CHINESE BANKS: WILL THE 2009 CREDIT BINGE COME

C O N F I D E N T I A L SECTION 01 OF 02 BEIJING 000357

SIPDIS

STATE FOR E, EAP, EAP/CM
TREASURY FOR OASIA/DOHNER/WINSHIP AND LOEVINGER
NSC FOR LOI
STATE PASS USTR

E.O. 12958: DECL: 02/10/2035
TAGS: CH ECON EFIN PGOV PREL
SUBJECT: CHINESE BANKS: WILL THE 2009 CREDIT BINGE COME
BACK TO HAUNT?

REF: BEIJING 292

Classified By: Economic Minister Counselor William Weinstein; reasons 1
.4 (b, d)


1. (C) Summary. New loan issuance by Chinese banks in
January totaled RMB 1.6 trillion (USD 235 billion),nearly
equal to last year's record pace of RMB 1.62 trillion, and
would have been even larger if regulators had not intervened
mid-month to curtail lending. In public, Chinese financial
officials remain confident that the 2009 credit surge will
not lead to a resurgence of non-performing loans (NPLs) that
could undermine the banking sector. On February 2, however,
Fitch Ratings downgraded its assessments of China Merchants
Bank and China CITIC Bank due to capital depletion and rising
credit risk. Fitch also remains concerned about the accuracy
of China's banking data. The IMF Beijing office, while not
disputing Fitch's assessment, believes there is no systemic
risk in sight, and that the Chinese Government has the
resources and will to address any NPL problem that might
arise. End Summary.


2. (C) Comment. We agree with both Fitch -- about future NPL
problems in some Chinese banks -- and the IMF -- that the
Government is ready and willing to address quickly and firmly
any bank problems that might emerge. Chinese banking
regulators are proud of the progress they and their banks
have made over the past decade, and will do everything within
their power to prevent a return to the "bad old days" of
massive NPLs. However, if the government is forced sometime
in the next five years to expend significant resources for
bailing out banks, then the negative consequences could be
considerable: damaged public and investor confidence in the
banks, the regulators, and the government; rising fiscal
deficits; slower economic growth for China and its trading
partners; and reduction of funds available for expansion of
much-needed social welfare programs that promote domestic
consumption and economic rebalancing. End Comment.

The Surge Continues
--------------


3. (SBU) On February 1, Chinese official media reported that
new loan issuance by Chinese banks in January totaled RMB 1.6
trillion (USD 235 billion),nearly equal to last year's
record pace of RMB 1.62 trillion. That number, however,
could have been even larger had not authorities slowed the
pace of lending sharply in the last ten days of January. As
of January 19, banks already had extended loans totaling RMB
1.45 trillion, but then were pressured by regulators to slow
the pace and even to recall some loans already extended.
Several large banks reportedly stopped new loan issuance
during the last few days of January, and the China Banking
Regulatory Commission (CBRC) instructed a few of the biggest
lenders to increase their required capital reserve ratios.
(Note: China's official "target" for 2010 lending is RMB 7.5
trillion, down from RMB 9.6 trillion last year, although
officials describe that number as a "ballpark goal" or even a
"floor" for lending. End note.)


4. (SBU) In public, Chinese financial officials including
CBRC Chairman Liu Mingkang remain confident that the 2009
credit surge, now extending into 2010, will not lead to a
resurgence of non-performing loans (NPLs) that could
undermine the banking sector. They note that the overall NPL
rate has fallen precipitously, from as high as 50 percent in
the mid-1990s and 17.9 percent in 2003, to just 1.58 percent
at the end of last year. Most outside observers concede that
the position of Chinese banks has improved enormously over
the past ten years.

Problems on the Horizon
--------------


5. (C) On February 2, however, Fitch Ratings downgraded its
assessments of China Merchants Bank and China CITIC Bank from
"C/D" to "D", bringing those banks' ratings into line with
other Chinese banks. Fitch cited the two banks' capital
depletion and "rising on- and off-balance-sheet credit risk
in the wake of last year's very rapid loan growth." It also
reported that Chinese banks in general appear to be carrying
additional, hidden credit risk from unreported loan sales:
China Merchants and China CITIC specifically have been most
active in packaging loans into "wealth management" products

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for sale to investors. According to Fitch, purchasers of
these products sometimes receive little or no information
about the quality of the actual loans.


6. (C) Fitch's Beijing representative on February 3 told us
her credit rating agency was very concerned about the
continuing flow of new lending by many Chinese banks, and
also was not entirely convinced that China's published NPL
numbers are accurate. She described a non-transparent
"lending culture" in the banks that encourages loan officers
to lend but discourages them from truthfully reporting loan
failures. The Fitch representative said Chinese banks over
the past year have issued large volumes of "bullet loans,"
for which the borrower pays only interest for several years
until the principal comes due, at which time the lenders
often "roll over" the loan to avoid having to list it as
non-performing. Finally, she cited anecdotal evidence in the
form of numerous vacant and/or unfinished real estate
development projects in every major Chinese city as
indicative of a larger potential NPL problem.

IMF: No Systemic Risk
--------------


7. (C) IMF resident representative Tarhan Feyzioglu told us
on February 4 that, although he did not dispute Fitch's
description of the problems within individual banks, he was
less concerned about a resurgence of NPLs. He said the IMF's
view was that NPLs might be a medium term problem (i.e., 2-5
years),but both the short-term and long-term outlooks for
the banking system as well as the overall economy were
healthy. Even if the aggregate NPL rate increased
significantly, and/or some individual banks encountered
serious problems, he did not see any real systemic risk on
the horizon. Also, with some USD 2.4 trillion in foreign
exchange reserves and a generally healthy fiscal situation,
Feyzioglu believed the central government had more than
sufficient resources available to clean up any NPL problem
that might arise.
HUNTSMAN