Chinese Banks’ Dominance Endangered by the Rise of Non-Performing Loans
One of the core Financial Soundness Indicators, as identified by the International Monetary Fund (IMF), is a banks’ Non-Performing Loans (NPL) ratio. While the United States suffered from a financial crisis in 2007-2008 due to the sub-prime bust, among other factors, they continue to recover and show improved stabilization, as seen with the decline of NPL since 2012. Unfortunately, this is not the case for China’s Big 4, as their NPL has been increasing in recent years.
According to the UK Foreign Commonwealth Office, the majority of new Chinese Non-Performing Loans originate in 3 coastal regions: Circum-Bohai Sea, Yangtze River Delta and the Pearl River Delta. These regions are also the major exportation sites and industrial areas of China, suggesting the main drivers for increased NPL in China are the decline in exports, and subsequent overcapacity. Moreover, government policies to maintain the lives of money-losing businesses - the so-called“zombie factories”- have made the situation even worse.
In response to the rise of Non-Performing Loans, banks must re-evaluate their existing risk management and control systems. A better understanding of risk management is crucial to effectively tackle the problem of poor loan recovery, tighten the credit assessment policy, and implement appropriate monitoring procedures to manage Non-Performing Loans. Investment in development of a proper risk management framework to monitor NPL is beneficial as increased NPL risks generally lead to a greater need to consider appropriate provisions and capital requirements, as well as overall scrutiny of the balance sheet to minimize any potential decrease in profitability for the bank.
In our article, we identify a few measures that can be adopted by the Banks to closely monitor NPL. These instruments include, but are not limited to:
- Enhanced internal reporting to improve the classification of loans
- A thorough “education” for the staff in charge of credit concessions
- The definition of loan collectability goals to loan officers
- The revision of credit authorization lending limits and contract negotiation clauses
- The establishment (or reinforcement) of risk resolution teams
- A powerful data quality framework
- The implementation of risk management software
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