China Implements New Regional Debt Rule to Prevent Financial Risk

Posted on February 22, 2013 at 6:02 PM

To further stabilize its financial system and prevent risks from spilling over,chinese-flag_13467891the Chinese government is moving towards segregating soured loans at the regional level from national debt disposal. In an attempt to address risks, China is clarifying its so far inefficient debt rules regarding their treatment of national and local debt. This is a clear attempt at rectify the financial risks posed by China’s previous state-directed approach to 10.7 trillion yuan ($1.7 trillion) in bad debts brought upon by local governments. Beginning in 2008, amidst the global financial crisis, Chinese local governments borrowed up to 4 trillion yuan from Beijing in order to fund their economic stimulus plans.

The move will prevent regional asset management firms from buying non- performing loans from giant state banks. Instead, provincial firms may only buy bad debts and non-performing assets from local financial institutions that do not have nationwide businesses. The nation’s Ministry of Finance and the Banking Regulatory Commission had jointly issued a circular to restrict regional asset management firms. China’s four giant asset managers, Huarong, Cinda, Great Wall, and Orient Asset Management Corp, will be allowed to buy the NPLs of national financial institutions. Set up by Beijing in 1999 to remove over 1.4 trillion yuan’s worth of bad loans from top lenders, these four juggernauts will take control of bad debt on a national level.

Yet, the move is met with somewhat of a mixed reaction from analysts, who remain skeptical of the measures’ effectiveness without reasonable fiscal arrangements. Senior analysts at the Chinese Academy of Social Sciences noted the difficulty local governments face when they try to find a solid capital channel to establish regional asset management firms without state-led efforts. Since local lenders, including urban commercial banks, make up less than 10 percent of the total market, many are concerned that setting up new management firms at the local level will lead to institutional redundancy and low efficiency, as their restricted power will make operation difficult. Instead, analysts are suggesting market-oriented reform of current asset management firms and increased cooperation between local governments and national firms.

Nevertheless, China’s new debt measures may prove to be a step in the right direction. Local firms’ prolonged dependence on national banks threatens financial stability. If one lender in a region fails, others are likely to follow. In December, for example, the local government was forced to intervene when a credit co-operative in Jiangsu found itself unable to pay back savers. Since regional authorities have a better understanding of local companies and credit providers, separating national and local debt disposal might prove to be a better solution in the long run. Beijing is also in the process of setting up local bailout funds, providing added security against risks posed by sour loans at the local level.

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