China's Debt to equities swap - a bigger risk for banks?

The percentage of bad loans as a total held by China’s banks is likely to more than treble in the next two years because growth in the world’s second-largest economy is slowing. China’s economy grew at a 25-year low of 6.9 per cent last year. The government’s 13th five-year plan anticipates average annual growth of 6.5 per cent.

According to official figures, bad debt in Chinese banks climbed 51% in the past year to CNY1.27tn (USD195bn). This is the highest level since June-2006. China’s non-financial companies have amassed a lot of debt, to the tune of 160% of the GDP. China commercial banks’ non-performing loans rose by about 45% from a year ago to almost 1.4 trillion yuan as of the end of February.

Last month China's central bank decided to draw up regulations to allow commercial lenders to swap non-performing loans of companies for stakes in those firms. The programme could reduce commercial banks' non-performing loans, which surged to 1.27 trillion yuan at the end of 2015.

There were reports yesterday that the debt-to-equity swap plan could be implemented as early as this month. However, there are still few details on the size or the way it’ll be implemented. The news highlights the government's urgency to address the surge in leverage in recent years and rising bad debt to mitigate the financial risks.

Analysts believe that moves to ease bad loan burdens at China's big banks may be of only marginal help in the near term. It will reduce banks' capacity for new lending to stronger borrowers.

“Debt to equities swap is a bigger risk for banks,” Castor Pang Wai-sun, Core Pacific Yamaichi head of research said. “It will prettify financial books in the short run but the banks will still be left holding stocks in firms that face difficulties.” he added.