Repackaging China Banks' Monstrous Loan Growth Debts Will Lead To China's 9-11 ?

China’s record loan growth and the repackaging and selling of debt by its banks has raised credit risks “considerably,” and might lead to another financial crisis, Fitch Ratings Ltd. said.

“Credit is disappearing from bank balance sheets, resulting in a pervasive understatement of credit growth and credit exposure,” Charlene Chu, Fitch’s senior director of financial institutions for China, said at a conference in Singapore today. “But credit risk has not disappeared, merely been transferred to investors.”

China’s government unleashed a record 9.59 trillion yuan ($1.4 trillion) lending boom last year to stimulate the economy amid the global credit crunch. The nation’s banking regulator has told lenders to report on their risk exposure by the end of this month to help prevent a pileup of bad loans.

Growing numbers of Chinese banks are entering increasingly complex transactions designed to circumvent regulations, according to Fitch. They involve banks selling loans to a trust company, which then creates a wealth-management product around them and gives these back to the bank to distribute. Banks then sell on the product to investors and with the money, pay off the loan, the risk assessor said.

“When we talk to banks about this they say, ‘We’ve sold on the loan and we have no exposure. If the product goes bad, it’s the investors who’ll wear the loss,’” Chu said. “Our view is, it sounds a lot like Lehman minibonds.”

Banks in Hong Kong and Singapore sold credit products guaranteed by Lehman Brothers Holdings Inc., known as minibonds, which crashed after the U.S. firm’s bankruptcy in 2008. Thousands of individual investors lost money on the notes, leading Hong Kong to crack down on sales techniques.

Less Data Flow

Chinese banks’ unwillingness to disclose loan information means the extent of problems could be worse than thought, Chu said. “Chinese banks have realized we’re tracking this and have begun to cut back data flow,” she said. “Disclosure about this issue is extremely poor and getting worse.”

Historically, Chinese banks have posted an average expected recovery rate of 34 percent on corporate non-performing loans, despite 72 percent of loans being supposedly backed by collateral, guarantees or pledged assets, a Fitch analysis of the 2009 financial statements of listed banks shows. Loans are typically termed non-performing after being in default for three months, depending on contract terms.

“Poor legal framework guiding such activity means unwinding these transactions in the event of a default could get very messy, particularly as the transactions become increasingly convoluted,” Chu said.

“Accelerating loan growth has considerably raised credit risk exposure,” Chu said. “Future asset quality deterioration is a near-certainty.”