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A Bad Bank is a Bad Bank - Analysing the Chinese Instance

Former Managing Director of Ahmedabad Stock Exchange
May 5, 2021 2:26 PM 4 min read

A bad bank is a bad bank. 

The job of a distressed asset manager or bad bank is to either liquidate or recapitalise troubled companies, and raise salvageable businesses out of distress. 

The Chinese Example

Huarong Asset Management Company, one of the four distressed-debt management firms of China, created 20 years ago, to dispose of the bad assets of China’s state-owned banks, is in deep trouble and its survival is in doubt.

In the late 1990s China experienced a massive bad debt crisis – there are estimates that more than half of its state-owned enterprises (SOEs) were insolvent in the mid 1990s – with the non-performing loans within the balance sheets of China’s four major banks thought to be between a quarter and a third of their total assets. The Chinese government reacted to the emergence of that destabilising mountain of bad debts by recapitalising the state-owned banks; carving out their non-performing loans and handing them over to four new asset management companies to manage such non-performing loans out of the system over time. These four AMCs are China Huarong Asset Management Co, China Orient Asset Management Co, China Cinda Asset Management Co and China Great Wall Asset Management Co.


How India Can Take A Hint

India needs to learn from the fiasco of China Huarong Asset Management Company, if its "Bad Bank" plans have to succeed. Union Finance Minister Nirmala Sitharaman has announced the concept of bad bank in the country. In her budget speech, Sitharaman said that an Asset Reconstruction Company and Asset Management Company will be set up that will manage the bad debts of public sector banks.

The price of Huarong’s US Dollar denominated bond, due in May 2029, collapsed on April 12th to just $77 from $105 the day before. A combination of factors - rogue management, rogue rating agencies, lack of real time oversight by the regulators and a lack of a vibrant debt market for ARC bonds - have all contributed, in more or less equal measure, for the collapse of Huarong Asset Management Company. 

State-owned enterprises in China historically carried either an explicit or implicit government guarantee. The Chinese central government is no longer willing to be the lender of last resort for its State-owned enterprises or local governments – it is clearly prepared to allow them to fail as part of its larger effort to de-leverage and improve the allocation of capital within the economy.

Lai Xiaomin, the former chairman of Huarong Asset Management Company, was sentenced to death on January 5th 2021 for soliciting $260m in bribes as well as bigamy. To send the sternest of warnings in matters concerning corruption and financial risks, China has put Lai Xiaomin to death in a swift manner. He was executed on a cold Friday morning o January 29th in the northern city of Tianjin, barely within 24 days of the judgment. China now blames Huarong’s problems on Lai who, according to Caixin Media, visited Hong Kong frequently and established a second family with twin children there. Instead of offloading the bad debt of China’s commercial banks - Huarong’s official mandate - Lai went rogue, dabbling in everything from private equity to junk bond trading in Hong Kong. As of June 2020, these non-core investments amounted to ¥590bn ($91bn), or about one-third of the total assets of Huarong. China can’t dispose of these non-core assets quickly because they are illiquid and difficult to value.


Market Dominated Debt Resolution

China’s corporate bond market is cleaved into two different markets. Even though, about 5,000 bond securities are traded on China’s stock exchanges in Shanghai and Shenzhen - they belong to a low-yield, high quality bucket. But in the high yield - high risk segment of bond market, where credit risk is concentrated, bonds trade infrequently and with poor liquidity. The high yield debt market in China remains illiquid and opaque - an insider’s market dominated by a few institutions rather than a funding vehicle.

China’s credit rating agencies, like their counterparts in India, have become erratic. Earlier this year China’s largest rating agency, China Chengxin International Credit Rating Co., was suspended for three months for alleged malfeasance. If investors do not have the tools to assess the risk of high-yield bonds of such distressed asset management companies, they will stay clear of distressed asset managers. The credit markets require trusted gauges of risk - to price and trade in debt in order to turn the corporate bond markets into an efficient credit allocation mechanism.

Huarong’s episode throws many lessons to learn from, if India's nascent bad bank plans have to succeed.

(V Venkateswara Rao is former MD of Ahmedabad Stock Exchange.)


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