Is “Bad Debt” (Only) Piling Up in China?


After the (in)famous Great Recession of 2007-2008, the average observer started paying more and more attention to the banking system. Why? Simply because the Great Recession made it clear that there are visible cracks in the financial system, anything from a quasi-incestuous relationship between the financial system and the banking system to issues pertaining to the banking system itself, for example non-performing loans.

Even more so, the very stability of the financial system in general and banking system in particular ended up being questioned, a stability which was considered beyond dispute by the average citizen let’s say two decades ago. While China was without a doubt affected by the Great Recession (for a more detailed perspective, we’d recommend reading our article about China during the Great Recession by clicking HERE if you haven’t by now) as well, it was most definitely not the star of the proverbial show… not by a long shot.

Who was?

First and foremost, the United States, the epicenter of the Great Recession. To be more specific, it was precisely US bad debt which ended up causing the near-implosion of the banking and ultimately financial system. Simply put, everyone believed real estate could only go up and that as such, mortgages were bullet-proof. As a result, banks ended up lending money more and more recklessly, which culminated with the widespread practice of handing out so-called NINJA loans (No Income, No Jobs or Assets) to anyone with a pulse.

Not only that, a more than questionable relationship between the banking and financial system started manifesting itself, which led to banking being essentially re-defined: it was no longer a situation in which Person A borrowed money from Bank A and would pay that money back over a period of many years. All of a sudden, Person A did indeed borrow money from Bank A but that bank then quickly packaged that loan and sold it to financial market investors. As such, banks quickly let’s say washed their hands of the loans they handed out, which created a moral hazard or “hot potato” situation in which banks issued loans, bankers received stellar bonuses and then the same bank got rid of the loan in question, with it becoming someone else’s problem. To make matters worse, multiple loans were packaged together as so-called Mortgage-Backed Securities (MBS), oftentimes solid loans together with ultra-risky loans… still, rating agencies awarded excellent ratings and everyone thought nothing wrong could possibly happen.

Unfortunately, they were (grossly) mistaken.

As bad debt started piling up in the US, this created a ripple effect throughout anything from the banking system which gave out loans to the insurance system which just as recklessly insured them as if they were close to 100% safe instruments. Banks, insurance companies and even auto companies ended up having to be bailed out, with the crisis spreading to other jurisdictions as well.

Over in the European Union, a full-fledged sovereign debt crisis emerged, especially in the so-called PIIGS nations (Portugal, Italy, Ireland, Greece and Spain) and led to banking concerns that would even persist into 2013, when the (in)famous Cyprus banking crisis occurred. The same way, jurisdiction after jurisdiction felt the effects of the Great Recession (and is still feeling them to this day in one way or another), including:

Yes, China.

While the Great Recession-related specifics were covered in the previously mentioned article, bad debt concerns remain valid in the present. For example, the fact that non-performing loans grew by approximately 10% during the first semester of 2019, to approximately 2.24 trillion CNY (over $300 billion). If we also include sub-performing loans in the equation (roughly 3.63 trillion CNY), we end up drawing the line and realizing that approximately 5% of loans are close to default or already in default over in China.

As always, the less economically-developed regions of China are the most affected entities and while 5% doesn’t exactly sound like something that spells the end of the (financial) world as we know it, we need to understand that we are currently in record-breaking territory when it comes to the time we have had between recessions on a worldwide basis. In other words, it isn’t the percentage itself but rather the fact that it comes after a period of (seemingly or allegedly) unprecedented prosperity. If that were to change as a result of let’s say a global financial crisis such as the Great Recession, then as explained in previous articles, China would be affected more so than Western nations due to being perceived as a risk-on rather than risk-off (or safe haven) entity.

Fortunately, the problem seems to be on Xi Jinping’s radar and measures have indeed been taken. For example, the fact that in 2018, publicly traded banks got rid of over 700 billion CNY of proverbial bad debt, with the figure in question possibly being in 1 trillion CNY territory for the banking system as a whole.

Furthermore, the top 4 state-owned mega-banks experienced a net profit increase north of 4%, with the industry average being even higher, approximately 7% based on the results which have been announced on the 30th of August 2019.

Should bad debt be considered problematic?

In our opinion, due to the current global politico-economic context, yes. Had we been analyzing these figures right after a financial crash, our team would have been more at ease. In light of the fact that the opposite is true at this point, “caution” is the operative word and should you be in need of assistance with anything from hedging to putting together a post-crisis acquisition plan, the team is at your disposal.

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