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Chinese Banking

Cleanup Begins for a Chinese City Flooded With Bad Debt

The Lucheng District of Wenzhou, Zhejiang Province, China

Photograph by Qilai Shen/Bloomberg

The Lucheng District of Wenzhou, Zhejiang Province, China

Is Wenzhou a bellwether for China’s increasingly fragile financial sector? That’s a newly pertinent question as the coastal city, hard-hit by last year’s collapse in informal banking, launches a bad-debt workout.

About 100 judges have been assigned to clean up Wenzhou’s troubled financial sector, starting next month. The city’s nonperforming loans have almost tripled, growing from 8.6 billion yuan ($1.38 billion) in 2011 to 23.86 billion yuan ($3.8 billion), the China News Service reported on Feb. 27. Wenzhou will order its judges to help those companies that have better business prospects and shutter enterprises that are energy-inefficient and heavily polluting, the report said.

Wenzhou, with a population of 9 million, is home to thousands of private, mostly export-oriented enterprises, and almost 90 percent of families there have participated in underground lending. More than 100 managers or heads of private companies “disappeared,” declared bankruptcy, or committed suicide last year, the Xinhua News Agency reported. Already, 800 credit brokers have been shut down.

It’s not just Wenzhou. Dating from when Beijing unleashed a massive, nationwide stimulus to counter the impact of the 2008 global financial crisis, China is awash in questionable credit. State-owned banks pumped cheap money into the economy, much of it going to state-owned enterprises that invested in dubious projects, including speculative real estate. State-owned firms set up finance arms, and banks created separate finance subsidiaries. Those units turned around and lent credit at much higher rates or created “wealth management products,” promising high returns with the intention of luring even more money from investors.

Most of the gray-market activity in Wenzhou was for short-term loans made by local business associations, pawn shops, and underground banks. Those outfits, operating without official licenses, charged interest rates as high as 6 percent a month or 300 percent a year. Even in the best of times, private—often family-run—companies struggle to get credit from official banks. When the credit crunch hit last year, they also were squeezed by the global economic downturn and rising land and labor costs at home.

Chinese banking assets grew by almost $14 trillion from 2008 to 2013, Fitch Ratings estimated last year. (Fitch also includes in its estimate loans issued by the informal banking sector and offshore banks—data not included in Beijing’s official figures). “This is equivalent to replicating the entire U.S. commercial banking sector in just five years,” said Charlene Chu, head of Chinese bank ratings at Fitch, in a note on Nov. 8. “Rising leverage either will swamp borrowers’ ability to repay, or banks’ funding and capital needs will fall short of existing resources,” wrote Chu.

What comes next? Likely, more bad bank loans. Standard & Poor’s (MHP) has predicted that the portion of nonperforming loans could grow from about 2 percent of total bank lending at the end of 2011 to 5 percent by the end of this year. The financial stresses might crimp growth, particularly as China’s new leaders, Party Secretary Xi Jinping and his No. 2, Li Keqiang, have pledged to stress quality over quantity in the country’s economy. China grew 7.8 percent last year, its slowest pace in 13 years. At the upcoming National People’s Congress, opening on March 5, China is expected to keep a target of 7.5 percent growth this year, Bloomberg News reported in December.

“In the future, the central government may look at more indicators, including pollution and debt, in assessing local officials,” said Zhang Zhiwei, chief China economist at Nomura (NMR), in an interview with Bloomberg News on Nov. 27. “You can’t continue the traditional way of accumulating heavy debts to push up GDP in your term and then leave the trouble to your successor.”

The origin of much of the new lending is also a concern. “The fact that much of the extra expansion [in China’s economy over the last half year] has come from non-loan credit [including banks’ bond purchases, off-balance-sheet credit, and trust loans] points to what we consider a high-probability risk to China’s economy this year: economic volatility led by liquidity tightening related to unwinding of some shadow banking activities,” warned Tao Wang, head of China economic research at UBS Securities (UBS) in Hong Kong, in a note on Feb. 26.

Roberts is Bloomberg Businessweek's Asia News Editor and China bureau chief. Follow him on Twitter @dtiffroberts.

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