China: Will Financial Bubbles Burst?

A Chinese woman borrowed 200,000 yuan, or about 30 million won, from the Industrial and Commercial Bank of China in 2001 on behalf of her elder brother who used the loan to buy a Volkswagen sedan. Her brother did not repay the loan, and she fell into default. However, she took out new loans from another bank.

A real estate developer was able to receive loans from a bank although he did not present any of the four permits necessary for a loan. A steelmaker, which has expanded operations with $3 million in bank loans, is in the process of receiving another $7 million in additional loans for another expansion. It is widespread in China that corporations and consumers are recklessly expanding investment and consumption with the money that loan lenders are blindly handing out. The Chinese government announced a measure to tighten up conditions for loans, but it won’t temper the trend of “don’t ask how” loans, the Wall Street Journal reported.

In 2003, personal-credit lending totaled $188.5 billion, more than 4.5 times the 2000 level. The problem is that lending takes place without checking the borrower’s solvency capacity. In some areas of China, default rates for student and auto loans are more than 30 percent. The upward trend will likely bring more pressure on China’s banks which already have $400 billion in non-performing loans.

Shanghai Credit Information Services Co., a credit rating bureau established in 2000, has linked all bank branches in major Chinese cities to allow them to share information electronically. However, information about loan applicants is scant. The bureau’s service is limited to auto loans. In China, no laws require banks to share credit information with each other. A lender in default of a loan from one bank can borrow money from another.

The same is true of corporate loans in China, where total investment made up almost 50 percent of GNP last year. Much of total investment took place in the form of loans. As of last year, there were 100 automobile manufacturers and 4,318 cement plants. Bank loans have fueled overinvestment.

Last week, China’s financial regulator set a ceiling for corporate loans and demanded banks to enforce conditions for loans in a move to stop debt-fueled consumption from pressuring the banks.

However, local governments are encouraging reckless lending and investment for economic growth in their regions. The central government is shunning itself from raising interest rates and introducing redundancies because it wants to keep the value of the yuan, which is under pressure for appreciation, unchanged and to keep the economy growing by eight percent annually.

“If bank insolvency is coupled with overinvestment, the entire Chinese economy will go south,” Pak Rae-jeong, a researcher at LG Economic Research Institute, said. “It all depends on how the Chinese government will implement financial reforms.”

Seung-Jin Kim sarafina@donga.com