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China Bad Loans May Reach Total of $900bn

China's total liabilities for non-performing loans may be as high as $900bn, dwarfing official estimates and outstripping the country's massive foreign exchange reserves, according to a study of Beijing's bad debt problem.

The firm's estimate of NPLs in the big four banks will be of interest to foreign investors, who have put billions of dollars into three of the lenders as part of overseas initial public offerings.

China Construction Bank successfully listed in Hong Kong in late 2005, while both the Bank of China and the Industrial and Commercial Bank of China, the country's largest lender, are due to float overseas this year.

The latest estimate of China's total liabilities compares with the firm's 2002 estimates of NPLs, which was calculated at $480bn.

The survey says the higher estimate results from better access to information, a tide of potential new NPLs arising from China's rapid loan growth and the realisation that the problem was not confined to large banks and the distressed debt companies attached to them.

Aside from the large banks, the new estimate includes bad loans in state investment companies, credit co-operatives ¨C many of them in rural areas ¨C and other vehicles set by the government to dispose of bad loans.

China's build-up of bad debt, even as the economy has been growing at rates of 9 to 10 per cent, is at odds with the survey's broader finding that the global NPL position had improved.

"With the exception of China, every market covered [by Ernst & Young] in the 2004 report has witnessed a reduction in its level of NPLs written before 1997," the report says. "China's banks are at a crossroads in addressing their NPL problems."

Ernst & Young's mostly gloomy findings mirror a similar report published last week by PwC, which said bad loans were being added to a financial system in China that had yet to be fixed.

"While NPL ratios appear to be decreasing [in official figures] in number, NPLs are probably increasing," said the report's author, Mike Harris.

However, Mr Harris said there was some cause for optimism as the four distressed debt companies China established in 1999 to take loans off the books of the big four banks had become more active this year. In recent years, they had offered only about Rmb20bn ($2.5bn) a year in auctions of bad loans to foreigners but this year could sell as much as Rmb150bn, Mr Harris said.

The lack of activity in China's NPL market had been turning off foreign investors. Auctions that attracted 20 or more investors a few years ago now drew in only about five to 10, said Ernst & Young.