China may allow major commercial banks to convert one trillion yuan (US$154.5 billion) of bad loans into equity in three years or less.
The plan will enable commercial lenders to swap non-performing loans (NPL) to troubled companies for stakes in them, Caixin magazine reports.
It covers so-called “special loans” and normal loans in banks’ balance sheets and comes after the nation’s five largest lenders reported falling profit growth and rising loans last week.
This is one way to tackle bad assets although it could also expose banks to further risk.
Related stocks could also be affected.
Swapping debt into equity in a troubled borrower might get bad loans off lenders’ books and hence reduce their NPL ratios.
Also, it will allow banks to reduce their loan provisions.
The debt-equity swap will be handled by the four managers of distressed state assets since commercial lenders are not allowed to invest in non-banking companies or hold stakes in them.
If the program is implemented, banks will no longer have to bundle bad loans and sell them to asset managers.
China Huarong Energy, formerly China Rongsheng Heavy Industries, said it will settle a 17.11 billion yuan debt with Bank of China, its biggest creditor, by issuing 17.11 billion new shares.
As a result, Bank of China will become its largest shareholder with a 14 percent stake.
All this is coming at a critical juncture in the banking industry.
The big five — Bank of China, Agricultural Bank of China (01288.HK), Industrial and Commercial Bank of China (01398.HK), China Construction Bank (00939.HK) and Bank of Communications (03328.HK) — reported a combined net profit of 933.3 billion yuan for last year.
All but one had zero profit growth last year.
Bank of China reported 0.74 percent profit growth for 2015 compared with an 8.08 percent rise in the previous year.
These five banks had a combined 1.27 trillion yuan of bad loans as of last year, the highest in a decade.
Agricultural Bank of China reported a 2.39 percent NPL ratio, the highest among its peers, up 70 percent from 2014.
Provisions fell sharply.
Agricultural Bank of China said its bad-loan coverage ratio fell to 189 percent from the year before.
China Construction Bank reported a significant fall in provisions to 150.99 percent, just above the red line of 150 percent set by the banking regulator.
These banking giants have been unable to handle Beijing’s supply-side reform given their falling profits.
The debt-equity swap might be their only opportunity to improve their asset quality.
Of course, the banking regulator could lower the provision requirement to ease pressure on banks, freeing up capital.
However, such a move might prompt investors to rethink their positions given the heightened risk level.
This article appeared in the Hong Kong Economic Journal on April 5.
Translation by Julie Zhu
[Chinese version 中文版]
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