China Tells Banks to Cut High-Risk, Hidden Loans
SHANGHAI — Disappointed with his low savings deposit rate, a 29-year-old chemical company salesman named Zhang Zhenlei says he took 130,000 renminbi out of his savings account last November and bought into a higher-yielding investment trust through his bank's wealth management division.
The money, equivalent to $19,000, would be used to help finance two government highway and infrastructure projects, the bank told him.
"They told me the details and which companies would get the loans," Mr. Zhang said. "And they told me the risk was under control."
Mr. Zhang got in right under the wire. Last month, the China Banking Regulatory Commission issued a sharp warning, ordering investment trust companies to stop selling such products in cooperation with banks.
Regulators were apparently worried that banks and trusts were forming partnerships and using products like the one sold to Mr. Zhang to evade rules that went into effect earlier this year aimed at slowing bank lending and reducing excess credit. That came after government data showed a sharp rise in inflation and property prices.
Regulators, suspecting that banks and trusts are secretly repackaging old loans and moving them off bank balance sheets, are concerned that financial institutions here may have engaged in the same sort of financial engineering that got Western banks into trouble.
On Aug. 10, government overseers acted again, ordering banks to move any off-balance-sheet loans back onto their books and to make provisions to safeguard against a rise in bad loans, according to a copy of the government order given to The New York Times by an industry expert.
The decision came after the Fitch credit rating agency warned several weeks ago that such off-balance-sheet deals were understating the extent of bank lending in China and thereby masking the dangers associated with an increase in risky loans.
Fitch estimates that Chinese banks had about $350 billion in trust-related products on their balance sheets at the end of June, and that much of that lending had not been publicly disclosed.
"Regardless of how the transaction is structured, credit is disappearing from bank balance sheets, resulting in pervasive understatement of credit growth," a Fitch analyst, Charlene Chu, wrote in a June presentation. "Credit risk has not disappeared but merely been transferred to investors."
The off-balance-sheet deals are raising warning flags about a possible slowdown. While the Chinese economy remains robust — it overtook Japan in the second quarter to become the world's second-largest economy, behind that of the United States — analysts worry that a surge in bank lending last year and early this year might have led to wasteful spending on infrastructure and real estate projects.
In recent years, the government has been trying to crack down on what it deems wasteful spending on "luxurious" local government buildings, highways to nowhere and so-called image projects that are constructed in poverty-stricken areas.
The basis for those worries was laid last year, after the government encouraged aggressive lending as part of a huge economic stimulus package. The result was a record 9.59 trillion renminbi or $1.4 trillion in new bank loans in 2009, about double the previous year. Some analysts fear the sharp increase in lending included many bad loans that will begin to show up over the next few years.
Aware of the risks, Chinese regulators are pressing state-run banks to raise billions of dollars in capital to cushion any downturn — a task that could be complicated by any perceptions among private investors that the banks are exposed to a lot of risky debt. The government is also conducting stress tests to determine how banks will perform if property prices plummet.
Beijing is now trying to restrict lending and ease asset price inflation without setting off a slowdown.
"They're stuck in a policy bind," says Michael Pettis, a professor of finance at Peking University in Beijing, noting China's heavy dependence on investment-driven growth. "They have to choose between cleaning things up and maintaining high growth."
Pushing in the opposite direction are banks and investment trusts, which want to continue pumping money into the economy to bolster their profits. Analysts say the banks and trusts have been adept at evading the rules with clever and complex financial products.
Even though most banks contacted in recent weeks said they had stopped offering such products, several said they had found ways to continue to sell them. Analysts say it is unclear just how pervasive such products are.
Something similar happened here in the 1990s, when aggressive financing by banks and investment trusts led to big losses, huge bankruptcies and new regulations.
Chinese banks appear to be stronger this time around. Over the last decade, huge restructuring and government recapitalization efforts allowed the big state banks to clean up their balance sheets and eventually raise billions of dollars in public stock offerings.
Still, analysts say the lack of transparency about lending makes it difficult for investors and regulators to assess the risks facing some banks.
"Essentially what you had was a bank using a trust company to package that bank's own loans into a wealth management product, which was then sold to its own customers," said Jason Bedford, a manager at KPMG in Beijing. "The problem is you don't have a clear transfer of risk off of the balance sheet."
With the help of trusts, banks are repackaging loans as investments, analysts say, thereby making room to issue additional loans. And trusts are turning to wealthy bank clients to raise new capital.
Banking customers are also contributing to the continued use of partnerships between banks and investment trusts, analysts say. Those customers, which include corporate clients, have been frustrated with the low yields they earn on savings deposits — close to 2 percent — and with the dearth of alternative investment options. Higher-yielding investment trusts were seen as ideal.
"Banks have a lot of demands from high net worth depositors," particularly big corporate accounts, Mr. Bedford at KPMG said.
Stephen Green, an analyst based in Shanghai at Standard Chartered Bank, describes investment trusts as financial intermediaries, filling in gaps in the financial markets and acting as a jack of all trades — part hedge fund, mutual fund, private equity firm and bank lender.
Trusts are also a vital source of financing for private companies, and lately real estate developers, which often have a difficult time securing loans from state-owned banks — largely because the government is trying to restrain real estate development.
But many investment trusts are state-owned, and they often finance state infrastructure projects. For instance, the Xi'an Trust, which is owned by the government in the city of Xi'an, is providing money for land, water and electricity projects to build a new high-tech base for the city.
For wealthy investors like Mr. Zhang, though, investment trusts offer attractive interest rates, about double the savings deposit rate.
Mr. Zhang, who is a V.I.P client at his state-owned bank, says he spent a half hour filling out paperwork so that he could invest in a trust and help finance an infrastructure company in Inner Mongolia and also a highway development company in Guangdong Province, in southern China.
"It turned out very well," said Mr. Zhang, who has already gotten his money back, with interest payments, after the six-month lockup period ended.
As for the crackdown on trust products, regulators may have difficulty, analysts say. A wealth manager at I.C.B.C., one of China's biggest state-owned banks, was offering investment trusts to banking clients two weeks ago.
"Now we have a 57-day trust product with a yield rate of 2.6 percent," the manager told one prospective client over the phone. "It's available from today. Though financial products aren't authorized for principal to be guaranteed, usually we can orally guarantee your principal."
