Chinese banks pose a major risk

`China has turned upside-down the traditional logic that banks should worry about their customers defaulting on loans. In China, the customers worry over that their banks will default on them and their assets will be frozen.'

Taiwanese media have recently devoted a lot of coverage to banking news from Beijing. Reports say that since the China Development Bank has already provided 30 billion yuan (NT$1.2 trillion) in loans to Taiwanese businesses, while the Export-Import Bank of China, will also provice loans to Taiwanese firms.

Will this news prove to be much-needed relief to cash-strapped Taiwanese enterprises, or merely a pipe dream? Most media outlets have failed to provide balanced viewpoints in handling these stories, misleading the Taiwanese into thinking that it will be a boon.

Actually, the British newspaper Financial Times recently reported that last year China launched a plan to provide loans to Taiwanese businesses. As it approaches its first anniversary, it is apparent that the policy has proven to be a failure. Dozens of Taiwanese businesses have applied, but only a Shanghai subsidiary of Taiwan-based Hanbell Precise Machinery, the world's fourth-largest compressor manufacturer, was granted a 26 million yuan loan this past April.

According to other reports, a number of Taiwanese businesses that had sought loans from the China Development Bank have said that after submitting their applications, they discovered that the banking officials were unaware of how to conduct a bond float and completely ignorant of how to manage capital financing.

As a result, the bank asked that a credit insurance company back the applicant, which raised the cost of the loan far above that of a normal business bank. In addition, the bank lacked a branch network to serve applicant in other locations.

With the increase in cross-strait economic cooperation, Taiwanese firms have a growing need to obtain financing in China, especially small and medium-sized businesses. If China is serious about providing a financial channel for Taiwanese businesses, it should carefully pick partner banks that understand contemporary commercial finance.

Otherwise these loans will be nothing more than a charade, no matter how many more banks participate or how much money they lend. Policies that lack substance are nothing more than illusions to tease Taiwanese businesses. This leads to discussion about China's fiscal "united front" strategy and leads one to suspect that nation's political motivations.

It is also important to note that China's economy still falls under the direction of the government, whose policy has been to favor big business interests and gradually phase out support for medium and small businesses.

Why has it chosen to turn back from its earlier path? How long can this kind of policy continue? How should Taiwanese businesses respond when the money supply dwindles due to policy adjustments or internal changes in the banks?

This is not just speculation. Chinese banks are state-run, inefficient, financially insecure and have high amounts of bad debt.

Nonetheless, the China Banking Regulatory Commission just recently released figures indicating that during the first half of this year Chinese banks experienced a "double drop" in non-performing loans. It said that by the end of June, there was a total of 1.28 trillion yuan in non-performing loans in China's commercial banking sector, a 341 billion yuan drop since the beginning of the year. It also claimed that the proportion of non-performing loans dropped 1.1 percent to 7.5 percent of all loans.

But at the end of last month, Michael Petit, managing director of Standard & Poor's (S&P) Asia-Pacific corporate and government credit ratings division, said in a hearing of the US-China Economic and Security Review in Washington that "the most visible weakness" of China's financial system was the extent of its bad debt.

According to statistics from S&P, the total amount of China's bad debt had reached between 3.97 trillion yuan and 5.16 trillion yuan at the end of last year.

Well-known consulting and auditing company Ernst and Young also said in May that China's bad debt stood at 7.15 trillion, with four major state banks accounting for 2.84 trillion of this pool. Also in May, Fitch Ratings, another global ratings agency, estimated China's bad debt was 3.78 trillion.

Although there are substantial differences between the final calculations of these international financial institutions, they all far exceed the official Chinese government numbers. The frailty of the Chinese banking system and the glut of bad debt will a negative effect on China's economic growth and reform, and it may not be an overstatement to say that a collapse is possible.

Taiwanese businesses should ensure that they are prepared for this possibility and hedge against the loss of their investments.

It seems that China has turned upside-down the traditional logic that banks should worry about their customers defaulting on loans. In China, the customers worry over that their banks will default on them and their assets will be frozen. One could say that this is another kind of Chinese economic "miracle!"

Wu Hui-lin is a research fellow at the Chung-Hua Institute of Economic Research.

Translated by Marc Langer