For Asia's Bad Banks, It's Pay Up Time

Easy money has long fueled Big Business. Now, a huge bill is coming due

Only a few years ago, the elite financiers running Asia's cloistered banking business led a charmed life. The stunning economic expansion and robust stock and property markets of the late 1980s meant giddy times for the bank presidents of Tokyo's Ohtemachi financial district. And from Jakarta's Jalan Sudirman financial strip to the concrete canyons of Seoul, lenders prospered amid seemingly endless demand for high-rise offices and flashy condos. The last thing anyone worried about then was what Long-Term Credit Bank of Japan Ltd. President Katsunobu Onogi wistfully calls the "preciousness of capital."

Well, guess what? Capital sure is precious now. Japan's banking system hit the wall when equity and property prices began collapsing in 1990, and it has been struggling to recover ever since. But now the malady is spreading to the rest of East Asia. From Seoul and Tokyo to Taipei and Bangkok, lenders have run up an estimated $660 billion in nonperforming loans to overextended real estate developers, money-losing state enterprises, and politically connected corporate deadbeats.

Fixing this mess could take years and cost hundreds of billions of dollars, if not more. Much of Asian banking is caught in a time warp: Despite mounting competition and risks, some bankers still think their business remains a sure thing. But if the current problems are allowed to fester, Asia's banks could be trapped with bad loans weakening their capital bases. That would severely crimp their ability to make new loans.

That kind of credit squeeze could push some of the world's most dynamic countries into an economic slump. "This is important," cautions Citicorp Vice-Chairman William R. Rhodes, who believes that emerging economies need healthy banks to help channel global investment capital and turn it into growth. "Banking system fundamentals have to be strong to support the flows," he says.

Bureaucrats and bankers in Hong Kong and Singapore, where banking systems remain rock solid, understand this maxim fully, which is why both should continue to prosper as regional financial hubs while competitors struggle with problem banks. Asia also boasts the highest savings rates in the world--and that will buy time for many banks. Yet that advantage is for naught when vast sums are channeled into money-losing state ventures--as in China--or to leaders' cronies and relatives, the way business is done in President Suharto's Indonesia.

For years, bankers worried more about getting big than staying profitable. State-directed lending has left price-sensitive commodity industries such as memory chips, electronics, and chemicals overbuilt and, in some cases, losing money. Technocrats in Taiwan, Indonesia, and Thailand may rue decisions to let construction and real estate speculation represent a third or more of their economic output in recent years.

PET PROJECTS. As a result, vast tracts of apartment blocks on the outskirts of Bangkok are collecting dust, as well as bills for overdue interest. Taiwan's port city of Kaohsiung has a glut of office and residential space, and China's Pearl River Delta has ended up with too many airports, container ship terminals, and half-finished commercial buildings. But as bankers try to cope with these new realities, the people who really need capital--entrepreneurs who create jobs--are facing a financial squeeze as nervous bankers give them short shrift. South Korean and Thai borrowers, for example, pay interest rates well above world rates because of their countries' inefficient, accident-prone financial systems.

Asia's bad-debt overhang is the darker side of the region's economic miracle. For decades, Asia thrived amid centralized economic planning that promoted the accumulation of savings and relied on technocrats to allocate capital efficiently. With competition held down, financial regulators could easily pressure domestic lenders into pumping money into pet projects. The regulators had little regard for profitability. Now, the bill for years of easy credit is coming due.

The biggest financial sinkhole, of course, is Japan, where bankers are in the fifth year of a battle with a stagnant economy. Collapsing equity and property prices have left them with at least $350 billion in bad loans. With this mountain of bad debt, banks have all but ceased lending at home, thwarting efforts by the Ministry of Finance and Bank of Japan to boost the economy with massive amounts of cheap money and public-works spending. The crisis may overwhelm Nippon Credit Bank Ltd., one of Japan's top 20 lenders with $132.4 billion in assets and $10 billion in bad debts. Markets were rocked in February by rumors the bank's nonperforming loans threaten its survival. The bank denies the reports.

In South Korea, the collapse in January of the Hanbo Group, a steel and construction conglomerate with close ties to two state-run banks, is shaking banking circles. American International Group Inc. Chairman Maurice R. Greenberg figures neither country will be able to escape from its problems without resorting to a rescue similar to the $1 trillion Resolution Trust Corp. cleanup of failed savings-and-loans in the U.S. Says Greenberg: "They can't just cover their problems up or deal with them with a Band-Aid."

Indeed, Asian policymakers generally acknowledge that their financial-services industry needs repair, although they lean more toward gradual deregulation than to outright bailouts. Malaysia, for example, has built a bond market to give corporations new ways to raise funds, and Thailand is slowly handing out licenses for new banks. Taiwan may privatize seven provincially owned banks. Japanese Prime Minister Ryutaro Hashimoto is pushing a "big bang" plan to allow, among other things, greater competition among banks and brokers. And South Korean President Kim Young Sam has launched a reform commission, recognizing that years of lax management and government protection has taken a toll.

CASH DRAIN. Kim also proposed financial reforms four years ago, only to see them wither, and there's no certainty they will be enacted this time. In fact, kicking the government out of lending decisions is a "hard habit to break," concedes Sohn Byung-doo, an adviser to South Korean President Kim Young Sam and vice-president of the Korea Economic Research Institute in Seoul. But some governments probably have little choice. Economic success stories brought billions of dollars in foreign investment in Asia's stock markets and currencies. If the region's woes worsen, fund managers might flee Thailand and Indonesia, which are dependent on foreign capital inflows as current-account deficits have exploded.

Whatever the reason, local and global investors have been dumping Asian bank shares with a vengeance lately (chart), sending many markets reeling. To get banks back on a healthier footing, financial authorities will have to address their problems with more enthusiasm than they currently show. When bad debts started accumulating on Japanese banks' books in in the late 1980s and then hit a crisis point in 1992, the Finance Ministry figured the next economic rebound would trigger a big jump in the Nikkei, boost bank profits, and call an early end to the troubles. But significant economic and stock market recoveries never materialized. By 1995, free-falling stock and property prices had triggered a record number of corporate bankruptcies, forcing banks to frantically sell foreign investments to square their books. Some smaller lenders even went under.

In response, the Bank of Japan slashed short-term interest rates nearly to zero. That helped a bit, as many banks were able to earn a windfall by borrowing cheaply and investing in Japanese government bonds yielding 3%. Nonetheless, the government had to bail out a dozen credit unions, and even had to shut down Hanwa Bank, a midsize lender with $700 million in bad loans.

Still, by last December, a top Finance Ministry banking official felt confident enough to predict that "Japanese financial institutions are getting over the crisis." Truth is, the workout is just entering a different phase: scrutinizing finance affiliates that banks used to funnel billions into property speculation. Finance companies are hurting in the wake of the property-price collapse, and it may cost bankers a staggering $135 billion to assume their debts, estimates analyst J. Brian Waterhouse at HSBC James Capel. One heavily leveraged nonbank lender, Osaka's Nichei Finance Corp., went broke last year with $8.3 billion in liabilities after failing to get several banks to renegotiate their claims. In February, Sakura Bank Ltd. and Nippon Credit Bank refused a request from Apollo Leasing to forgive some $2 billion in debts.

Nippon Credit is making other news. The Finance Ministry is trying to figure out how to shore up the lender, which is saddled with $10.7 billion in bad loans. Unable to sell debentures it uses to finance its business without paying a huge premium, it faces a cash crunch.

Nippon Credit Vice-President Shoji Nishikawa insists the bank has enough cash to get by and will soon announce a big restructuring plan. Indeed, after rumors that Nippon Credit might go under swept the Tokyo stock market in early February, Finance Minister Hiroshi Mitsuzuka went before the Diet to proclaim the government would "firmly support" the top 20 banks. However, many analysts think Mitsuzuka is preparing to guarantee any new debenture offerings by Nippon Credit. He may even stage-manage a merger with Industrial Bank of Japan Ltd. or Fuji Bank Ltd.

As the Japanese lending mess drags on, bankers and regulators in Seoul are scrambling to contain the damage after the recent demise of Hanbo. The steelmaker fell under the weight of $5.8 billion in debt, some 20 times its total equity and six times the combined net profit of Korean banks in 1996. The banks have $11 billion in troubled loans, estimates Hannuri Salomon Securities, and are already operating on the edge of South Korean standards for capital adequacy.

Hanbo's failure raises questions about many Seoul bankers. Those running former state-owned banks still follow bureaucrats' suggestions on lending. Some have received illicit payments to keep feeding loans to the chaebol. On Feb. 5, prosecutors arrested the heads of Korea First Bank and Cho Hung Bank. They allegedly accepted $460,000 in cash apiece, stuffed into instant-noodle boxes, from Hanbo founder Chung Tae Soo to provide loans for a steel project. The bankers have been jailed and have not entered pleas. A ruling party official and an aide to President Kim have also been arrested and charged with taking kickbacks.

What's baffling is that Hanbo, which was also backed by the state-run Korea Development Bank and Korea Exchange Bank, was allowed to invest heavily to expand an overbuilt steel industry. In the wake of the collapse, Korea's central bank pumped $7.1 billion into the financial system to prevent chain-reaction failures among creditors and suppliers.

"DANGEROUS." Thailand's new Prime Minister, Chavalit Yongchaiyudh, has also inherited a first-class banking disaster. Years of go-go development of everything from condos to golf courses left lenders with nonperforming credits that represent roughly 10%, or $15.5 billion, of their loan portfolios. The debt is now equivalent to 9% of Thailand's gross domestic product and is expected to expand in 1997. "It's quite dangerous," says Goldman, Sachs & Co. banking analyst Wanna Matanachai.

Things may get worse. Thailand's currency, the baht, is under attack. Further depreciation would weaken many companies that have borrowed from Thai banks in dollars, to take advantage of lower interest rates, but whose revenues are in baht. After Somprasong Land PLC defaulted on $80 million in Eurobonds, rumors began swirling that one of Thailand's biggest finance companies, Finance One Public Co., might soon hit the skids. The company says it's fine. But concerns over Thailand's banks and currency have prompted investors to hammer Bangkok's stock market to a 54-month low.

Things look positively serene by comparison in Jakarta, where stocks are trading at record highs and leading publicly traded banks are boasting impressive returns on equity of 20% and up. If only the state-owned banks, which account for half of the country's lending, were as healthy. Companies run by friends and relatives of President Suharto have borrowed heavily from the state lenders, and a World Bank study notes that these favored few are among the banks' biggest delinquent clients. The study, issued last year, concludes that nearly 17% of the banks' loans are nonperforming or shaky.

Politicians aren't in a hurry to go after these problem loans. Witness the confusion over the amount of state support extended to the privately owned Bank Pacific. The nation's 12th-largest lender with $975 million in assets, Pacific is now 38% owned by Bank Indonesia, the nation's central bank. Until recently, it was run by the family of 82-year-old Ibnu Sutowo, who founded the national oil company, Pertamina, and was once considered Suharto's equal in political influence. When one of the bank's finance affiliates couldn't make loan payments on a money-losing resort in West Java last year, the government came forward with a $212 million cash infusion and removed Sutowo's daughter as the bank's president. Yet the central bank has never confirmed any help or the extent of Bank Pacific's bad-loan exposure, which may be as high as $876 million. Bank Pacific declines to comment.

Nowhere are banking woes more murky, or potentially as destabilizing, than in China. Official statistics put the amount of nonperforming loans at 25% of state bank portfolios. One estimate prepared for the U.S. Embassy in Beijing says the bad loans could come to $240 billion--a huge 40% of all loans outstanding. It's not hard to understand why the state banks are in such tough shape. Government policies force them to lend at less than their cost of capital. And of all state bank lending, 70% has gone to government-owned companies, about half of which are losing money.

Banks don't want borrowers to go bust; that would threaten their own survival. They want to make companies profitable, through mergers or new managements. But Beijing is starting to get serious about ending the worst excesses in its financial system. In January, the central bank shut down the Agribusiness Development Trust & Investment Corp., one of the country's largest investment companies and biggest property speculators. Some officials have been arrested for embezzlement.

Add it all up and it's clear that many of Asia's banks are neck-deep in the sort of bad-loan problems that have weighed down Japan for years. Too much capital has been squandered on misguided property, industrial, and financial lending. Crunching numbers and assessing risk has never been the hallmark of banking cultures heavily influenced by bureaucrats and corrupt politicians. Yet if Asia's clubby bankers don't catch on quickly, the future could be treacherous.

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