Moody’s identifies another $540b of Chinese problem loans

Following on from today’s post on Gary Shilling’s warning that China is headed for a hard landing, credit ratings agency, Moody’s Investor Services, today released a report claiming that it has identified an additional 3.5 trillion yuan ($US540 billion) of potential problem loans that the Chinese National Audit Office (NAO) did not disclose in their 27 June report.

From the Economic Times:

China’s local government debt may be 3.5 trillion yuan ($540 billion) larger than auditors estimated, potentially putting banks on the hook for deeper losses that could threaten their credit ratings, Moody’s said on Tuesday.

Moody’s reviewed a report released by China’s state auditor last week, which found that local governments had chalked up 10.7 trillion yuan of debt. Moody’s said it identified more loans funded by banks after accounting for discrepancies in figures given by various Chinese authorities…

Investors worry the pile of loans, about half of which were racked up during a 2008 stimulus spending binge, could destabilise the Chinese economy in the long run. If banks have to absorb heavy losses, it could restrict lending.

“We assume that the majority of loans to local governments are of good quality, but based on our assessment of the loan classifications and risk characteristics…we conclude that banks’ exposure to local government borrowers is greater than we anticipated,” says Yvonne Zhang, a Moody’s analyst.

The ratings agency said a jump in local government loan defaults could push the non-performing loan ratio for Chinese banks as high as 12 per cent, well above its base-case scenario that envisions losses in the range of 5 per cent to 8 per cent…

Many investors have long eyed China’s mountain of local government debt as a major risk. The worry is that slower growth in the world’s second-biggest economy could set off a wave of loan defaults and hobble its banking system.

According to the Moody’s report, which I cannot attach since it is copyrighted, the $US540 billion of additional potential problem loans has been estimated from other Chinese government agencies, which reported larger loan exposures than the NAO. These loans are also considered to be of lower credit quality than those disclosed by the NAO.

In a report released on June 1 by the People’s Bank of China (PBoC), the central bank indicated that claims on local governments represented up to 30% of total bank loans, or about RMB 14 trillion. In contrast, the China Banking Regulatory Commission (CBRC) reported that such loans reached RMB 9.09 trillion at end-November 2010, or about 20% of the total loans in the system.

If we take the mid-point between these two regulators and assume that roughly 25% of total bank loans, or about RMB 12 trillion, are to local governments, then there would be a RMB 3.5 trillion difference between their calculations and that of NAO. Short of being ideal, this rough estimate has at least the merit of not ignoring a potential significant risk exposure.

This is because we believe that the loans not covered by the NAO report pose the greatest risk of delinquency, as these loans were presumably deemed by the audit agency as not being properly underwritten such that they could be categorized as local government obligations. As such, we prudently assume that the majority of these loans (50% to 75%) could become delinquent, or would need to be restructured.

When adding up all these tranches of local government loans — together with the other loans carried by banks (for which we generally assume a 5% NPL rate) — we assess that a 8% – 12% NPL range could best represent the amount of problem loans facing Chinese banks.

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Unconventional Economist
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  1. All you China bulls out there that have made comments on Gary Shilling article on here think China is different. I believe this is just the start of the massive upon massive piles of debt that China will end up having. When 60% of their construction GDP collapses there goes the Chinese economy. It wont matter that people have 50% or have paid their house off. Without jobs the economy will be up a creek.

  2. Victor Shih of Northwestern University has been warning about local government debt for quite some time and Michael Pettis has been writing about massive debt of state owned enterprises. Moody is just another, probably a bit louder, voice in the choir.

  3. I recall reading somewhere recently (can’t recall where?) that a big part of the problem in China is financial institutions giving out credit notes to businesses who then use said notes as colateral or to borrow against. Because it’s off the books so to speak the government has no records of what’s actually going on and the growth in this type of transaction has been big since the GFC. Therefore its the unrecorded transactions hidden away from the prying eyes of the State that are the really worrying factor in bank debts and potential defaults. Someone else might know more than me about this?

  4. “Went by a number of massive buildings that were 80-90% finished when construction stopped. Best explanation I got for those was that the skimming had already been taken out of them, so no need to continue. Developer borrows $25 million, skims $5 million off the top and then hires his cronies to build and skims another $3-5 million off that and then why even bother continuing? This seems to happen most often with quasi-government type buildings.”

    This is from a blog I have followed for a while now – I do like these kind of ‘on the ground experiences’. As he says, mostly quasi-government buildings where probably a lot of these NPLs will be.

    The level of corruption and shifty deals in China is the stuff of legend. Often seen this way to Western eyes when in reality an extension of traditional way of doing business, and increasingly, outright dubious practice. A significant percentage of these types of loans will fail. But if those like Niall Ferguson are correct, when that times comes the lending institutions will be recapitalised (and as someone here today said, possibly a manager or two given the ‘bullet’…).

    The China story is not over yet. And is maybe just beginning. That is how I see it. A failure or two, three, four will occur but the path has been chosen, and it will be pursued. We’ll have to wait and see. One thing to remember – that for a variety of domestic political reasons, China is in the process of being semi-demonised in the US. Sometimes you may need to take that into account (a recent BI article, mentioned at China Law Blog is a good example).

    • 3d1k
      “The China story is not over yet. And is maybe just beginning. That is how I see it. A failure or two, three, four will occur but the path has been chosen, and it will be pursued. We’ll have to wait and see.”

      Alot of people said that about Japan in the 80s. China’s hard landing is going to be worse than Japan.

      Fiancial issues and even more problems like this article below will be the downfall of China.

      • LBS, can I just outsource my responses to China Fanboy to you when I’m away?

        The thing the Fanboys have never adequately answered is why China should be different to Japan when we are seeing all the same problems times ten. The answer is always “China is much earlier along its development path”, some blather about how China has a lot of people and the CCP won’t let it happen, and how China’s share of global GDP has historically been much larger.

        Well hello? Japan didn’t have a stupendous bubble this early in its development path either … and since when did China’s share of GDP in the 12th Century become so important to economic forecasting?!

        China clearly has a bubble. Bubbles have never ended well regardless of the economic system involved, so lets all pretending the 100 year China boom is guaranteed, and start preparing our economy for the inevitable.

      • Lads,lads,lads. Calm down.

        Here we go. I have never said there are no bubbles in China. Clearly there is a lot of exuberance. Bubbles do end, sometimes very badly. China has very real issues of corruption to manage. The evolving power structure CCP/PRoC etc may prove problematic. China is going to need to navigate its way through changing world consumption of Chinese manufactured goods. China needs to tackle environmental degradation (which it is starting to do, somewhat successfully), China’s property bubble will come to some sort of end, exactly what, I’m not sure. NPLs will be an issue, a big one.

        I have never said China is similar or otherwise to Japan. In any case, Japan has managed to continue its role in the global economy for many years (despite serious difficulties). China has undergone an enormous economic and demographic transformation in rapid time. Has achieved remarkable gains. Is now a serious player in global economic terms. Is expanding its geopolitical interests in regional terms. All in the space of a couple of decades – compare that with the rest of the world, sitting back on their laurels – handing the manufacturing processes to China which China then used as a platform to transform their economy. USA, Australia – we couldn’t wait to send these processes offshore. (no point moaning now they’re gone). Development of this kind has rarely been seen in world history. So of course, there will be problems, problems come hand-in-hand with risk and development (just ask someone in resources), the task is then to surmount them wherever possible

        Yes, I do think there will be problems. However, I do think the path has been chosen and will be followed – in some form. Two billion people are not going to be thwarted in achieving their goals. Two billion people who want a more prosperous life along with the gadgets and lifestyle aspects of the developed world. These are people who have collectively succeeded in transforming their nation in the space of twenty years.

        I’ll continue to punt for a soft-landing, best outcome for everyone. Chinese people themselves, resource rich countries and the region. If the US can pull itself up, the benefits will flow through to China. Same with Europe. The Asian region is definitely developing, again with flow-on effects for China.

        If it turns out to be a hard landing – well deal with it then. Because you can’t move forward based on the possibility of future failure. It may or may not come, anticipation of collapse stymies sentiment and growth (which can be self-fulfilling and is no doubt related to why bubbles form in the first place – optimism!!!)

        Optimism – develop some. You’ll feel better for it. You won’t waste years agonising over something that you cannot control and may not even happen.

        Optimism….. Try it:)

          • Optimism feels better. Anyway – I share with you my deep philosophical thought:

            It ain’t over, until it’s over.

        • Fanboy, you don’t get it do you. I am being optimistic. The scenario you so much desire — a 20 year China boom — is a nightmare outcome for Australia and will make my personal circumstances very difficult. The best possible scenario for myself is a thumping recession in China, a runaway tech boom in the US, and a weak Australian dollar.

          So don’t accuse me of being a pessimist when I can’t see how the China boom will continue. Because I’m in technology, and because I’m a lifelong treehugger, I can’t think of anything more depressing than my country being totally dominated by the mining sector. I’d like my country to be seen as clean and green, not ravaged and poisoned, and profiting enormously from exporting the dirtiest of fossil fuels. I’d like my country to have a vibrant and viable technology sector, a tourism industry, perhaps even some niche manufacturing, not just a welfare state supported by mining income.

          From my perspective you are the pessimist and I am the optimist because frankly your vision for Australia is the stuff of nightmares. If you want a taste of Futurehell (TM) go for a drive up to the upper Hunter.

          • At Last The Truth – It’s really all about whatever’s best for the Lorax.

            I’ve known this all along.

            Not to worry about the broader Australian economy, not to worry about windfall gains to the Australian government, gains that will allow it to supplement environment and welfare programs close to your heart, not to worry about the nearly two billion individuals in China hoping for a better life, not to worry about the multitude of foreign business enterprises in China, not to worry about the livelihoods of those in the resources sector and their families, not to worry about superannuation of the shareholders in resources companies.

            Worry about one thing only.

            The self interest of one individual is paramount. All must crash and burn for the sake of the one, the Lorax.

            The Lorax. Your narcissism knows no bounds.

          • Doesn’t sound nasty or low to me.

            Fair enough if you’d said it was a little selective, after all I seized upon your comment:

            “…The best possible scenario for myself is a thumping recession in China…”

            If my assessment of your stance is incorrect, my apologies. I would accept ‘opportunistically slewed’. We each have a particular interest, mine always apparent as is now, yours.

            I still kinda like you, possibly more, now that you’re out of the closet.

            With affection

          • FWIW I’ve seen some enormous mines and in South America and Africa. Agree, often a blight on the landscape. Fortunately contained, ideally rehabilitated and in reality a blessing, we are reliant on these resources for modern life. Until there is some alternative we keep digging holes and drilling seams and wells.

            Would I want to live next door to one, nope. But here in the West many live in remote towns that are nothing but for the mining and in a curious way, there is a certain beauty to them – particularly in early morning and dusk light, with reddish purple ranges in the background and perfect skys.

      • LBS

        Any country that has undertaken a construction program like China has is bound to experience the occasional design flaw, failure in the manufacturing process or incompetent building practice. What do you expect. These are not Australian resources projects!!

        • 3d1k,

          I agree but the Chinese are not known for their attention to detail or quality on their products nor their construction. I have been reading alot about buildings and infrastructure that is falling apart and only a few years old. My point is if they are going to have to fix a ton of this it wont be good.

          • And fatal escalator reversals of two year old kit. It sounds like NPL risks come a frightening second to fatality risks on the new infrastructure.

  5. “China’s currency markets are not subject to the volatilty of a free market, because of this lack of transparency, we have very little idea of how much monetising or debt cleansing occurs via the Chinese Central Bank.
    So what if 25% or 75 of their municipal debt goes belly up. It will be purchased by the CCB, written off, and replaced and the malefactors maybe given the 9mm sleeping injection.”

    “repeat quote from yesterday”

    Are western banks buying chinese debt ?

    • Charles Ponzi

      MSM are too busy spruiking real estate. Apparently it’s a good time to buy. Any negative news on China will scare the herd off the cliff. We will deny our economic dependence on viagra as long as we’re in bed with China.

      • I don’t think anyone denies our economic dependence. I’ve stressed the importance of that a thousand times – hence my preference for a China soft landing. I’m pro-Australia and we NEED China.

        • Charles Ponzi

          Preferences have nothing to do with reality. I’d prefer to be twenty years younger and ten times wealthier. NEEDING China places Australia in a very dangerous position. There should be lots of fish in the sea and relying solely on China to fulfil our pursuit of economic growth at the expense of the environment, affordable housing and sustainable development will only end in tears. Boom and bust will be the price of blind lust.

  6. To those comparing Japan 1990 to China now. Right on. China has to have at least as serious a downturn in its economy. India too. And Japan simply isn’t going to ever have high growth again for long.
    No-one is ever going to “catch the USA” unless they develop like the USA did from 1946-1990. Levittowns, urban sprawl, low cost urban land, no property bubbles, no “planning gain”, no successful rent seeking surrounding urban development. Low cost urban land and houses causes increased productivity and income growth. Inflated urban land prices causes the opposite.
    Oregon and California have derailed the US economic miracle, with similar NIMBY land planning rackets in other regions adding to the problem. The miracle continues in Texas, Southern USA and heartland USA.
    Australia, France, and Germany have been through similar phases of economically beneficial urban expansion. Australia has “given it away”. The underlying urban economics problems in China and Australia are actually similar.
    It is HIGH TIME the economics profession WOKE UP about this.

  7. how come nobody ever asks where China gets all the money to buy America make beleive debt? I think you might not find a good answer