The End of the Nonperforming Loan Bubble – More Supply, Less Credit

At the end of 2017, China’s market for nonperforming loans (NPLs) was a bubble. Asset management corporations (AMCs) and investors were willing to pay huge price premiums for banks’ bad loans. The president of China Great Wall Asset Management Co., Zhou Liyao, attributed the bubble to a period of “irrational exuberance.”[1] But a better explanation is that prices were inflated by the influx of new, inexperienced investors backed by cheap credit. However, the bubble is now over, with prices having declined precipitously since the first quarter of 2018 on the back of a sharp increase in the supply of bad loans and a contraction in shadow banking that had previously been an important source of investors’ funding.

However, lower prices are a mixed blessing. On one hand, a price correction is undoubtedly important to ensuring that distressed debt investors make a sustainable contribution to what is likely to be a long, drawn-out process of NPL disposals by the banks. Already there are signs that large, foreign institutional investors that focus on distressed debt, the mainstay of banking sector clean-ups overseas, are investing more in Chinese NPLs now that prices have come down to more rational levels.

But on the other, the bubble meant that banks could extract more value from their bad loans than would otherwise have been the case. In contrast, lower prices raise the cost to banks of writing off NPLs. And with banks under increasing pressure from regulators to dispose of ever more bad debt, that will accelerate banks’ need to raise fresh capital.

During the clean up of the last wave of Chinese bad loans, which started in 1999, AMCs typically either held onto the bad loans they acquired or they sold them to a handful of foreign investors (mainly investment banks) and local governments (who acquired the debts as a way to protect local industry). There wasn’t a pool of local, private investors willing to buy portfolios of bad loans.

That changed about three years ago when Chinese private capital started investing in NPLs. Interest quickly accelerated such that in December 2017, the Economic Observer, a Chinese business newspaper, reported that there were as many as 3,000 private investment funds of various sizes “eyeing” the bad loan market.[2] Although the funds took on different forms—ranging from wealthy individuals to entities that were part of existing private equity firms—what they had in common was a lack of prior experience investing in distressed debt. Competition among these new market entrants, particularly in wealthier provinces like Jiangsu and Zhejiang, pushed up prices for bad loans, which in turn inflated the prices AMCs were willing to pay banks.[3]

“Last year was a feast, especially in the fourth quarter,” said Xie Jia, general manager of the NPL disposal center at Industrial and Commercial Bank of China (ICBC), in July this year.[4] “AMCs’ enthusiasm for buying NPLs was extremely high, as were prices…Some bidding was abnormally intense, far exceeding banks’ expectations.”

At the beginning of 2017, NPL portfolios were typically being acquired by AMCs for about 30% of the face value of the loans.[5] But by the second half of the year, that rose to about 50%, with some portfolios of bank loans being acquired for as much as 80% of the underlying debt’s face value.[6] Prices have since fallen precipitously.

According to Zhong Bin, a general manager at China Orient Asset Management Co., “In the first quarter of this year [2018], the average price of a portfolio of assets [we purchased] was 45% of face value. In the third quarter it was 38.9%, which is about 10 percentage points lower than at the end of 2017.”[7]

A Shadow of Its Former Self

Xie from ICBC dates the decline in prices from the first quarter of 2018, which coincides with the contraction of shadow banking. Starting in March, the outstanding volume of trust and entrustment loans—those components of the People’s Bank of China’s (PBOC) total social financing (TSF) data at the core of shadow banking—has contracted every month (see Figure 1).

While overall credit to the Chinese economy has continued to increase on the back of rising bank loans and bond issuance, the tightening of core shadow banking channels has stymied the flow of credit into financial assets like NPLs. That has likely been further compounded by the collapse of dozens of P2P platforms in the middle of the year as a result of tighter government regulation. Investors had relied on debt raised from shadow banking sources to buy far more NPLs than would have been possible with their own capital only.

Fading Shadow
Monthly change in the two major categories of shadow banking, in billions of yuan
Source: People’s Bank of China.

PwC’s distressed debt team, which is heavily involved in this space, had the following to say in a November report: “Chinese buyers don’t typically have lots of capital at their disposal. This means they need to borrow in order to complete larger deals. Given the clampdown on lending in China, not only by banks, but also by shadow lenders (including the AMCs), domestic investors are finding it difficult to raise the necessary funds needed to acquire portfolios, big or small.”[8]

Too Much of a Bad (Loan) Thing

Falling prices have also been driven in part by a spike in NPL supply. According to data from the China Banking and Insurance Regulatory Commission (CBIRC), China’s banks disposed 800 billion yuan worth of bad loans in the first half of 2018, up 28% from a year earlier.[9] That’s likely the result of greater pressure from the CBIRC on banks to clean up their loan books. In a statement published on January 13, the banking regulator labelled banks’ “covering up” of NPLs as a source of market turmoil and promised to make it a focus of its operations.[10] That followed a year in which fines imposed on banks—hitherto sparingly doled out—spiked sharply and were heavily targeted at transgressions that involved bad loans.[11]

Meanwhile, in March it was reported that the CBIRC intended to cut the level of reserves banks needed to hold against bad loans from 150% to 120%, a move that would give banks space to more aggressively write off NPLs.[12]  (It’s important to note that more aggressive write-offs haven’t been accompanied by banks disclosing higher NPL levels. Rather, regulators appear to be willing to tolerate banks reporting unrealistically low levels of bad loans, thereby lessening pressure on the banks to raise fresh capital, as long as they actively dispose of their bad assets.)

No Bubble, More Trouble            

For the AMCs, the end of the bubble is not necessarily a boon. Last year the AMCs were able to buy NPLs from the banks and then flip them at higher prices to the secondary market. The end of the bubble likely means that AMCs have been left holding some NPLs for which they paid more than the current market rate, resulting in loans that some market participants quip have become “nonperforming” for a second time.

At the same time, AMCs are under increasing political pressure to return to their “core business” of buying NPLs. This is born partly from Beijing’s desire to see the AMCs extricate themselves from shadow banking activities (see here for our previous report), but also from the need to provide greater support to banks in their efforts to dispose of larger volumes of bad loans. The decline in demand from the secondary market makes it more difficult to do that by putting the burden on AMCs to work through bad loans themselves—potentially even holding them indefinitely—a process that will require more capital.

The retreat of domestic investors has resulted in the AMCs becoming more welcoming of, and even courting, foreign distressed debt investors. Although reluctant to get involved initially, these foreign funds have been monitoring the situation for years in anticipation of the inevitable banking system clean-up that would unleash a wave of bad loans on the market. And the recent fall in prices may just cause them to reconsider their options. According to PwC, foreign funds have already acquired 12 portfolios of NPLs in the first three quarters of 2018, compared with only nine for the whole of 2017.[13]

Lower prices may attract foreign capital, but for Chinese banks, they may soon long for a return of the 2017 bubble. Extracting less value from NPLs means that the cost of writing off loans is higher. That must come out of profits or, failing that, shareholder equity. With slowing economic growth eating into banks’ profits, the need for banks to recapitalize will mount, particularly if they intend to further accelerate the pace of bad loan write-offs (see Figure 2).

Rising Write-offs
Quarterly bank write-offs of NPLs have risen notably from a year earlier, as outstanding NPLs continue to climb upwards
Sources: PBOC, CBIRC.


Over the past nine months, the dynamics of China’s NPL market have shifted significantly. It has been driven by Chinese regulators’ renewed commitment and greater urgency to clean up the financial system and write off bad loans. The shifting priorities have led to the shrinking of the shadow banking system. However, with growth slowing, combined with central policymakers’ clear concerns about the private sector’s inability to tap sufficient credit, it remains to be seen how far and how fast the regulators are willing to push their agenda of financial rectitude.


[1] Dong Wei,“长城资产总裁周礼耀:用创新发展挖掘逆周期“宝藏”” (China Great Wall AMC President Zhou Liyao: Use Innovative Developments to Dig out Counter-Cyclical ‘Treasure’), China Youth News, November 6, 2018

[2] “万亿不良资产市场引多机构竞相围猎 爆发或暗藏风险” (One trillion yuan distressed asset market guides many institutions to compete or conceal risk), Economic Information Daily, December 1, 2017,

[3] While investors can buy one or two loans from banks, usually via exchanges or e-commerce platforms like Taobao, only AMCs can buy batches of three or more loans directly from banks. Investors can then negotiate to buy portfolios of bad loans from the AMCs.

[4] Li Yumin, “不良资产供给扩张价格下滑10% 高价抢“包”不复存在(Nonperforming asset supply expands and price falls; overpriced bun scramble has ended),” 21stCentury Business Herald, July 6, 2018

[5] “万亿不良资产市场引多机构竞相围猎 爆发或暗藏风险” (The trillion yuan NPL market is creating competitive hunting among institutions; is risk erupting or being concealed),’ December 1, 2017, Economic Information Daily

[6] Yang Jiao, “等待供应增加、价格下降,不良资产处置市场“变天”” (Waiting for supply to increase, prices to fall, and the NPL disposal market to undergo a makeover), Yicai News, May 29, 2018

[7] Yang Chang, “商业银行不良资产暴露有所增加” (Exposure of commercial bank distressed assets increases), Economic Daily, November 12, 2018

[8] “2019: A Sunnier Outlook for International China NPL Investors,” PwC, November 2018,

[9] “加强监管引领打通货币政策传导机制提高金融服务实体经济水平” (Strengthening regulation in order to guide the monetary policy transmission mechanism to raise the level of financial service to the real economy), China Banking and Insurance Regulatory Commission, August 11, 2018

[10] “中国银监会关于进一步深化整治银行业市场乱象的通知” (CBRC notice on deepening remediation of banking industry market turmoil), China Banking Regulatory Commission, January 13, 2018

[11] Jason Bedford, “UBS Evidence Lab: Banks behaving badly – What 12,534 bank fines tell us,” UBS, August 30, 2018.

[12] Li Zheng and Engen Tham, “China regulator to cut banks’ bad debt buffers: sources,” Reuters, March 6, 2018,

[13] “2019: A Sunnier Outlook for International China NPL Investors,” PwC, November 2018,

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