisals. The iron & steel sector, which accounted for a major part of the

stressed loans was severely impacted due to sluggish offtake by Indian

consumers and intense competition stemming from the Chinese market.

Further, sectors such as infrastructure and engineering procurement &

construction (EPC) were saddled with various issues, thereby delaying

execution while challenging their economic feasibility. On a related note, lack

of funding channels for local government in the absence of a deep corporate

bond market and muted participation by pension funds negatively impacted

the country’s banking system while aggravating the crowding out of lending to

small businesses.

10


Asset Quality of Public Sector Banks Deteriorates; Private Sector and Foreign Banks Intact

Source: RBI

Power, Iron and Steel Accounted for a Quarter of Stressed Assets

Source: RBI

Similarly, the Asian major – China, is also exposed to an exceptionally large low

quality credit market as the banks were compelled to boost credit to SOEs,

following the global financial crisis. The Chinese banking system is faced with

the legacy of state utilisation of bank credit for financing the operations of

SOEs regardless of their profitability or risk. Moreover, supported by an ultra-

low interest rate regime, major infrastructure developments such as roads,

energy plants and rail systems were completed. The boom in investments has

however led to overcapacity in many capital intensive sectors such as steel,

cement and mining. Meanwhile, since 2009 shadow banking activities in the

Chinese banking system increased with top banks increasing their exposure in

the property sector making them more vulnerable to a property downturn.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2011 2012 2013 2014 2015

Gro

ss N

PA

Rat

io

Public Sector Banks Foreign Banks Private Sector Banks

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

PowerGeneration

Iron & Steel Textiles Aviation Telecom Mining

Per

cen

tage

(as

of

Mar

ch 2

01

5)

Share in Advances Share in Stressed Advances

11


The slowdown in economic growth spelt trouble for the banking system with

revenues of borrowers now coming under pressure. Accordingly, the reported

NPA ratio at China’s banks increased to 1.7% in 2015 from 1.3% in 2014, and

further to 2.2% as of May 2016. Alongside the NPAs, in China there is another

category of “Special Mention Loans” (loans with which borrowers are

experiencing difficulties and which may threaten the financial institution's

position) totaling CNY 3.2 trillion as of 1Q 2016. When these are taken into

consideration, the market estimates of the true NPA position reaches an

alarmingly high of 15-19% of the loan book, as per the assessment by the

brokerage CLSA. This definitely indicates a red flag.

As of end-2015, Just 1.7% of Chinese Loans Were Officially Classified as NPA

Source: CBRC

NPA and Special Mention Loans Trending Upwards

Source: CBRC, PwC Analysis

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2010 2011 2012 2013 2014 2015

YoY G

row

th (%

)NP

A R

atio

(%

)

NPA Ratio Loans and Advances Growth Gross NPA Growth

0.8 trn1.2%

2.1 trn3.1%

1.2 trn1.6%

2.8 trn3.8%

NPA Special Mention Loans

RM

B t

rilli

on

(%

of

loan

s)

Dec-14 Sep-15

12


13


In China the build-up of bad debt has continued for 18 consecutive quarters

exerting tremendous pressure on the banking system. The majority of bad

loans are stemming from China's Big four state-owned banks - Industrial and

Commercial Bank of China - the world's biggest lender by assets (accounting for

2.1% of global assets as of June 2016), China Construction Bank (accounting for

2% of global banking assets as of June 2016), Agricultural Bank of China and

Bank of China - where each bank saw a nearly 100 bps increase in their NPA

ratio as of June 2016 compared to the previous year. Moreover, on the back of

souring bad loans, the loan loss provisions of the largest Chinese banks have

diminished over the years, while these banks are now faced with a dilemma

between breaching the 150% provisioning requirement or reporting a profit

decline.

Shrinking Buffers in Chinese Big Banks Continue in 1Q 2016

Source: The Wall Street Journal

0%

50%

100%

150%

200%

250%

300%

350%

400%

2011 2012 2013 2014 2015 Mar-16

Loan

Lo

ss P

rovi

sio

n (

%)

Industrial and Commercial and of China Agricultural Bank of China Bank of China

Regulatory Minimum 150%

14


Deliberate Non-Payment, a Common Scenario in Both Nations

According to the Credit Information Bureau (India) Limited (CIBIL), there were

6,819 willful defaulters in India owing INR 750 billion as of December 2015. This

figure registered 51% growth since 2012 compared to INR 220 billion from

3,703 willful defaulters until December 2012. (The RBI defines willful default as

deliberate non-payment of dues by the borrower despite adequate cash flow

and good net worth). Although the banks have filed lawsuits against the top

willful defaulters, the enforcement of law remains questionable with significant

delays due to corruption and political influence.

Another major limitation is the classification of these borrowers where the

banks do not adopt a uniform policy when declaring a borrower as a willful

defaulter. For instance, Kingfisher Airlines which owes an aggregate INR 69.6

billion to banks (2.2% of aggregate banking sector NPA), has been declared a

willful defaulter only by the State Bank of India (SBI) and Punjab National Bank

(PNB), with most other banks yet to adopt the classification. Similarly, in China

a number of state-owned enterprises such as Bohai Steel have historically used

their political connections to coordinate with creditors, while delaying debt

servicing and extending repayments. Consequently, these structural

shortcomings have left behind mountains of bad debt, threatening the stability

of the banking system.

15


Top Wilful Defaulters in India (As of December 2015)

Company INR billion As a % of Aggregate

Banking Sector NPA in 2015

1. Winsome Diamonds Forever Precious Group 39.7 1.2%

2. Zoom Developers 19.1 0.6%

3. Kingfisher Airlines (Out of INR 69.6 billion only INR 18.0 has been declared as willful default)

18.0 0.6%

4. S Kumars-Reid & Taylor 17.9 0.6%

5. Pearl-Pixion Group Companies 12.3 0.4%

6. Deccan Chronicle 9.9 0.3%

7. Beta Naphthol 9.5 0.3%

8. XL Energy 6.5 0.2%

9. Teledata GroupCompanies 5.8 0.2%

10. JB Diamonds 4.7 0.1%

11. Vindhyavasini Steel Group COS 4.6 0.1%

12. Zylog Systems 4.4 0.1%

13. REI Agro 3.1 0.1%

14. Indian Technomac 3.0 0.1%

15. Panther Fincap (Ketak Parekh) 2.3 0.1%

Source: CIBIL

16


17


Banks Bite the Bullet - Write off Bad Loans, Taking a Hit on Solvency

In line with the mounting bad loans, write-offs by banks surged at a CAGR of

44.1% during 2012-15, with public sector banks having written-off loans

totaling INR 1,140 billion at a CAGR of 50.7%. The regulator hoped that the

banks would find a way out of the problem, and hence did not intervene to

address the toxic loan problem until the recent past. However, in line with the

continually worsening asset quality and the consequential waive-off of

defaulted loans, the RBI conducted an asset quality review (AQR) across the

entire banking system (broadly similar to a stress test) in October 2015, to

clean up the balance sheets of those troubled institutions. The RBI

observations were encouraged to proactively and conservatively look at the

troubled accounts and emphasised the recognition of restructured assets as

NPAs while creating adequate provisions to cover restructured loans.

Accordingly, fiscal 2015 alone witnessed a steep 55.3% YoY surge in write-offs

as part of the balance sheet clean-up.

Capitalisation ratios of the banking sector slipped to 12.9% in 2015 from 13.0%

in 2014 (the RBI stipulates a Minimum Total Capital to Risk Weighted Assets

Ratio (CRAR) of 9% for India – higher than the BASEL III requirement of 8%).

Public sector banks continued to report the lowest Capital to Risk Weighted

Assets Ratio (CRAR) at approximately 12%, whereas private sector banks’

(PVBs’) CRAR reached 16% as of 2015. The RBI also announced a March 2017

deadline for banks to clean-up their balance sheets, due to the high incidence

of bad assets. Accordingly, following the clean-up and the planned capital

infusion of INR 250 billion by the government, the capitalization ratios of the

banking sector may hover in the range of 11.0%-11.5%, with CRAR of public

sector banks further moderating to 9% - on par with the regulatory minimum.

In the absence of a capital infusion in 2016 and 2017, CRAR would be 0.5%

lower. Under various NPA scenarios, it could be seen that CRAR would drop

below the regulatory requirement in the event actual NPAs reach 9-10%

compared to the current 4.3% level in 2016.

Impact on Banking Sector Capital (as of 2015) Given Various NPA Scenarios

Projected NPA 6% 8% 10%

CRAR 9.5%-10.0% 9.0%-9.5%

(Regulatory Minimum) 8.5%-9.0%

(Basel II Recommendations)

Source: UZABASE

18


“We believe enough capital is available. While the profitability of some banks

may be impaired in the short run, the system, once cleaned, will be able to

support economic growth in a sustainable and profitable way,” - Former RBI

Governor Raghuram Rajan

"As of now, the public sector banks are adequately capitalised and meeting all

the Basel III and RBI norms. However, the government wants to adequately

capitalise all the banks to keep a safe buffer over and above the minimum

norms of Basel III. We have estimated how much capital will be required this

year and in the next three years till financial year 2019," - Ministry of Finance

Indian Bank CRARs Moderate from Strain of Bad Debt Write-Offs

Source: RBI

12.4%

12.6%

12.8%

13.0%

13.2%

13.4%

13.6%

13.8%

14.0%

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

2013 2014 2015

CR

AR

RatioIN

R m

illio

n

Write-offs CRAR

19


RBI Intervention in terms of the AQR followed a Number of Pre-Operative Procedures

Other Government Intervention to address the Worsening Asset Quality in the Banking System

Creation of the Central Repository of Information on Large Credits (CRILC) database, which facilitates the compilation of information on levels of indebtedness of various groups in the financial system

Issuance of detailed guidelines on a framework to revive the distressed assets in the economy in order to improve the system’s ability to deal with corporate and financial distress

Introduced detailed guidelines on the formation of a Joint Lenders’ Forum (JLF), corrective action plan (CAP), ‘refinancing of project loans’, ‘sale of NPAs by banks

Introduced 5/25 scheme and the Strategic Debt Restructuring scheme with the aim of controlling the stress levels in the sector

The Bankruptcy Code, passed by the Parliament during the Budget session in 2016, is due to become operational thereby facilitating faster recovery of loans by banks

Proposed Debt amendments to the Recovery Tribunal Act and SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act) further empowering banks legally

Capital infusions to bolster the capital adequacy ratios of the weak public sector banks to match the capital buffer levels as prescribed by the Basel III norms According to the capital infusion road map, public sector banks would receive INR 250 billion in 2016-17, and INR 100 billion each in 2017-18 and 2018-19

Source: The Indian Express, UZABASE

Government Infuses Capital to Strengthen Solvency

Source: Government of India

0

50

100

150

200

250

300

2013 2014 2015 2016 2017

INR

bill

ion

Announced in Budget Actual

20


Allocation Break-up of INR 250 billion Capital Infusion

Bank Amount (INR million) As a % of the total Allocation

State Bank of India 75,750 33.1%

Indian Overseas Bank 31,010 13.5%

Punjab National Bank 28,160 12.3%

Bank of India 17,840 7.8%

Central Bank of India 17,290 7.5%

Syndicate Bank 10,340 4.5%

UCO Bank 10,330 4.5%

Canara Bank 9,970 4.4%

United Bank of India 8,100 3.5%

Union Bank of India 7,210 3.1%

Corporation Bank 6,770 3.0%

Dena Bank 5,940 2.6%

Allahabad Bank 440 0.2%

Total 229,150 -

Source: Ministry of Finance

Similarly, in China banks have written off more than USD 300 billion of bad

loans in the past 3 years-compared a mere USD 1.8 billion worth of bad debt

write-offs in India, in order to reassure investor confidence that the country

can cope with its mounting NPA.

What China can Learn from India’s Bold Approach - An Example from the Asian Neighbour

Though the cleanup is still underway, India has become the front runner in

addressing asset quality concerns which has scored some early success by

taking prudential measures. Banks have now expedited the process of

recovering bad loans from overextended tycoons like Mallya. In contrast,

China, seems to still ignore the full extent of the problem. Even though Chinese

banks have continually reported mounting bad debts, banks have still not

curtailed lending. According to the PBOC, new loans worth USD 718 billion

were disbursed in the first quarter of FY 2017-a threefold increase compared to

the same period last year.

21


Unlike India, given the systematic importance of China’s banking system to the

world- considering its asset size, an NPA ratio of 10% would equal USD 3.4

trillion (34% of Chinese GDP) or 5% of world GDP. Further, this is even greater

than the Indian GDP which is approximately USD 2.1 trillion as of 2015. This

would exacerbate the need for proactive measures to address the potential

loss, before the debt bomb leads to a crisis. Furthermore, according to the

Bank of International Settlements, the corporates collectively owed USD 17.4

trillion as of September 2015 (177% of the Chinese GDP), which is staggering

compared to the much lower USD 985 billion in India (50% of the Indian GDP).

A bank with a cleaner balance sheet always looks more promising, as it

indicates a stronger position to direct credit for economic development.

Therefore, the biggest lesson that China can learn from India is the prudential

recognition of bad loans without delaying their recognition by ways of

restructuring, thereby, challenging the credibility of the reported figures.

Additionally, the Chinese cabinet discussions regarding lowering the loan-loss

provision ratio to 120-130% from its current level of 150% - a move to report

larger profits in the banking system, raises a crucial question on the direction of

the reforms. The earlier ratio was set when the asset quality was better than

current levels, therefore lowering it further and making more funds available in

a flagged economy may worsen the current scenario.

“You can put lipstick on a pig, but it doesn’t become a princess, so dressing up a

loan and showing it as restructured, and not provisioning for it when it stops

paying, is an issue. Anything which postpones a problem rather than

recognizing it is to be avoided.” -RBI Governor Raghuram Rajan

The world’s second largest economy is still in a stronger position to tackle the

problem as they have more financial capacity. The country’s sovereign debt to

GDP of 43.5% as of 2015, compared stronger than the 66.8% in India, indicating

the Chinese government’s stronger position in funding capital injections to turn

around the weary banking sector. Further, due to the higher savings rate in the

country, the Chinese banks are still enjoying ample liquidity - an essential

component for banks’ stability. These combined factors may lead to a slower

recognition of NPAs, and might inaccurately indicate a lower need for a large

bailout in the immediate future.

Will China muddle through? The question remains………

22


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Fending off Toxic Debt

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