By Jin Yan

In recent years, China's banking industry has made considerable progress in disposing of NPLs and preventing lending risks, with the NPL ratio dropping year by year.

The ratio of NPLs at Chinese banking institutions fell by 3.92 percent, 4.48 percent and 3.39 percent, respectively, in the past three years.

At the end of 2003, the outstanding NPLs at state-owned commercial banks, by the five-category classification system, decreased by 171.3 billion yuan (US$20.6 billion) from one year earlier, while its NPL ratio stood at 20.36 percent, down by 5.85 percentage points from the beginning of the year.

The measures to dissolve financial risks include, first, the establishment and perfection of the financial supervision system.

The first plenary session of the 10th National People's Congress decided in 2003 to establish the China Banking Regulatory Commission (CBRC) to supervise banks, financial asset management companies, trust companies and other depository institutions.

At present, the CBRC is designing regulatory appraisal as well as early warning systems for both Chinese and foreign commercial banks in an effort to improve its regulatory apparatus.

Second, NPLs were disposed of on a consolidated basis. China set up four financial asset management companies (AMCs) to dispose of non-performing assets on a consolidated basis, stripping off and taking over 1.4 trillion yuan (US$169 billion) in NPLs from State-owned commercial banks.

The AMCs then used leases, transfers, restructuring, debt-for-equity swaps and asset securitization, among other methods, to dispose of the non-performing assets.

By the end of last year, the AMCs had disposed of 509.4 billion yuan (US$61 billion) in non-performing assets (excluding policy-based debt-for-equity swaps), recovering 99.4 billion yuan (US$11.9 billion) in cash, which accounted for 19.52 percent of the non-performing assets disposed of.

Third, multiple measures were adopted to step up efforts to rejuvenate NPLs. Efforts were made to explore possible ways of NPL disposal, such as debt dunning and lawsuits.

Guidelines on Risk-based Loan Classification were promulgated in 2001 to enhance banks' capacity in writing off bad loans.

The Accounting Standards for Financial Institutions were enacted in 2002, which specified that the financial institutions should set aside adequate specific provisions according to results of the five-category loan classification, and write off bad loans promptly.

Fourth, new measures like debt restructuring were used to lessen asset risks, as commercial banks sliced off part of their non-performing assets to specialized internal departments for professional management.

Although considerable progress has been achieved in recent years in the NPL disposal work by China's state-owned commercial banks, their non-performing ratio is still relatively high, and the task of preventing and dissolving credit risk remains tough.

The AMCs set up in 1999 only took over idle, overdue and bad loans by the classification method in use then from State-owned commercial banks, and a considerable part of their NPLs were not included. Therefore, a fairly big chunk of their NPLs remained in the hands of the four State-owned commercial banks.

And they face many difficulties in disposing of their NPLs. The costs of debt dunning and lawsuits are high, their NPL-recovering archary is limited, and the long inadequate bad loan provisioning requires a long period of time to reduce their bad loans.

First, the risk-based supervision of banks will be strengthened. Supervisory standards need to be raised, and operational risks at depository financial institutions evaluated on a comprehensive basis to understand the reasons for such risks and formulate risk-control measures.

Meanwhile, the surveillance of state-owned commercial banks' work in reducing both the volume and ratio of their NPLs must be enhanced, with the focus on 13 indicators in the four categories of asset quality, profitability, liquidity and capital adequacy.

The five-category loan classification will be further improved and inspections looking at implementation work carried out. All the commercial banks will formally adopt the five-category loan classification this year, while the old four-category classification system will be abolished.

A prudential accounting system and transparent information disclosure system need to be established. Banks must clean up losses in both bad loans and non-loan assets, according to prudential accounting standards, and raise the scale and scope of bad loan provisions, while regulators elevate capital adequacy supervision and strengthen the restraint of capital.

Second, commercial bank reform will be stepped up. They need to establish sound corporate governance structures and organizational systems to assist stable operations and sustainable growth.

The banks must formulate specific development strategies while ushering in domestic and foreign strategic investors to gradually diversify the investor structure.

Third, the NPL disposal work at banks needs to be linked with the reform of state-owned enterprises (SOEs). Some will be involved in policy-based bankruptcies.

The state will, in accordance with the needs generated by industrial structural adjustments, enforce the bankruptcy of SOEs that are insolvent, facing resource depletion or have been recording chronic losses.

That will help promote the strategic adjustment of the State sector and improve the quality of bank assets.

A total of nearly 200 billion yuan (US$24 billion) in bad loans to bankrupt enterprises were written off from 1998 to 2002.

Fourth, market mechanisms need to be actively adopted in disposing of NPLs. Efforts will be made to improve the social credit system so market mechanisms and market-based pricing principles can play bigger roles in the disposing of SOEs' bank liabilities.

The development of the capital market needs to be promoted aggressively to increase the proportion of direct financing for SOEs.

Efforts will be made to explore new ways for banks to dispose of their NPLs to assist both the banks' NPL disposal work and the reform of SOEs.

Jin Yan: senior expert at the Research Bureau of the People's Bank of China

(China Daily March 24, 2004)