Twofish's Blog

August 5, 2009

There are worse things in the world than NPL’s

Filed under: china, finance — twofish @ 2:14 am

OK, you’ve been pushed out of an airplane and are plummeting to the ground.  You want to pull on the parachute ripcord, but there is this economist that says that you shouldn’t because you might break your arm, and in any case you can’t keep pulling ripcords and expect a parachute to come out.

But you tell the economist to go stuff it, you pull the rip cord, it turns out that you did break your arm, and then the economist tells you ‘ha ha I told you so.”

That’s basically the story of the Chinese economy over the last few months.  The government pulled the parachute, it came up, and now people are worried about non-performing loans.  It’s not clear whether you have a broken wrist, a broken arm, or are just sore.

If the government keeps pumping the accelerator, yes it will have an NPL problem, but I don’t see one happening if it takes its foot off the accelerator and starts gently tapping on the brakes.  Even if you do have an NPL problem its better than the alternative.

Two comments:

People keep on talking about the massive NPL’s that the government ran up in the “last loan expansion”  Actually it didn’t.  Since the 1998 reforms, there have been two periods of massive lending.  One in 2001 and one in 2005.  Neither of them seem to have resulted in massive amounts of NPL’s.  This time you can argue that because of the massive expansion of the Chinese economy, you have more NPL’s, maybe but…….

I’m going to say something shocking…

*Running up massive NPL’s in the early 1990’s was the right policy*

In economics, there are no good or bad policies, only better and worse ones.  The massive bank loans of the early 1990’s lend to a problem that took China about a decade to solve, but it was better than what happened to Russia.  Because Russian banks didn’t issue massive NPL’s, you ended up with hyperinflation combined with huge unemployment.  In the case of China, the NPL’s kept the system going long enough so that it could be dismantled in an orderly way.

Right now we don’t how bad China’s new NPL problem is or whether it has one at all.  Personally, I think it’s important to worry about it, and now that you aren’t going to fall to your death, you can start worrying about your arm.  I don’t think it’s going to be that bad, but however bad it is, it is better than the alternatives.



  1. That’s a nice analogy that I’m sure to use in some form or another.

    What about an adaptation: We were in free-fall since 2004, and we even put our currency up an altitude notch or two just to make it clear we weren’t about to stall. Now the surplus fuel that seemed to have mysteriously filled our tanks, contributed to a pickup in inefficient fuel usage, and somehow built a couple of multi-level concrete stories to our wings, seems to have run out. The concrete on the wings is creating a lot of drag. Our altitude/currency is too high, we’re losing speed and lift at the same time.

    What can we do not to stall other than dive, pick up speed, blow the poorly constructed platforms off our wings, and attempt to level out.

    All without keeping the local populace happy in terms of employment, incomes, expectations, and wealth. In that order.

    Comment by Alex — August 5, 2009 @ 3:08 pm

  2. Did China ever really solve it’s old NPL problem? The AMCs were an artificial solution, and evidence from a 2005 paper shows that there is no way they were covering their dividend and bond interest obligations.

    Also, the figures are pretty staggering. In 2004 NPLs represented 13% of China’s loans, or about RMB 1.7 trillion out of 13 trillion. If you add in the NPLs on the AMCs balance sheets, then there were NPLs of RMB 2.8 trillion out of 14.05 trillion (~20%), or $340 billion in 2004 dollars. In the first half of 2009 there has been $1.1 trillion in new lending by the Chinese banks. We could extrapolate that this will result in $130-200 billion in new NPLs. That’s a large increase to a problem that China has not appeared to solve except by transferring the debt to even more opaque and closely held banks.

    Comment by Will Lewis — August 5, 2009 @ 4:22 pm

  3. Yes China solved it’s old NPL problem. If it didn’t do that then the banking system would have blow up last year.

    China moved it’s bad old loans into asset management companies, which issued bonds that were paid for by the state. They did not cover their interest and bond dividend obligations and were never intended to. The purpose of the AMC’s was to move bad loans off the books of the banks, and then pay off the deficit with state funds. Since the money originally went to pay what were basically unemployment obligations, this worked out nicely. It’s actually quite clever what the government did. What they did was to go to the banks and say, we will this one time give you one yuan for each one yuan of loan that you turn over to the AMC’s. Naturally the banks would then turn over the worst loans that they have, which was the point.

    The big mistake was to pay for social welfare spending through the banks rather than directly through government payouts, but the reason that was done was that in 1993, there was no organized way for the government to pay out social welfare benefits except through bank loans to SOE’s.

    As far as the numbers go:

    1) If you view the 1990’s NPL’s as social welfare spending, then the numbers aren’t that bad. If you break down all of the loans then it turns out that three of the four big banks are clean, whereas pretty much all of the NPL’s come from the Agricultural Bank of China, which is being used as a policy bank. NPL’s from ABC are essentially government fiscal spending.

    2) For the reasons above, it’s unwise to extrapolate current bank loans. The problem with NPL’s is that banks are not welfare agencies. This isn’t to say that social welfare spending is not important, but you can (and the the government is) routing a lot of the spending outside of banks.

    3) Also the banks are not opaque at all. We have a good idea where the current NPL’s are. The unknown is future NPL’s, but I’m more optimistic than most people, because the Chinese banks have gone through two bursts of lending (once in 2001 and once in 2005) without huge NPL’s developing. Also there is no need to force fiscal spending through the banks.

    Also, let me point out that problem with NPL’s. The problem with NPL’s isn’t the deficit spending itself. The problem with NPL’s is that it makes it impossible for a commercial bank to efficiently allocate capital, and it also weakens the ability of the bank to withstand a crisis. If you have to do direct deficit spending, then you can do that through treasury borrowing or through policy banks. If you have to spend 10% GDP on stimulus, that’s not a bad thing to do. The problem is that you need to find some better way of dropping the money than through NPL’s.

    Comment by twofish — August 10, 2009 @ 10:14 pm

  4. Twofish, now Brad is gone to do real work, we will have to have our disagreements elsewhere.. Just kidding. I think you are right re the “NPL problem”, if the loans are made by (effectively state owned, certainly implicitly state-guaranteed) the big 4 banks to strict SOEs and majority SOEs. Then they are basically repayable grants (as under the old central planning system). The Centre has shown that it can harden budget constraints, so, as long as we realize that this is a form of covert fiscal stimulus, there should be no risk of a banking crisis (besides where would people take their money). The risk of inflation is also pretty remote and the two other risks that I can think of are 1. misallocation (but that is not uniquely the case with these funds) and yet another reason to not liberalize financial markets further.

    Comment by Rien Huizer — August 6, 2009 @ 5:53 am

  5. It’s not just NPLs people are worried about. It’s reasonable to regard it as ‘necessary evil’ to pull the economy out of downward spiral. My reading of various web postings is that people believe a sizable proportion of increasing loans in 1H is directed into stock and property markets speculation, that SMEs in China are still facing an uphill battle to credit access, that ‘corrupted’ local authorities conspiring with real estate developers to pop up property prices which only further depress domestic consumption and ‘kidnapped’ commercial banks and Chinese economy along the way.

    In fact, Andy Xie had an exact post addressing these issues earlier this week, and I would very much like to hear your opinion.

    Comment by anonymous — August 7, 2009 @ 8:22 am

  6. First of all, it’s pretty easy to check if we are in a bubble. Just look at price/earning ratios for stocks or rent/price ratios for real estate. Another very quick check to see if you are in a bubble is to ask someone purchasing real estate what they plan to do with it. If the answer is live in the apartment, that’s a good answer. If they answer is resell it, it’s bubble time.

    The important thing is that people tend to blame bubbles on “corrupted officials” when in fact bubbles are just part of the market. They are like winter snowstorms that have very little to do with corrupt officials or conspiracies, and the important question is what happens when the bubbles pop. I

    Comment by twofish — August 11, 2009 @ 12:29 am

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