Dealing with the bad loans of the Chinese banks

Abstract

Chinese banks suffer from serious financial fragility manifested by high proportions of nonperforming loans and low capital-adequacy ratios. A key policy introduced recently by the Chinese government to reduce financial risks is the establishment of four asset management companies (AMCs) for dealing with bad loans. Drawing on the experiences of the Resolution Trust Corporation in the United States and bank restructuring in the Central European transition economies, we argue that the original AMC design will not be successful in resolving the existing nonperforming loans, nor will it prevent the creation of new bad loans. We recommend a modification of the current proposal that redefines the relationships between the parent banks and the AMCs by transferring the deposits of problem enterprises along with their nonperforming loans from parent banks to AMCs.