Reshuffle may lead to risks for lenders

A reshuffle of local leaders, which takes place every five years in China, is likely to subject the country's banking system to new risks, analysts warn.

"The financing demand at the local level will surge greatly after new leaders take office since they view investing in new projects as the most effective way of shoring up the local GDP growth rate, which is an important criterion Beijing uses in judging officials' performances," said Zhou Mingjian, chief economist at the securities broker Golden Sun Securities Co Ltd.

China warned its banks to resist the demand for credit that is likely to come from local governments when new city, town and village officials pursue projects to bolster economic growth, Bloomberg reported on Wednesday.

The China Banking Regulatory Commission told lenders this month to be on guard for applications seeking loans for new projects that, in reality, have merely been disguised to look like existing, unfinished ones, Bloomberg cited an anonymous source as saying.

The source said loan requests may come in more frequently as local leaders appointed in the national reshuffle seek money to help add jobs in their regions.

The changes in local governments began in 2011 with appointments of top officials at the provincial level and below.

"This order from the China Banking Regulatory Commission is needed because the pressure and tricks these officials will use to get money for new projects will add to the rising default risks of loans lent by banks to local governments through financial platforms," Zhou said.

For the past two years, China has taken measures to contain the high risks associated with loans to local-government finance platforms - special companies owned by local governments.

The National Audit Office said in June that local governments held 10.7 trillion yuan ($1.7 trillion) in debt at the end of 2010, about 41.7 percent of which would come due in 2011 or 2012.

Liao Qiang, a director at the international rating agency Standard & Poor's Financial Services LLC, said the China Banking Regulatory Commission may be about to exercise "regulatory forbearance" and allow banks to effectively postpone recognition of losses on such loans. Several heavily leveraged local government finance platforms had sought late last year to defer making loan repayments, he noted.

"For a long time now, we've factored in significantly high credit losses for the Chinese banking industry across business cycles," he said.

"The strain on local-government financing platforms' liquidity could exacerbate the loan quality of Chinese banks."

Standard & Poor's estimates that about 30 percent of the loans made to local-government financing platforms could turn sour in the next three years if local governments do not extend support to those entities.

Nevertheless, Liao said the banking industry may be strong enough to withstand a severe deterioration in loan quality.

"The big banks that we rate have good operating profits, strong liquidity and moderate but strengthened capital reserves," he said. "These will be important strengths amid adversity."

To channel more capital to local governments and guarantee loans, the central government began in October to allow Shanghai, Shenzhen as well as Zhejiang and Guangdong provinces to sell bonds directly to investors for the first time since 1949.

Zhou predicted that permission will be extended to more places in 2012.