How to get a $295m loan from a Chinese bank:
1. Be a local government investment vehicle, or own one.
2. Say you will use the loan for a high-profile investment.
3. Proceed to use the money for something else.
That’s just what Jiangqiao, a Shanghai district township, did, according to a document reportedly issued by China’s National Audit Office. Sometime in 2008, Jiangqiao borrowed RMB2bn from two Chinese banks, via a local government investment vehicle (LGIV) owned by the township.
The money was borrowed in the name of the high-speed railway line being built between Beijing and Shanghai — a hugely important project for the Chinese government. No collateral was provided.
Instead of spending the funds on the railway, Jiangqiao reportedly used them for development projects completely unrelated to the train line. The explanation given :
“We were under heavy burdens to repay debt at that time,” an unnamed source inside the township financial firm told the [Guangzhou-based 21st Century Business Herald] newspaper.
A Chinese entity in need of cash? Did we read that right?
It seems rapid changes are afoot in the live-and-let-loose relationship between local governments and China’s commercial banks, which was formed when the country’s stimulus programme began in 2009.
Where once local governments could rely on banks for financing various (PRC-edicted) infrastructure and development projects, that credit line is beginning to tighten.
Chinese officials are increasingly making an effort to limit, or at least better scrutinise loans made to local governments. Proposed measures include things like letting the vehicles tap credit from banks only if the projects they are borrowing for are expected to generate enough cash to repay the loan.
At issue here is the interplay between China’s central government, the local governments and the country’s financial system. China may have allocated RMB 4,000bn for its stimulus package, but a large proportion of the country’s recent economic activity was nevertheless generated via commercial bank credit, issued on behalf of local governments and their investment vehicles.
Standard Chartered analyst Stephen Green puts the whole issue very well:
Forgive us if we appear cynical, but it may be useful to describe this whole [Local Government Investment] process as a game.
Part one of the game involved the LGIVs borrowing from the banks to finance investment projects, pretending they were able to repay the funds; the central government, focused on stimulating growth above all else, pretended not to notice. While many officials tried to warn of the problems building, the drive for growth ensured that they were mostly ignored. Local governments – betting that the bigger the problem, the more central government would ultimately have to bail them out – piled on as much debt as they could. This part of the game is ending only gradually . . .
With economic growth assured, part two of the game now starts. It involves the central government recognising that the risk of a fiscal crisis exceeds the risk of a growth crisis, and thus attempting to stop, or at least slow, the flow of credit. At the banks, loan officials will be looking to protect themselves by making sure letters of guarantee are secured and that collateral is defined.
But part two is trickier than it first appears. No one will want to cut off credit to a half-finished project; not only would this guarantee the creation of a non-performing loan, but it would also be politically unpopular. So the bank regulator has to allow banks to continue lending to unfinished projects. But if banks continue to lend to LGIVs for such projects, then the funds could flow to other places too. One cannot exclude the possibility that enterprising local governments might try to intentionally starve a few LGIVs of financing and make sure their problems are exposed, in order to pressure Beijing to keep the credit tap open.
Part three of the game will start when the central government moves to recapitalise the banking system with FX reserves, a solution widely assumed as likely these days. At this point, we do not know the scale of the problem – we do not yet know the size of the outstanding debt or of the extra debt that will have to be extended in 2010-11, or what repayment will be like. But as we pointed out recently, refinancing problems are likely to appear in 2010 in some areas as land-sale revenues plummet. It is unclear what degree these loans require capital to be paid down at some point. Obviously, such terms could be renegotiated if LGIVs were unable to pay.
An additional difficulty will be the wide reach of the problem. Many of the LGIV loans have been extended by city commercial banks (CCBs) and rural credit co-operatives (RCCs). According to the [China Banking Regulatory Commission's] initial figures, some CNY 1.4trn of loans have gone to thousands of county government-owned entities; these can basically be written off now. This means that the bailout package, when it happens, will involve many thousands of financial institutions. Thus, the package will not be just another large transfer of FX reserves to a few major banks. There could well be a wave of financial-sector consolidation at this point as large banks are recapitalised and asked to absorb hundreds of CCBs and RCCs.
There’s some debate as to whether China can actually recapitalise its banks using FX reserves, but the point really is that lurking underneath China’s economic recovery is a potentially-fermenting mass of local weakness — characterised by the kind of loan sketchiness being done in Jiangqiao.
Related links:
Frayed string for China’s property balloon – Andy Xie
China may face ‘massive’ bank bailouts - Bloomberg
China airs concerns over debt in regions – WSJ
China’s muni mess – Forbes