One Analyst Says China's Banking Sector Is Sitting On A $3 Trillion Neutron Bomb

Tyler Durden's picture

To be sure, we’ve long contended that official data on bad loans at Chinese banks is even less reliable than NBS GDP prints. Indeed, the lengths Beijing goes to in order to obscure the extent to which banks’ balance sheets are in peril is truly something to behold and much like the deficient deflator math which may be causing the country to habitually overstate GDP growth, it’s not even clear that China could report the real numbers if it wanted to. 

We took an in-depth look at the problem in “How China's Banks Hide Trillions In Credit Risk: Full Frontal”, and we’ve revisited the issue on a number of occasions noting in August that according to a transcript of an internal meeting of the China Banking Regulatory Commission, bad loans jumped CNY322.2 billion in H1 to CNY1.8 trillion, a 36% increase. Of course that’s just the tip of the iceberg. In other words, that comes from a government agency and although the scope of the increase sounds serious, it still translates into an NPL ratio of just 1.82%. Here’s a look at the “official” numbers (note that when one includes doubtful accounts, the ratio jumps to somewhere in the neighborhood of 3-4%):

Source: Fitch

There are any number of reasons why those figures don’t even come close to approximating reality. For instance, there’s Beijing’s habit of compelling banks to roll over bad loans, and then there’s China’s massive (and by “massive” we mean CNY17 trillion) wealth management product industry which, when coupled with some creative accounting, allows Chinese banks to hold some 40% of credit risk off balance sheet.

Well as time goes on, and as market participants scrutinize the data coming out of the world’s second most important economy, quite a few analysts are beginning to take a closer look at the NPL data for Chinese banks. Indeed, if Beijing continues to move toward “allowing” defaults to occur (even at SOEs) and if China’s transition from smokestack economy to a consumption and services-driven model continues to put pressure on borrowers from the manufacturing sector, the situation is likely to deteriorate quickly. If you needed evidence of just how precarious things truly are, look no further than a recent report from Macquarie which showed that a quarter of Chinese firms with debt are currently unable to cover their annual interest expense (as you might imagine, it's even worse for commodities firms). 

Just two weeks after we highighted the Macquarie report, we took a look at research conducted by Hong-Kong based CLSA. Unsurprisingly, it turns out that Chinese banks' bad debts ratio could be as high 8.1%, a whopping 6 times higher than the official 1.5% NPL level reported by China's banking regulator. 

We called that revelation China's "neutron bomb" but it turns out we may have jumped the gun. According to Hong Kong-based "Autonomous Research", the real figure may be closer to 21% when one takes into account the aforementioned shadow banking sector. Here's more from Bloomberg:

Corporate investigator Violet Ho never put a lot of faith in the bad loan numbers reported by China’s banks.

Crisscrossing provinces from Shandong to Xinjiang, she’s seen too much -- from the shell game of moving assets between affiliated companies to disguise the true state of their finances to cover-ups by bankers loath to admit that loans they made won’t be recovered.


The amount of bad debt piling up in China is at the center of a debate about whether the country will continue as a locomotive of global growth or sink into decades of stagnation like Japan after its credit bubble burst. Bank of China Ltd. reported on Thursday its biggest quarterly bad-loan provisions since going public in 2006.


Charlene Chu, who made her name at Fitch Ratings making bearish assessments of the risks from China’s credit explosion since 2008, is among those crunching the numbers.


While corporate investigator Ho relies on her observations from hitting the road, Chu and her colleagues at

Autonomous Research in Hong Kong take a top-down approach. They estimate how much money is being wasted after the nation began getting smaller and smaller economic returns on its credit from 2008. Their assessment is informed by data from economies such as Japan that have gone though similar debt explosions.


While traditional bank loans are not Chu’s prime focus -- she looks at the wider picture, including shadow banking -- she says her work suggests that nonperforming loans may be at 20 percent to 21 percent, or even higher.



“A financial crisis is by no means preordained, but if losses don’t manifest in financial sector losses, they will do so via slowing growth and deflation, as they did in Japan,” said Chu. “China is confronting a massive debt problem, the scale of which the world has never seen.”

As a reminder, here's a look at the scope of the "problem" Chu is describing:


And here's a bit more on special mention loans and the ubiquitous practice of "evergreening":

Slicing and dicing the official loan numbers, Christine Kuo, a senior vice president of Moody’s Investors Service in Hong Kong, focuses on trends in debts overdue for 90 days, rather than those classified as “nonperforming.” Another tactic some analysts use is to add nonperforming debt to “special mention” loans, those that are overdue but not yet classified as impaired, yielding a rate of 5.1 percent.


Banks’ bad-loan numbers are capped by “evergreening,” the practise of rolling over debt that isn’t repaid on time, according to experts including Keith Pogson, a Hong Kong-based senior partner at Ernst & Young LLP. Pogson was involved in restructuring debt at Chinese banks in 1998, when their NPL ratios were as high as 25 percent.

So let's just be clear: if 8% is a "neutron bomb", a 21% NPL ratio in China is the asteroid that killed the dinosaurs. Here's why: 

If one very conservatively assumes that loans are about half of the total asset base (realistically 60-70%), and applies an 20% NPL to this number instead of the official 1.5% NPL estimate, the capital shortfall is a staggering $3 trillion. 

That, as we suggested three weeks ago, may help to explain why round after round of liquidity injections (via RRR cuts, LTROs, and various short- and medium-term financing ops) haven't done much to boost the credit impulse. In short, banks may be quietly soaking up the funds not to lend them out, but to plug a giant, $3 trillion, solvency shortfall. 

In the end, we would actually venture to suggest that the real figure is probably far higher than 20%. There's no way to get a read on how the country's vast shadow banking complex plays into this but when you look at the numbers, it's almost inconceivable to imagine that banks aren't staring down sour loans at least on the order of a couple of trillion. 

To the PBoC we say, "good luck plugging that gap" and to the rest of the world we say "beware, the engine of global growth and trade may be facing a pile of bad loans the size of Germany's GDP."

We close with the following from Kroll's senior managing director in Hong Kong Violet Ho (quoted above):

"A credit report for a Chinese company is not worth the paper it’s written on.”

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Aussie Battler's picture

Sounds like a recipe for moe stimulus, BULLISH

Ham-bone's picture

China...Fictional Fairytale Vs. Factual Truths

China is economically doomed but do they hold the ultimate trump card in 10k+ tons of gold???

zaphod's picture

This is how real estate works in China.

1) Borrow $100M from your local government crony
2) Build a massive apartment complex that no one will ever live in
3) Sell 0 out of 10,000 units
4) Rent ~10 units for a low rental fee that yield ~$10K/year
5) Go back to your government contact and renegotiate the loan to 0.01% interest so everyone can save face

You have now created a $100M successful project. It built 10,000 apartment units, of which 10 are lived in. Those 10 units pay $10K/year in rent, which covers the $10K/year in interest payments on the $100M loan (at 0.01% interest).

You now have a platform to show everyone how you successfully built a "performing" $100M complex, and use that for your next $1B project.

4shzl's picture

Charlie Chan say: "Bad loan like dead fish -- cannot stand the test of time."

JLee2027's picture

3 Trillion or 5x Lehman Brothers.  Yeah, that would take it all down.  Get your ropes and trees ready...

Surviver22's picture
Surviver22 (not verified) JLee2027 Nov 3, 2015 4:16 AM

Current Events Linked to Ancient Biblical Prophecy!

ironmace's picture

Good. Fuck em. Let them haul firewood for food in there BMW's and Range Rovers with donkeys tied to the bumpers pulling them.

Trade in your Bentley for a wooden wheeled cart, Sum Ting Wong.

Buck Johnson's picture

That will happen, trust me.


JenkinsLane's picture

When I read the headline I said "Jesus" out loud.

lazysunday's picture

Oh so the gap is exactly the UST reserves....

t0mmyBerg's picture

It has been obvious for some time that China will have NPLs of something between 3 and 10 Trillion dollars.  To put that in perspective, the Subprime crisis was somthing a lttile over what, 1 trillion?  And that occurred in the West which is much better capitalised and has much better functioning and deeper markets than China.  They will try to paper it over, but the sheer numbers boggle the mind.

I have put the question to well-connected china experts who are somewhat on the cheerleading side and they just seem to think the government will be able to easily deal with it.

I fail to see how.

CHoward's picture

The Chinese will be fine.  I've known people who are as stupid as a brick and have come out smelling like a fucking rose. 

Ban KKiller's picture

Let's just rewrite the loans. No failures allowed. Right? Can NOT admit mistakes...

malek's picture

OK - and for comparison how big is the Neutron Bomb the US is sitting on?

jcdenton's picture

32.8 TRILLION ..

in CASH ..

if we will take it .. (Read Me First)




Why is this so hard?

Grandad Grumps's picture

It took me a while to figure out that defaulted loans mean nothing to a bank... just more useless numbers.

Banks bring money into the world from thin air and can take it out the same way. When a loan defaults, all the bank loses is the future income, no principal because it never existed.

yogibear's picture

Wake me up whe the hundreds of trillions in dervatives blow up.

kaboomnomic's picture

Let me get this straight. 3 T$ of BAD DEBT??

Let's see:


CHINA CURRENT ACCOUNT (OH... FUCK!! Just this 2015 year? China total current Account nearly 3 T$!!)

That of course. IF (and I mean a BIG IFF'S) that china wants to BAILOUT ALL THAT TOXIC DEBT!! Do you really think that China will bailout any companies that ISN'T GOV'T OWNED COMPANIES???

Pretty much DUMB article from somebody claiming to knows about economic's..

economessed's picture

The communists sure do suck at capitalism.  Who could have ever seen this coming?

xrxs's picture

Don't worry, the ghost cities will fill up any day. /s

TheSheepWolf's picture

How about all of those Syrian refugees? They could help fill this up, right? Oh wait a sec... They would not get few hundreds of EUR every month... 

TheSheepWolf's picture

How about all of those Syrian refugees? They could help fill this up, right? Oh wait a sec... They would not get few hundreds of EUR every month... 

Dr. Bonzo's picture

After reading about this shit for 7+ years this is getting fucking old. Explode already.

fowlerja's picture

The Chinese are in big me...when I was non-performing about 20% of the girl friend threw me out of her house.

gregga777's picture

"But, the people of China owe all of that debt to themselves."

Well, yeah, in a perverse manner that's right. Just take that estimated $3 trillion in non-performing loans out of the deposits that the people of China have on deposit at Chinese banks or in brokerage accounts and use it to bail out the Chinese banks. There. The people of China paid that debt that they owed to themselves. I don't think that they'll look at it that way. Do you?

Hmmm, maybe that explains the massive capital flight out of China. The insiders must know that there's a massive "bail-in" coming and they are trying to get their deposits out of Chinese banks and out of China. They are in for a big "bail-in" surprise if they are putting that money into American banks. Or European banks. Or any bank for that matter! They are "damned if they do and damned if they don't."

Bunga Bunga's picture

Yawn, shit is hitting fan. Who could have thunk? Run as fast as your internet connection and get on Huobi or OKCoin.

Crabshacker's picture

Well...I have a pack of hot dogs on a stick hanging out my window, so, I'm covered...

Crabshacker's picture

Well...I have a pack of hot dogs on a stick hanging out my window, so, I'm covered...

bankonzhongguo's picture

Not that it matters but I audited the SOEs for years in good and bad times across most industries and segments domestic and international operations.

If you applied normal and customary OCC review with every internal credit policy you would find half of all commercial credits non-performing - just rolling over quarter after quarter on the whim of the long suffering provincial command branch.

Now you might be able to stand on your high horse and shame these guys for a lack of corporate governance skills, but after what the Fed and its shareholders have done to regulators and the real estate industry - well just say the MBA crowd is finally reading China's Confucius Banking Reg playbook - Heaven is High and Mao Wang has Left the Building.

On one hand you have trillions and in the other you have Asian political culture. Somewhere in between your have somebody's brother in law living in a $5 million house in Arcadia with no furniture trading on the factory's 180 day Acceptance willing to burn millions in inventory so his uncle can put $10,000 in his back pocket and buy a Lexus

East or West it's all a demented bankers' slaughterhouse.


luckylongshot's picture

While we look at the Chinese banking system through western eyes we should not. China owns its central bank and so is one of the few countries where the criminal Rothschild led private banking cabal is not in charge. This means the Chinese can and do cancel non performing loans, can and do make loans interest free and can and do give start up loans that do not have to be repaid. What is happening in China may not turn out to be that much of a problem.

laomei's picture

China NPL data is bullshit.  To the system in China, a loan that misses interest payment isn't NPL.  Missing principal repayment is also not NPL.  It has to be something like 90 days late in paying back the principal to be NPL. Which means, they can miss every single payment and then have another 3 months to work out a deal to avoid being classified as NPL.  It's more or less all garbage and it's being churned... loans being taken on to pay back loans and wages, over and over and over again.  

tool's picture

OK I've got it. All that money pouring in to property from those so call new rich Chinese business people are actually banana stand venders who claimed they needed a business loan to expand their business. They funnel the money overseas to store it in a house outside China and beyond the clutches of the bank and their government. Makes sense if the government is demanding banks make loans to stimulate the economy wouldn't you take it and run. The beautiful thing about the scam is you don't default because the banks are forced to roll over the loan so its all good and gives you time to get you and your family the fuck out of China and live the life of a millionaire????

hedgiex's picture

No worries. Monetize the debt with ZIRP. Of course, they cannot control the global markets so let the RMB go with token defenses. What's new. The spillovers to the Asian economies (except Japan a contortion on its own) hugging to their vanities (i.e. their currencies) which are all overvalued. Pay them in RMB and enjoy the discounts.