China Might Permit Banks to Exchange Bad Debt with Equity

China Might Permit Banks to Exchange Bad Debt with Equity

The central bank of China appears to be willing to permit commercial banks to exchange bad debts for equity stakes in companies, Reuters reported today. The development comes on the heels of the country revealing its revised economic target of 6.5 – 7% growth with exports dropping more than 20% in February. The move could be termed as a stimulus package aimed at strengthening the economy and inflating stock prices.

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Non-Performing Loans Surge

Last year, China witnessed a surge in non-performing loans (NPLs) as fallout from the economy growing at its slowest race in two and half decades. The China Banking Regulatory Commission’s official data indicated that the total amount of NPLs, debts, and ‘special mention’ loans, was more than four trillion Yuan or $614 billion at the close of 2015.

The move to allow the exchange of bad debt for equity would enable commercial banks to cut NPL ratios as they would need to set aside less cash to take care of the losses due to the bad loans. Also, such a move could free up fresh cash for lending to infrastructure products, as well as upgrades in factories as the establishment hopes that this would revitalize the country’s economy.

Special Approval from State Council

The State Council, which is a cabinet-equivalent body, would have to give its special approval for the new regulations. That would enable the establishment to skirt the requirement of revising the commercial bank law that curbs investments in non-financial institutions. The new regulations were in contrast to the earlier practice of selling the NPLs at a discount to asset management firms designed by the State. In turn, such asset management firms would either try to recover the NPLs or re-sell to distressed debt investors.

There are certain things that still need clarity from the People’s Bank of China like the banks valuation of the new equity stakes, i.e. the ratio or the amount of NPLs that represent assets on their balance sheets. In any case, the latest move provides a way for reducing the debt and cutting down the servicing costs so that they become worthy of fresh credit.