As pessoas trabalham em uma plataforma de engenharia de petróleo offshore em Qingdao, Shandong province, julho 1, 2016. Because of too much debt, a Chinese engineering company has recently transformed itself into a bank.  
(STR / AFP / Getty Images)As pessoas trabalham em uma plataforma de engenharia de petróleo offshore em Qingdao, Shandong province, julho 1, 2016. Because of too much debt, a Chinese engineering company has recently transformed itself into a bank.  
(STR / AFP / Getty Images)

China is desperate to solve several problems it has due to its debt to GDP ratio being north of 300 por cento. It may have found a pretty unconventional one by letting companies become banks, de acordo com um relatório do Wall Street Journal.

With profits headed south, heavily indebted Chinese heavy-machinery giant Sany Heavy Industries said this week it won approval to set up a bank in the Hunan Province city of Changsha. With 3 bilhões de yuans ($450 milhão) of registered capital, it will be a relatively large institution as Chinese city-based banks go. Sanyplans to join forces with a pharmaceutical company and an aluminum company.

Sany already operates an insurance and finance division with the goal of internal financing and insurance services for clients.

Sany Heavy Industries already operates a Finance and Insurance arm, although it's unclear what gold has to do with it. (Company Website)

Sany Heavy Industries already operates a Finance and Insurance arm, although it’s unclear what gold has to do with it. (Company Website)

Problema da dívida

One problem is that companies are defaulting on bond payments and there is no adequate resolution mechanism for bad debts, at least according to Goldman Sachs.

“A clearer debt resolution process (por exemplo, how debt restructuring on public bonds can be achieved, how valuation and recovery on defaulted bonds are arrived at, the timely disclosure of information and clarity on court-sanctioned processes) would help to pave the way for more defaults, which in our view are needed if policymakers are to deliver on structural reforms,” the investment bank writes in a note.

It would not be the first time China tries a circular financial arrangement to solve some structural issues.

By becoming or owning banks, the companies can just shift debt around different balance sheets to avoid a default, although this is probably not the resolution that Goldman Sachs had in mind when talking about structural reforms.

Another problem is that the regime has more and more difficulties pushing more debt into the economy to grease the wheels and keep GDP growth from collapsing entirely.

China needs 11.9 units of new debt to create one unit of GDP growth. Ao mesmo tempo, the velocity of money or the measure of how often one unit of money changes hands during a year has fallen to below 0.5, another measure of how saturated the economy is with uneconomical credit. If the velocity of money goes down, the economy needs a higher stock of money to keep the same level of activity.

(Macquarie)

(Macquarie)

So if companies can’t pay back loans, old banks don’t want to give out loans, and consumers don’t want to circulate the money, you can just let some companies become banks to prevent them from defaulting and maybe even issue new loans to themselves. It would not be the first time China has tried a circular financial arrangement to solve some structural issues.

Sany Not Alone

According to the Wall Street Journal report, the Sany Heavy Industries case is only one of a few. Other companies in the tobacco and travel sectors, por exemplo, have taken over banks or formed new ones.

ChinaTopix reports that the China Banking Regulatory Commission (CBRC) has already awarded five licenses for private banks and received another 12 applications during the past year. It also mentions that industrial firms are behind this move:

“One bank, Fujian Huatong Bank, which has a registered capital of Rmb3 billion ($450 milhão), was promoted by 10 Fujian-based companies in different sectors, including retail, manufacturing and real estate.”

We don’t know if the regulator had this in mind when they launched the initiative to boost private banks in China in 2014 in order to improve lending to the technology sector, but it did explicitly mention that private companies should form banks.

“Qualified private enterprises shall be encouraged to set up private banks. The innovation of products, services, management, and technology by private banks will inject new vitality into the sustainable and innovative development of the banking sector,” the CBRC states in an undated report.

It remains to be seen whether this is a long-term sustainable solution.

Siga Valentin no Twitter: @vxschmid

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Amidst a backdrop of souring loans and diminishing reserve ratios, Chinese banks last week announced the least encouraging quarterly earnings in almost a decade.
Facing a challenging domestic and international economic environment, the banksunderlying profits are deteriorating. The rising figure of official and nonofficial toxic loans are evaporating reserves and without drastic cuts to minimum reserve requirements, all but guarantees future losses.
It may be time to say goodbye to the industry’s string of quarterly profit increases and 10 percent dividend yields.
For years, Chinese banks managed earnings by adjusting provisions for bad debt which have been comfortably above the regulatory minimum. That threshold sits at 150 percent of existing non-performing loans (NPLs), which Beijing lowered from 200 percent to help banksbottom lines and free up capital.
A Loan by Any Other Name
China’s official bad loan ratios sit between 1.5 percent and 2 percent at major banks. That figure is widely recognized as understatedeven the most bullish investors peg the true NPL ratio to be in the high single digits.
Charlene Chu, partner at Autonomous Research Asia and head of its China banks research group, estimates that NPLs are as high as 22 percent system-wide, according to a recent interview with Barron’s Asia.
The discrepancy between these figuresand what makes calculating China’s NPL proportion so difficultlies in what one considers to be debt. Chinese banks and regulators, and many mainstream Western research firms, analyze NPLs within a bank’s loan portfolio.
Nobody wants to be the first to report a profit decline after so many years of growth.Richard CaoGuotai Junan Securities

But for China, a large amount of credit resides outside that scope, in the form of wealth-management products (WMPs). WMPs are a catchall for financial instruments that may reside on or off balance sheet to provide new financing or to service existing debt.
These products are structured differently than loans, which utilizes the bank’s existing balance sheet. In a typical product, the bank contributes capital to a partnership entity with non-bank counterparties such as securities firms or investment trusts, to issue credit to a struggling company. Instead of a loan, the bank holds an investment in an unrelated partnership.
The structure is somewhat similar to a collateralized loan obligation (CLO) or collateralized debt obligation (CDO). But here, instead of raising mostly outside capital as would a CLO, the bank could hold majority of both debt and equity.
Such financial engineering allows banks to dress up their balance sheets. Loans masquerade as investments, which have a lower risk weighting than debt under Chinese capital adequacy rules, allowing the bank to report a lower NPL ratio and set aside less reserves.
Such WMPs are often the only credit available to “zombiestate-owned enterprises facing restrictions on formal borrowing, such as those in the steel, cement, and manufacturing industries.
Autonomous believes that total outstanding WMPs grew 57 por cento em 2015, with off-balance sheet WMPs up 73 por cento. “If WMPs grow just 25% para 30% this year, they will be twice as big as the combined amount of structured investment vehicles and conduits that blew up on Western banks during the global financial crisis,” Chu said.
Reserve Ratio Cut Expected
The banks, meanwhile, struggle to meet even the official NPL reserves on their books.
To eke out a first quarter profit gain, two of the four largest state-controlled Chinese banks had to lower bad loan provision at March 31 to below the regulatory minimum.
Bank of China and Industrial and Commercial Bank of China Ltd. (ICBC)’s buffer has fallen to 149 percent and 141 por cento, respectively. China Construction Bank is slightly above at 152 por cento. The bank with the most NPLs, Agricultural Bank of China, has a coverage ratio of 180 por cento.
“The regulator is probably tolerating such a temporary breach and a cut in the ratio is on the way,” Hou Wei, a Hong Kong based analyst at Sanford C. Bernstein, said in a Bloomberg report. Nomura research indicates that China’s reserve ratio could be cut from 150 percent to 120 percent without material risk to China’s financial system.
During last week’s earnings disclosure, China Construction Bank Chairman Wang Hongzhang said that it was possible that the reserve ratio may be cut to between 120 e 130 por cento, but qualified that statement by saying the degree of ratio cuts may not be standard across the industry.
The temptation is there. According to BNP Paribas research last year, a small cut of minimum reserves of 10 percent points would boost bank earnings by 7 percent across the industry.
Reckoning Ahead?
Cutting reserves is a double edged sword. It can boost earnings and allow a bank to lend more, but it weakens the bank’s capital and its ability to withstand loan losseswhich is on the rise.
The official NPL ratios are at their highest levels in several years. At this point, relaxing loan reserve ratios in the face of deteriorating asset quality sends a bad message and puts into question the intention and role of Chinese regulators, a Fitch Ratings note suggested earlier this month.
But even if Beijing cuts reserves down to the 100 percent level pre-financial crisis, is it enough? If the current ratio of official NPL more than doubles to 4 ou 5 por cento, loan losses would carve into banksretained earnings and tier-one capital, estimates Sanford C. Bernstein.
“For the first quarter, [the banks] can still maneuver a bit by cutting costs here and there, and end up with zero profit growth and still maintain the minimum NPL coverage ratiobut for the full year nobody can achieve both,” Richard Cao, analyst at Guotai Junan Securities in Shenzhen, told Bloomberg.
“Nobody wants to be the first to report a profit decline after so many years of growth,” Cao added.
But they may not have a choice. Quarterly earnings and dividend levelswhich the banks hold sacrosanctwill be cut.
Depois de tudo, nobody wants to be the first to trigger a global financial crisis either.

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China Orient Asset Management, the state-sponsored massive holder of bad debt, announced a restructuring plan Dec. 30 to pave the way for an eventual IPO. The plan would allow the Chinese Communist Party to pass ownership of the toxic asset pool onto third party shareholders.
Orient, one of four so-called Chinese bad banks set up to buy non-performing loans (NPLs) from banks, said it would restructure into a joint-stock company and sell a small stake to China National Social Security Fund.
The fund will hold a small, 2 por cento, stake in Orient, which is currently owned entirely by China’s Ministry of Finance. The restructure will also pave the way for authorities to float an initial public offering later this year.
Beijing has been looking for a new source of funding for its bad banks, and Orient is the last of the four to announce its IPO intentions. The other three are Great Wall Asset Management, China Cinda Asset Management, and China Huarong Asset Management.
Great Wall also announced plans to form a joint-stock company with China National Social Security Fund and China Life Insurance Group sometime in January. It aims to list either in Hong Kong or China in the first half of 2017, a senior company executive told Reuters on Dec. 24. The bad banks serve as clearinghouses for China’s bad debt problem.

The other two bad banks are already partially publicly listed. Cinda raised $2.5 billion in a Hong Kong IPO in 2013, while Huarong sold $2.3 billion of shares via Hong Kong in 2014.
Lipstick on a Pig
Os bancos ruins foram criados pela China em 1999 para resolver problemas NPL do país resultantes de anos de empréstimos bancários a má gestão das empresas estatais (SOEs). Each of the four managers corresponded to one of China’s “big fourcommercial banks—Banco da China, Agriculture Bank of China, China Construction Bank, and Industrial and Commercial Bank of China.
Os bancos ruins comprou NPLs de bancos estatais, libertando balanços deste último para que pudessem manter os empréstimos para as empresas públicas.
To finance the purchases, which were sometimes overvalued so as to not saddle the state-owned banks with excessive losses, the bad banks were initially capitalized by the state. They borrowed an additional 570 billion yuan from the People’s Bank of China at the time, and raised another 820 billion yuan via bonds, sold to the commercial banks.
The South Morning China Post estimated that in a five-year span after their creation, the bad banks collectively took on more than two trillion yuan in non-performing loans from the banks. Many of the subsequent purchases were financed via bond issuances by the bad banks, either bought by the Ministry of Finance or the commercial banks themselves.
Essencialmente, the bad banks serve as clearinghouses for China’s bad debt problem. Beijing is able to shift such devaluedand sometimes worthlessassets away from the banksbalance sheets, trocados por dinheiro ou títulos emitidos pelos bancos ruins, many of which were issued credit-worthy grades by the rating agencies. That’s how the country’s big banks can claim a 1 para 2 percent bad loan ratio.
By itself, this tactic of an asset transfer can work if it’s an isolated affair. NOS. banks restructured following the financial crisis in 2007, selling pools of toxic mortgage-backed securities, credit default swaps, and other assets into newly formed entities and spinning them off into hedge funds. The banks took one-time write offs at sale, but were able to clean up their balance sheets, tighten risk management, exit legacy businesses, and move on.
China’s bad banks had the same mission back in 1999they were given ten-year loans to finance the asset purchases, and were supposed to go away after winding down the NPLs in ten years. But SOE reform didn’t work due to politics: swallowing the bitter pill and consolidating the country’s massively inefficient SOE sector would invariably cost jobs and upset the public, fueling social unrest and threatening the Party’s grip on power. So the bad banks were kept, became bigger than ever, and are now an integral part of Beijing’s “kicking the can down the roadfinancial strategy.
The bad banks allow China to prop up inefficient SOEs, by granting them lifeline loans indefinitely. Banks will issue them more loans, and as bad debts accumulate, they’ll unload them to the asset managers. This cycle has played out over the last 15 anos.
Non-performing Loans for All
The bad banks actively manage these distressed assets. Beijing granted them power to restructure, swap debt for equity, and sometimes hold bankruptcy auctions, hoping to recover enough cash annually to service the debts and cover interest payments.
China’s bad banks purchase bad debts at a discount to begin with, with the commercial banks shouldering some losses from their initial loans. While on their balance sheets, the bad banks have the ability to manage unrealized gains and losses by dictating valuation and controlling write downs. Carl Walter and Fraser Howie, co-authors of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Risewrote that as of 2008 the bad banks were sitting on 1.5 trillion yuan of unrecognized write-downs.
Cinda was the first bad bank to IPO in Hong Kong in 2013, and we can use its publicly available filings to draw some conclusions.
What has been a boon for Cindacourtesy of China’s equity market bubble over the last two yearsis debt-to-equity swaps. The company exchanged some of its loans for SOE stock in recent years. As the country’s stock market rose, Cinda saw opportunities to unload the shares at a gain.
Gains on disposal of equity assets increased 11 percent from 2013 para 2014, and is expected to increase another 25 por cento em 2015. As of June 2015, Cinda held equities at 206 companies for a total of 40.8 billion yuan on its balance sheet.
By all other measures, Cinda’s financial position has been deteriorating as it has grown its balance sheet. Assets excluding cash increased from 116.9 billion yuan to 500.5 billion yuan from 2010 para 2014, an increase of 428 por cento. During this five-year period, return on average assets, or a measure of

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NEWS ANALYSIS
Chinese banks generally follow a fairly straightforward business modelso simple, it’s often only got one step: lend money to state-owned enterprises and government-sponsored infrastructure projects.
It matters little whether these entities can repay the loans. A willingness to lend aligns with the Chinese Communist Party’s mandate to increase economic output and keep jobs in place. Bank profits can be managed by selectively writing down bad loans. When the loans become truly non-performing, they’ll be restructured or sold off to one of the state-sponsored “asset management companies,” or bad banks.
Rinse, and repeat.
This playbook has been followed for decades. And the most recent monthly data from the People’s Bank of China (PBoC) confirms that banks have doubled down on this practice in 2015.
Record Lending Activity
While the major Chinese banks are publicly traded entities, they are not comparable to western banks which have an independent board, a risk-management department, and the legal obligation to prioritize profits to their shareholders.
Chinese banks are lame-duck arms of the Chinese Communist Party, forced to carry out the Party’s economic policy decisionsmany times in conflict with their own priorities as profit-seeking entitieswhile preserving a semblance of normal operations for its public shareholders. Em outras palavras, Chinese large banks have limited free will to operate independently.
The banks gave out loans worth 11.1 trilhão de yuans ($1.73 trilhão) in the first 11 months of the year, according to data from the PBoC. Even before adding December’s figures, this year’s lending activity has already surpassed 2014’s record 9.78 trilhão de yuans ($1.51 trilhão) in loans issued.
So who are they lending to?
The majority of loans were for mortgages, transport infrastructure, and most importantly, troubled companies that stayed afloat only because banks gave them new loans to pay off old debt, central bank sources told Caixin, a China-based financial media.
Mortgages were boosted by six interest rate cuts since late 2014, liberalized household registration policies, and other measures to support a struggling housing market. Beijing made transportation infrastructure a major policy agenda, looking to attract more people to lower tiered cities. China’s Ministry of Transportation announced that fixed asset investment in roads and waterways amounted to 1.65 trilhão de yuans (US$255 billion) during the first 11 months of 2015, acima 107 percent from 2014.
Banks had little choice but to perpetuate the Ponzi scheme of giving loans to struggling companies. They were sometimes strong-armed by government officials to lend to these companies because letting them fail would drive up social instability, one bank’s risk-management executive told Caixin.
Chinese leaders have talked about deleveraging, which was part of the plan to support the stock market and orchestrate a large-scale debt-to-equity swap. But the stock markets crashed and the country’s indebtedness is actually risinghaving already surpassed that of many developed economies. According to data from the Bank of International Settlements, China 240 percent nonbank corporate debt-to-GDP ratio is among the highest in the world, higher than United States and Germany.
Managing Bad Loans
Hong-Kong based investment bank CLSA estimates non-performing loans (NPLs) could be as high as 8.1 percent of all bank loans, compared to official statistics of 1.6 por cento. NPLs are generally loans that are over 90 days past-due.
Western banks mark down the value of their NPLs to a clearing price and then sell the loans. Chinese banks are sometimes reluctant to do so. Labeling a borrower as delinquent requires reporting to the PBoC, which will likely force other banks to also write down their loans. Such actions would encourage more bankruptcies and layoffs, something Beijing doesn’t want. The problem is more acute at mid-tier and smaller unlisted banks who have less support from the state asset management companies, causing potential capital shortfalls of unknown proportions.
Independent analysis of banksbalance sheets by UBS found that at 18 listed Chinese banks, overdue loans not written down jumped 57 percent to 645 bilhões de yuans ($101 bilhão) in the first half of this year from the end of 2014, while NPLs not written down increased 17 percent to 692 bilhões de yuans.
Fifteen years ago Beijing set up four state-owned “asset management companiesto buy up bad debt from the nation’s banks. These so-called bad banks include Great Wall Asset Management Corp., China Cinda Asset Management Co., China Huarong Asset Management Co., and China Orient Asset Management Corp.
The companies buy up the junk loans at a discount, taking them off the hands of Chinese banks. This has the benefit of keeping actual bad debt ratios low at banksthough then they are simply freed up to issue more loans of dubious quality.
These bad banks have wide mandate to buy troubled assets. According to ratings agency Moody’s Investors Service, the four bad banks could absorb as much as $41.2 billion in additional bad loans over the next five years. In the past two years alone, Moody’s estimates China’s bad-bank industry has absorbed almost one trillion yuan ($154.3 bilhão) in bad loans.
It’s unclear how the bad banks are performing. They’re not required to disclose prices paid for the distressed assets, so it’s difficult to estimate actual returns for the bad banks.
State-Sanctioned ‘Ponzi
Essencialmente, o Partido Comunista Chinês—through the nation’s banking systemis overseeing the creation as well as disappearance of loans, and passing on very little cost to inefficient state-owned enterprises.
Up until recently, Contudo, the bad banksand their toxic balance sheetswere owned by the Chinese government. But increasingly, the bad banks are passing the risk onto institutional investors and even retail investors.
Two of the banksCinda and Huaronghave already publicly listed their shares in Hong Kong, taking advantage of investors chasing yield in a low interest rate environment.
Huarong, one of the bad banks, recently put 51.5 bilhões de yuans ($8 bilhão) of NPLs for sale on Alibaba Group’s popular Taobao e-commerce platform.
Great Wall announced last week that China’s National Social Security Fund and China Life Insurance will buy stakes in the firm. Financial terms were not disclosed, but the purchases might allow China’s Ministry of Finance, which currently owns all of the bad banks, to slowly extricate itself.
Great Wall has plans to bring five to eight more institutional investors for up to a

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For most people of the internet generation in China, conversations with friends involve pinging them via WeChat, the messaging platform by Tencent Holdings.
Need to pay for a latte at the coffee shop? It’s as easy as firing up WeChat Payments on the smartphone, and it’s done.
And when it’s time to apply for a loan for your small business idea, naturalmente, there’s a Tencent app for that.
The service is called WeBank. Approved by regulators in early 2015, it was the first online-only bank approved by Chinese regulators.
Small Loans for Small Businesses
Dentro 2015, online banking has become the new battleground for Chinese internet giants.
WeBank and Alibaba Group Holding Ltd.-backed MYbank are competing to offer loans and investment products online.
Beijing is approving online-only private banks in an effort to diversify the banking industry and spur business growth. No passado, Chinese banks were all state-owned. They primarily catered to larger, state-owned enterprises (SOEs) or governments. Small, privately owned companies and individuals with limited collateral have long struggled to obtain credit from large banks.
Economists say small and medium-sized businesses generate three out of every four new jobs in China. With SOEs contracting or consolidating, Beijing desperately needs private and smaller businesses to help deliver on its economic and jobs growth targets.
Uniquely Equipped
Online-banking platforms are uniquely equipped to offer loans to consumers and smaller businesses.
Alibaba’s Alipay online-payment platform has more than 400 million active users. WeChat boasts 549 million active users. These consumers already use internet and their mobile devices on a daily basis.
Online banks affiliated with the “Big Threeinternet giants Baidu, Alibaba, and Tencent hope to mine the troves of behavioral, geographical and financial data they already collect from existing services to screen borrowers for credit worthiness.
With social platforms, online stores, and web portals catering to hundreds of millions of existing daily users, online banks affiliated with these internet giants have access to marketing and advertising platforms that few brick-and-mortar banks could hope for.
WeBank received its banking license in January 2015. MYbank, the online-only arm of Ant Financial, the financial services arm of Alibaba, launched soon thereafter.
Last month, Baidu and Citic Bank announced plans to set up a joint venture bank to offer loan and investment products online. As of early December the application has not yet been approved by regulators.
Tencent is the largest shareholder in WeBank at 30 por cento. Other major shareholders in WeBank include Shenzhen Baiyeyuan Investment and Shenzhen Liye, each with a 20 percent stake, according to data from Bloomberg.
These online banks offer consumers financial services products such as money-market funds, investment products, and loans. Without storefronts and overhead, online-only banks compete by having a lower cost base to brick-and-mortar banks.
“At a traditional bank, business has to go through several departments, resulting in additional costs,” Zheng Xinlin, a WeBank vice president, told Caixin Media. “Ours is a low-cost, one-stop service.
As of September, WeBank had underwritten more than 1 bilhões de yuans ($156 milhão) worth of consumer loans, 40 percent of which were for employees of Tencent, according to sources who spoke to Caixin.
Big Hurdles Remain
While internet firms believe online banks can provide much-needed capital for consumers and small businesses, regulators could be dampening those hopes.
Beijing has moved to rein in the lightly regulated market of online paymentsan area that can affect the ability to transfer money into and out of online banks.
Draft rules issued in August by the People’s Bank of China put restrictions on online payment services such as Alipay and WeChat Payments. New guidelines would limit fund transfers, cap the amount of total daily transactions, and increase the requirements to provide identification when opening accounts.
The last rule would require applicants to give documentation such as educational background, tax bureaus, and bank accounts in order to open online accounts offering more than the most basic services.
Some critics warn these regulations could stifle development in one of the most innovative corners of the Internet.
Outside of government hurdles, competitive pressures have kept Internet-only banks from fully taking off.
WeBank’s first year in operation has been a rocky one. Under current Chinese banking rules, customers must physically provide identification at a real bank branch in order to make deposits. At launch, WeBank partnered with China Merchants Bank, the nation’s sixth-largest lender, to accept bank applications.
But in September, China Merchants Bank ended its relationship with WeBank and has refused to let its customers link accounts to WeBank’s online platform. Some of China’s biggest state banks have also declined to partner with WeBank, according to Caixin sources. Later in the month WeBank’s president, Cao Tong, resigned after only ten months on the job.
WeBank and Mybank hope facial-recognition technology will allow the firms to remotely verify identities without the need to visit a physical bank branch. But so far, regulators have not approved such technologies.

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