Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

China's zombie companies can rest easy. It's a shame the same can't be said for investors in the nation's banks.

The big five lenders, starting with Agricultural Bank of China Ltd., plan to set up bad banks that will convert soured debt to equity.

Agricultural Bank, Industrial & Commercial Bank of China Ltd., Bank of China Ltd., China Construction Bank Corp. and Bank of Communications Co. will fork out 10 billion yuan ($1.5 billion) each to establish the asset-management companies, Caixin magazine reported.

Inching Up
China's nonperforming loans are starting to rise again
Source: Bloomberg

That banks are forging ahead with debt-to-equity swap plans, albeit via asset-management firms they happen to own, is great news for all those struggling steel and construction companies facing potential closure.

State Council guidelines issued last month indicate that zombie corporations -- those ailing state firms plagued by overcapacity -- can't count on bailouts, but it's difficult to determine which ones are actually destined for the scrapheap.

The nation's top lenders, also all backed by Beijing, are unlikely to want to be seen as responsible for mass unemployment by refusing to rescue companies, no matter how dire their situation. In fact, those companies may have an even better chance of getting capital infusions, considering financial institutions will probably be keen to use their investment-banking units to help monetize equity assets.

On the face of it, bank investors might also feel relieved that lenders are farming out bad debt to distinct vehicles.

Using an asset-management company should ensure that the equity resulting from the bad-debt switch doesn't sit on a bank's balance sheet. That will help lenders conserve precious capital: Had the equity been on their books, they would have had to apply a risk weighting of 400 percent, and get special approval from the State Council. Structuring it this way will also allow banks to maintain their much-coveted dividends.

Taper Time
Chinese bank shares have surged but are coming off recent highs
Source: Bloomberg

But dig a bit deeper and you realize this isn't a scenario that will necessarily play out well, and not just because equity stakes, even those held at arm's length, are inherently riskier than loans.

For one, how will these asset-management firms be funded long term? The answer is probably by the banks themselves.

According to the State Council, the debt-to-equity swaps can be financed by "social capital," a catch-all phrase that generally includes high-yielding wealth-management products. Those investment structures come with an implicit guarantee from the banks that issue them, as lenders have found in the past when they've had to rescue funds in trouble. It's ironic that just as authorities have been trying to rein in shadow banking, the debt-to-equity swap plan provides an added reason to gorge.

Whichever way you cut it, Chinese lenders -- and their shareholders -- will remain on the hook. Investors have already begun shying away from the big banks. Creating a whole host of asset-management companies may hasten the retreat.

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

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Nisha Gopalan in Hong Kong at

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Katrina Nicholas at