China State Commercial Banks' Non-Performing Loans: Workout and Prevention

Abstract

The purpose of this thesis is to examine the very significant problem of State bank nonperforming loan (NPL) in China. NPLs undermine the stability of China's banking system and the efficient operation of its markets. This thesis will make recommendations for developing better workout procedures to deal with existing NPLs and explore the role of banking regulation and supervision in NPL prevention, as well as in avoiding impacts of NPLs on the stability of banking system, drawing on experiences at national, regional and international levels. The accumulation of NPLs in China has been caused by the dominant role of State banks in China's financial markets, policy loans to state owned enterprises (SOEs), unnecessary administrative controls on banks' lending activities, weak internal controls within State banks and inappropriate banking regulation and supervision. All these have seriously ruined the conditions of market discipline in China and resulted not only in large amount of NPL stock, but also the constant creation of new NPLs on State banks' balance sheets. The NPL problem in China is not limited to individual banks. It is a systemic problem closely connected to the SOE problem. The existing bank NPLs cannot be worked out without debt and enterprise restructuring. The balance sheets of banks and firms must be cleaned up by, first, recapitalizing banks to write off and make provision for existing NPLs, and, second, setting up independent asset management companies to purchase and manage bank NPLs. To prevent the increasing accumulation of new NPLs, unnecessary administrative controls on banks must be removed; prudential banking regulation and supervision much be enhanced; appropriate internal control systems must be promoted within banks, especially with regard to the proper risk evaluation systems and internal decision-taking structures. To avoid the damaging impacts of NPL problem on the stability of the banking system, ' an explicit limited deposit insurance system should be introduced; the central bank's lender of last resort facilities must be properly defined; bank insolvency resolution mechanisms must be put in place. In a word, the proper functioning of market discipline must be restored in China.