Finance

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

If you haven't yet, it's time to start looking at all those overdue loans on the balance sheets of Chinese banks.

Five of the world's biggest lenders are set to release quarterly results this week. For investors, that's a good chance to get a handle on the rise in nonperforming loans that can be expected if new banking rules, outlined earlier this month, come into effect.

On April 14, the Basel Committee on Banking Supervision asked for comments on a set of guidelines that could change the way banks account for soured debt, the idea being to standardize the definition of credit that's in danger of not getting paid. People have until July 15 to respond, after which Basel would review feedback and eventually publish recommendations that banks globally are expected to follow.

Among other things, the potential rule would classify any loans that are overdue by more than 90 days as nonperforming. It would also force lenders to continue considering advances as soured even if they've made concessions to avoid the borrower tipping into bankruptcy. Finally, financial institutions will have to consider all their exposure to a company as having gone bad if the company in question misses a payment on any of its dues.

It's hard to quantify exactly how much that would increase the reported nonperforming loans for Chinese banks, but it would be significant.

Currently, banks put loans in any of five baskets established by the China Banking Regulatory Commission -- pass, special mention, substandard, doubtful and loss. The system emulates what's used in the U.S. and takes into account a borrower's financial condition, cash flow and collateral. It also considers how long loans have gone unpaid. 

While the regulation's sturdy, as in the U.S., banks have a lot of discretion when it comes to whether a loan is placed in the special mention basket or the nonperforming one, which comprises of substandard, doubtful and loss. The new Basel rules would consider anything that hasn't been paid for 90 days as nonperforming, period. That could mean a lot of debt in the special mention category would move to nonperforming, a category that's already growing very fast.

Take a look at the aggregate special mention figures for Agricultural Bank of China, Bank of China, Bank of Communications, China Construction Bank and Industrial & Commercial Bank of China:

Singled Out
China's five biggest banks have seen the amount of loans in trouble, but still performing, almost double
Source: Company filings

And now what the bad-debt ratio for China's five biggest lenders would look like if special mention loans were moved to the nonperforming basket:

Dimmer Picture
Once loans that are in trouble but still performing are included, the problem looks a lot more serious
Source: Company filings
* Data refers to China's five biggest banks.

Basel has another surprise, too. Every time a bank restructures a bad loan, it will no longer have an option to consider that debt as performing again. According to Bank of China's annual report:

``All rescheduled loans are subject to a surveillance period of six months. During the surveillance period, rescheduled loans remain as nonperforming loans and the group monitors the borrower's business operations and loan repayment patterns. After the surveillance period, rescheduled loans may be upgraded to ``special-mention'' upon review if certain criteria are met.''

Not anymore. 

Finally, the proposed regulations could change the way banks look at various loans to a group.

At the moment, there's some leeway in terms of which facilities are considered nonperforming and which aren't. So if, for example, a company is paying its loans but hasn't been topping up the overdraft, the latter may go into the soured basket while the former would not. That could cease, as the Basel guidelines state.

``In the case of exposures to a non-retail counterparty where the bank has more than one exposure to that counterparty, the bank must consider all exposures to that counterparty as nonperforming when any one of the exposures is nonperforming. In other words, nonperforming status should be applied at the level of the counterparty.'' 

In a country such as China, which is dominated by large conglomerates, that rule alone could boost nonperforming loans a lot.

As China's banks update the market this week, investors should pay close attention to special mention and overdue debt. If global regulators have their way, a good part of that may soon be shifting home.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net