Nonperforming Loan Disposals Without Resolution

Abstract

Using proprietary data on nonperforming loan (NPL) transactions in China, we document that banks conceal NPLs in disposal transactions that are supposed to resolve NPLs. In these transactions, banks provide financing and retain the credit risks and debt collection obligations. Transaction prices contradict underlying credit risks: Despite being delinquent for 4.5 years, the median NPL package is sold at face value with zero haircut. The majority of NPL packages are resold at a premium to banks’ non–government-owned borrowers, further supporting the concealment view. Banks under stricter regulation conceal NPLs more and engage in more illicit concealment. NPL-concealing banks increase zombie lending, suggesting that an ineffective resolution exacerbates credit misallocation. Recognizing the hidden NPLs implies the total NPLs in China is two to three times the reported amount. This paper was accepted by Victoria Ivashina, finance. Funding: B. Charoenwong acknowledges financial support from the Singapore Ministry of Education [AcRF Tier 1 Research Grant A-8000760-00-00]. T. Ruan acknowledges financial support from the National University of Singapore (NUS) [Start-Up Grant A-0003870-00-00]. B. Charoenwong and T. Ruan acknowledge financial support from the NUS Business School Financial Database [Grant N-311-000-251-001]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.02163 .