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Chinese Banks See Risks in 23% of $1.1 Trillion Loans (Update1)

By Bloomberg News

July 24 (Bloomberg) -- Chinese banks may struggle to recoup about 23 percent of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, according to a person with knowledge of data collected by the nation’s regulator.

About half of all loans need to be serviced by secondary sources including guarantors because the ventures can’t generate sufficient revenue, the person said, declining to be identified because the information is confidential. The China Banking Regulatory Commission has told banks to write off non-performing project loans by the end of this year, the person said.

Commission Chairman Liu Mingkang said this week borrowing by the so-called local government financing vehicles may threaten the banking industry. The nation’s five-largest banks, including Agricultural Bank of China Ltd., plan to raise as much as $53.5 billion to replenish capital after the sector extended a record $1.4 trillion in credit last year.

“In China now, it is the same as the people getting loans in Phoenix here in the U.S. three years ago,” said Vikas Pershad, chief executive officer of Chicago-based Veda Investments LLC. “People who want money get money, and then they all lose track of it.”

Highways, Airports

Local governments set up the financing vehicles to fund projects such as highways and airports due to limits on their ability to directly borrow money. The central government this year restricted borrowing on concern money isn’t being used for viable projects.

“The issue is symptomatic of the way the stimulus package was rolled out in 2008,” said Nicholas Consonery, Asia specialist at the Eurasia Group. “It is difficult for local governments to finance these projects. It is written under the Chinese constitution that local governments cannot offer their own debt.”

Only 27 percent of the loans to the financing vehicles can be repaid in full by cash generated by the projects they funded, the person said.

Calls to the banking regulator’s press office in Beijing after business hours weren’t answered.

Fitch Weighs In

China last month ordered local governments to ensure repayment and to concentrate on completing projects already under way. Financing units that fund only public projects and rely on the fiscal income of local governments to repay debt should stop spending, the State Council said June 13. Local governments have also been barred from guaranteeing loans taken by their financing vehicles.

To minimize losses, the banking regulator has ordered lenders to create teams to discuss loan repayments with local governments and protect the rights of creditors, the person said.

The government has been grappling with how to rein in the credit-fuelled stimulus before it leads to overheating, according to a July 14 report by Fitch Ratings analyst Charlene Chu. Lending hasn’t slowed as much as official data suggests because Chinese banks are shifting loans off balance sheets by repackaging them into investment products that are sold to investors, the report showed.

“The growing popularity of this activity is increasingly distorting credit growth figures at an institutional and system level,” Chu wrote. “Consequently, Chinese banks’ loan loss reserves and capital are more exposed to credit losses than current data suggests.”

Chairman Liu said in April that inspectors would visit banks in the third quarter to check on loan reports that had to be submitted by the end of June. Those reports showed the banks had 7.7 trillion yuan of outstanding loans to the local financing vehicles at the end of last month, the person said.

It does increasingly look like China is about to go through exactly what we've been experiencing for the last 3 years. It looks like it will be a credit crunch of significant proportions followed by a collapse of the banking system and a recession or depression. My bet is a depression, mimicking the other two times in history when creditor nations overdid it - the US in the late 1920s and Japan in the late 1980s.

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