Shandong vs. Zhejiang: Diverging Experiences of Bad Loan Disposals

Since 2015, China’s banks have disposed of their nonperforming loans (NPLs) in ever greater volumes as part of a broader effort to rein in financial excess and risk. Those efforts are typically analyzed at a national level or by bank type. But the cost of dealing with China’s bad loans is also distributed geographically, and not every locality is equally as capable of addressing the problem.

A spate of regional bank restructurings and bailouts over the past few months have been a leading indicator of the divergences that are emerging among provinces’ NPL conditions. But that divergence is showing up in official data too. According to provincial-level data from the People’s Bank of China (PBOC), the NPL ratios of some provinces worsened significantly last year. For example, Gansu’s level rose from 3.5% last year to 5%, while Liaoning followed closely with an NPL ratio of 4.9%, up from 3.7%. At the other end of the spectrum, Beijing had an NPL ratio of 0.34% in 2018, down from 0.37% (see Figure 1), quite an achievement given the outsized burden of its local government debt.

Figure 1. Provinces’ NPL Burden is Diverging

Province4 - Shandong vs. Zhejiang: Diverging Experiences of Bad Loan DisposalsNote: Provincial NPL ratios published by the PBOC include all “banking sector institutions,” a group that includes policy banks, trust companies, and finance companies, as well as other smaller finance companies. CBIRC also publishes more widely cited data based on commercial banks only, but those figures won’t be available until later this year.

Source: PBOC.

Perhaps what best exemplifies this divergence is the fate of Shandong and Zhejiang, two economic powerhouses that have experienced significantly different NPL outcomes. It also helps that the PBOC’s financial reports for those provinces provide far more detail that allow for better comparison. The NPL ratio for Shandong, the third-largest provincial economy in China, stood at 3.3% in 2018, the highest among the major provinces and up from 2.5% in 2017. Zhejiang, the fourth-largest economy, was at 1.15%, down from 1.64% a year earlier.

But these ratios only tell part of the story. Zhejiang’s healthier NPL ratio is the result of getting ahead of its bad loans problem. According to the provincial PBOC’s report, Zhejiang’s NPL ratio peaked at 2.37% in 2015 and began falling the following year after banks in the province disposed of 228 billion yuan in bad loans (see Figure 2). Since then, both Zhejiang’s NPL ratio and the annual volume of its bad loan disposals have continued to decline.

Figure 2. Zhejiang’s NPL Ratio Declined After NPL Disposals Peaked…Source: PBOC.

Shandong’s efforts trail those of Zhejiang by about two years, with the province disposing of 220.1 billion yuan of bad loans in 2018 (see Figure 3). But while aggressive NPL disposals in Zhejiang helped bring down its ratio, in Shandong the NPL ratio continued to rise. In fact, it appears that things will get worse for Shandong before they get better.

Figure 3. …But Shandong’s Ratio Continued to RiseSource: PBOC; local media reports.

For one thing, Caixin recently estimated that Hengfeng Bank—a local Shandong bank that is currently undergoing restructuring by the provincial government—will need to dispose of more than 100 billion yuan of bad assets. Moreover, the Shandong PBOC reports that in 2018, as a result of dealing with NPLs, bank profits in the province declined by 76%, after having already dropped 47% the year before. This has broader implications because according to the National Audit Office, 78 banking institutions in Shandong failed to meet minimum required reserves against loss impairments at the end of 2018. This will put even more strain on banks to raise fresh capital to deal with their NPLs.

In contrast, NPL disposal efforts in Zhejiang have seemingly paved the way for the banking system to massively increase credit within the province. In 2017, aggregate new financing (known officially as “total social financing”) in Zhejiang was up 78% from the year before. It rose again in 2018 by another 46%, at a time when authorities significantly slowed the pace of credit growth elsewhere (see Figure 4). Of the total aggregate new financing extended throughout the whole country in 2018, Zhejiang received 11%, even though the province accounts for only 6% of national GDP. In effect, the province has enjoyed its own mini stimulus.

Figure 4. After NPL Disposals Peaked, Credit Growth in Zhejiang Surged Compared to ShandongSource: PBOC.

Of course, given that other provinces haven’t provided comparable data, it’s difficult to know the extent of divergence across the country. But one thing is certain. Cleaning up the financial system will unquestionably play out differently among provinces, and these divergent outcomes will have significant ramifications for how resources are distributed and how regional growth prospects might differ in coming years.

Dinny McMahon is our fellow focused on finance and macroeconomics. He regularly writes about the cleanup process of China’s financial system.


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