Effects of China's Non-performing Loans On Banking Financial Statement and Financial Statistics

Essay by zjzjUniversity, Bachelor'sA-, June 2004

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Effects of China's Non-performing Loans

On Banking Financial Statement and Financial Statistics

1.0 Overview of NPL in China

● NPL definition

As a matter of fact, there were no so-called NPLs in the minds of Chinese bankers until 1996. The Loan Rule, formulated by the People's Bank of China in 1996, stipulated that there were three types of NPLs, 'overdue', 'doubtful' and 'bad'. This approach underestimated NPLs as it did not include highly risky loans that were still payinginterests and were not yet overdue. Lardy (1998) suggests other reasons why the NPL problem might be underestimated in the old Chinese system. Bank accounting and auditing practices in China have severe shortcomings; external auditing was not a common practice until very recently. Apart from NPLs, banks often have substantial non-performing assets that are not reported. Finally, because the data on NPLs exclude interbank and trust lending as well as credit that is concealed in balance sheets as 'other items', they may underestimate significantly the total amount of non-performing assets.

In 1998, China adopted the international standard loan classification scheme that consists

of five categories: normal (pass), special mention, substandard, doubtful, and loss (unrecoverable). Reclassification of loans using the international standard was completed in the four large SOBs(State owned banks) by July 1999.

● History

The non-performing loans (NPLs1) of China's banks, in particular state-owned banks and entrust & investment companies mainly accumulated in the period of 1992-1997 during which China experienced first a high inflation and then a contraction. At the end of 1997 NPLs accounted for 35 percent of the total outstanding loans of financial institutions as a whole . Foreign analysts estimate that the bad loan ratio of Chinese banks is about 50%, or twice the official estimate.

● Causing factors

The rapid accumulation of NPLs during that period...