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Wednesday, 01 June 2016

Neighbourhood watch

China’s next debt crisis will be a local affair

China’s next credit crisis may be a local affair. A recent suggestion of setting up local bailout funds reflects the fact that it’s no longer big banks that present the biggest risks, but towns and regions. The elaborate ties between local borrowers, lenders and governments could make future credit problems both chaotic - and concentrated.

China’s credit growth has been moving away from big national banks in recent years. While large lenders account for over half of total loans, only 37 percent of total credit growth in 2012 came from bank credit. An equal amount, for example, came from “entrusted” loans, where companies lend to other companies - often suppliers or customers with local links.

Local lending can involve multiple players. City-level banks and smaller rural co-operatives often bring in “guarantee companies” - of which China has over 8,000 licensed to back loans. Others settle for less formal assurances. Wenzhou, a city famous for its entrepreneurs, emerged as a hotbed of cross-company guarantees and high-rate loans in 2011.

Governments themselves rely on local funding, too. Just under $1.5 trillion of local government loans were outstanding at the end of 2012, according to the chief bank regulator. While national banks have taken their share, the quality of loans may diminish with the size of the lender. Officials can too easily bully local banks by threatening to take official deposits elsewhere.

The result is that the if one lender in a region fails, others are likely to follow. Local governments have gone out of their way to avoid corporate bond defaults, most likely for fear they may be cut off from the market, too. In December, the local government stepped in after a rural credit co-operative in the manufacturing heartland of Jiangsu found itself unable to pay back savers.

An idea of setting up local bailout funds, first floated by the Ministry of Finance and bank regulator a year ago, is a step in the right direction. Regional governments have a better chance of understanding the linkages between companies and credit providers. But they would need to act quickly: if loans go bad, a lack of confidence won’t stay local for long.

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China’s government is moving to separate local and national bad loans through the creation of local-level debt disposal vehicles, Reuters reported on Feb. 18. It cited a joint circular that would set terms for the establishment of provincial “asset management firms”.

The Ministry of Finance and China Banking Regulatory Commission proposed in February 2012 to allow provincial governments to set up such companies to deal with bad loans at a local level. Presently, China has four national asset management companies that can buy bad loans directly from banks.

The ministry and CBRC had still not formally issued a document or decided on the exact conditions for local asset management companies, First Financial Daily reported on Feb. 20, citing sources close to the regulator.

Local governments had total outstanding loans of 9.2 trillion yuan ($1.5 trillion) at the end of 2012, according to the CBRC. While provincial governments with a few exceptions cannot directly take on debt themselves, many have instead raised funds through financing platforms designed to get around such restrictions.

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