China Banking outlook 2011

The systemic risk is low given that total government borrowing, and LGP loans (loan to local government-owned platforms) account for less than 50% of the GDP. And the government is closely monitoring the LGP loans by the China Banking Regulatory Commission(CBRC), Ministry of Finance (MOF) and banks. Additionally, loans to projects that rely on fiscal revenue to repay are largely loans to LGPs owned by big cities or rich province. Big banks' LGP customers are largely owned by these government, too.

There are some positive development in the resolution of LGP loans. First, LGP loans now are closely monitored by CBRC/MOF. The coming property tax and resources tax will be an initial positive step in providing new stable revenues for local government. Current reduction of local government layers will build a foundation for taxation reform of government.

Risk still exits. The problematic LGP loans may result from inadequate due diligence or weak lending practices by some banks in 2009. On a standalone basis and excluding subsidies, many LGPs cash flow and interest coverage are low, and thus low stand-alone credit ratings. In the case of severe macro slowdown, whether local government will support LGPs or allow banks to sell the collaterals remains a question.

From GS report: Banking panel on LGP loans: low systemic risk, ongoing fiscal reform (2nd Nov 2010)