The Peoples Bank of Chinas (PBoC) internal website is hardly a riveting read, but one section tells you more about the countrys leading banks than a thousand analyst reports. Tucked away under Previous Governors is a list of former Beijing central bank chiefs, running from 1949 to 2002.
At first glance the page contains little out of the usual, but a second look reveals an apparent programming glitch under the name of Hu Lijiao, the banks third governor. Hu took office in October 1964 but never officially left: in August 1966 he was quietly removed from his duties and sent to work in a labour camp in southern Guizhou province. Only after the maddest years of Chairman Maos Cultural Revolution had passed, seven years later, did the PBoC reform, this time under the watch of the fourth governor, Chen Xiyu.
Chinas financial system has changed out of all proportion since then, but one parallel remains: the identity of those pulling the levers behind the scenes. In the 1960s, power lay squarely in the hands of Mao Zedong. By the second decade of the third millennium, the power had been spread, but thickly, and only within the claustrophobic confines of the Chinese Communist party.
Those who run Chinas leading banks the chairmen and chief executive officers in the higher party echelons do so only in name. The real power lies with the nine-man Standing Committee, headed by president (and party general secretary) Hu Jintao, and a cabal of 370 old men comprising the Central Committee. When these two bodies tell the banks to jump, they jump. And when they tell their banks to lend, they lend.
So when Beijing, fearing that a global recession would cause upheaval and riots at home, announced a $600 billion fiscal stimulus package in November 2008, party leaders fulfilled their promise of not dipping into the countrys $2.4 trillion foreign reserves, by telling their pet banks to lend heavily.
The banks acquiesced, disbursing an avalanche of loans to leading state-owned enterprises (SOEs), local municipal authorities, and major domestic infrastructure companies, many of them divisions of the countrys 1,407 city councils.
Leading lenders such as Industrial and Commercial Bank of China (ICBC) and Bank of China (BOC) banks also answerable, in theory, to a coterie of global investors shelled out $1.4 trillion in new loans in 2009. They are on track to disburse a further $1.1 trillion this year and $800 billion in 2011 more capital lent by any countrys banking sector in recorded history.
Two disturbing consequences follow upon Chinas lending binge. The first is a pressing need among lenders to shore up their eroded capital base. The other is more worrying and inevitable: a likely new surge in non-performing loans (NPLs) that will stretch Chinas generous state finances to the limit.
Despite posting brisk profits for the full year 2009, the countrys banks desperately need capital. Directed by party leaders in Beijing, they spent the first quarter of 2010 tapping the Shanghai and Hong Kong markets. In March, Merchants Bank, widely regarded as the countrys best-managed lender, raised Rmb18 billion ($2.63 billion) from mainland investors via Shanghai; the bank is also seeking to raise Rmb4 billion from investors in Hong Kong.
By end-April, two more lenders are expected to have raised fresh capital. Bank of Communications (BoCom) has applied to raise up to Rmb42 billion in Shanghai and Hong Kong, while China Construction Bank, the countrys third-largest lender, is planning to bolster its capital base by selling Rmb75 billion of shares, also in the countrys twin financial centres.
Even ICBC, Chinas largest bank by assets, is seeking to raise cash, by selling around Rmb25 billion of bonds convertible into yuan-denominated A shares in Shanghai.
Analysts are mixed on Chinas dash to raise cash leading banks need a shot of capital to restore eroded balance sheets, but it also underscores the aggressive lending policies pursued by leading mainland lenders in 2009, and highlights the rigidity with which they remain controlled by the party.
Banks can raise capital in New York or London in the most troubling environment, but in China the CSRC, the countrys securities regulator, halts any capital raising when it gets worried, says Bill Stacey, a director at Hong Kong brokerage Aviate Global. Chinas banks arent allowed to go to market when they want, or to allow their rights issues to be underwritten. China has to loosen up the strings here they will hate it as it undermines their power and their patronage, but they have to give the banks more autonomy.
All the while, Chinas forgotten bank bides its time, waiting for the chance to tap domestic and global capital markets for the first time: Agricultural Bank of China (ABC), the last of the big four lenders to sell shares to the public, is hoping to complete a $2030 billion initial public offering (IPO), probably in Shanghai and Hong Kong, once its rivals have raised enough cash to tide them over.
Reginaldo Cariaso, executive director, equity capital markets, Asia ex-Japan at Nomura says: Agricultural Bank of China is the big IPO from China that everyone is waiting for over the next 1215 months.
Chinas looming NPL crisis is, however, of far greater concern. The countrys banks have wiped sour loans off their books twice before, in 199899 and again in 200405. But this time it is different. On the previous occasions, leading Chinese banks were wholly state-run organs; now they are listed institutions with foreign shareholders, subject (in theory) to higher levels of scrutiny and transparency.
Moreover, the party has never subjected its banks to such a stress test. Much of the lending during 2009 was parcelled out in a slapdash fashion to local city councils and state firms, which in turn pumped cash into local vanity projects likely to generate little substantive return.
Thus, NPL rates could be even higher than the bad loans pumped into state projects in the 1990s, much of which simply lined the pockets of party officials. Some analysts reckon up to one-half of all new 2009 and 2010 bank loans will go sour, costing the state between $1 trillion and $1.5 trillion, a bill that would shred Beijings foreign reserves.
Analysts are mixed over how bad the NPL situation will become. Anthony Lok, managing director, research at BOCI International in Hong Kong, believes the situation is manageable. Loans grew at a steady rate throughout the 2000s, he says. The only difference came in 2009, when China had a total loan blowout. But one year of excess spending does not make a bubble. The situation is not as bad as some people are making out.
Arthur Kroeber, managing director of Beijing-based consultancy Dragonomics says: An NPL problem is brewing. Of the loans made between 2008 and the end of 2010, one dollar in six will turn into a bad loan that is beyond the banks ability to mark down internally.
The question is whether it is financeable and I believe the answer is yes, he says. But this only works if between 2011 and 2020 China doesnt create any more bad loans or at least it only creates new bad loans that can be provisioned against.
Kroeber believes the most compelling question is whether China can wean itself off an almost unique process of boom-and-bust. Will China stop doing this? If they dont, then in 10 to 15 years time China will look much as Japan does today, full of awful debts that cant be dealt with. I am more optimistic here, as China has a much better track record than Japan at facing up to problems. But they certainly need to work out how to do things better in the future.
Others are concerned at the impact that higher lending will have on Chinas lesser lenders, those who have disbursed loans to second-rate infrastructure projects over the past 18 months.
Gao Jian, vice governor at China Development Bank, the countrys chief policy lender and one of the countrys best-run institutions, says he is most concerned about the impact on Chinas smaller banks. Rising NPLs will hit smaller lenders, he says. We have seen this situation in the past with NPLs, though there are some economists based in Hong Kong who have forecast substantial increases in NPLs in coming years, but I dont think that will happen.
Others arent so sure. Victor Shih, an assistant professor at Northwestern University in the US, rose to notoriety in early 2010 after calculating local Chinese government debt at around $1.7 trillion twice the official estimate and one-third of Chinese GDP. The rise, he said, was largely due to vast quantities of capital pumped into city authorities and SOEs by profligate banks banks that will come to regret their largesse.
There is a lot of de facto bad loans that are being rolled over by banks, he says. Besides special mention loans troubled loans marked down as failing rather than failed one can look for how many short-term loans are being extended as medium- and long-term loans. This suggests that many problematic loans are being extended.
Party leaders in Beijing are already kicking up a fuss about wayward bank lending, and seeking to rein in credit growth. But the truth is this is what the country does.
China may not be under Maos thumb any more, but for the countrys leading banks now sucking in capital from local and foreign markets while toiling under a burden of new bad loans, both legacies of Communist party edict the world is surprisingly similar to the 1960s, and the dog days of Hu Lijiao.