REAL ESTATE ACADEMIC INITIATIVE at Harvard University

RESEARCH BRIEFS JANUARY 2011

NPL Resolution in the Context of Chinas Transitional Economy

By Bing Wang and Richard Peiser1
government to resolve its NPLs to prevent a continuing drag on the U.S. economic recovery. NPL resolution has been particularly relevant in China, where the countrys efforts since the mid-1990s to resolve its NPLs are intricately linked to Chinas transition from a planned to capitalist economy and its restructuring of Chinas financial system. Examining the role of NPLs in the financial crises of other Asian countries, including Japan and South Korea (hereafter referred to as Korea), offers insight into Chinas approach to dealing with its NPLs, and affords lessons for countries around the world, including the United States, about efficiently and effectively resolving their NPLs. Extensive research about Chinas strategy for resolving NPLs from the mid-1990s through 2006 reveals several crucial factors that enabled the government to reform its troubled banks and revitalize Chinas economic growth. These measures, undertaken quickly and aggressively, include fundamentally restructuring the countrys state-owned banks to become private enterprises, establishing Asset Management Corporations (AMCs) to handle the NPLs, and attracting foreign capital
The REAI is an interfaculty, interdisciplinary program focused on real estate and urban development research and education at Harvard University. Periodic research briefs document the REAI-funded research work of Harvard faculty and students.
Bing Wang is Lecturer in Design and Real Estate and co-Director for the Harvard Design Schools Master of Design Real Estate program. Wangs research and her professional practice seeks to advance urban and building design in contextuallysensitive real estate development. Among her other projects in China, Wang is currently lead designer for a 350-acre mixed-use real estate development in Wuhan, China, and real estate advisor for two midrise office headquarters development in Shanghai and a resort development on Chong-ming island near Shanghai. Richard Peiser is the Michael D. Spear Professor of Real Estate Development at Harvard Design School. He also is Director of the Real Estate Academic Initiative. The study reported here is part of an ongoing research project on the performance of the RTC and its implications for the current financial recovery. This brief was written and prepared by Lisa Chase, research associate at the Harvard Business School.

The resolution of non-performing loans (NPLs) has been a crucial factor for countries around the world in recovering from financial crises and reinvigorating their economies. Real estatebacked NPLs, if not resolved quickly and efficiently, can severely curtail banks ability to recapitalize and invigorate the credit markets, thereby slowing the economic recovery process. Nowhere is NPL resolution more critical than in the United States, where enormous holdings of residential and commercial real estate backed NPLs threaten to derail the United States recovery from the recent economic recession. Studying Chinas handling of its NPLs offers lessons about the urgency for the United States 1 This brief summarizes research by
the authors about NPL resolution in China and other Asian countries from 1998-2006. The publication citation is Bing Wang and Richard Peiser, Non-Performing Loan Resolution in the Context of Chinas Transitional Economy, Urbanization in China: Critical Issues in an Era of Rapid Growth, edited by Yan Song and Chengri Ding, Cambridge, MA: Lincoln Institute of Land Policy, 2007, pp. 271286. The authors are grateful for the support of the Real Estate Academic Initiative at Harvard University.

2011 by President and Fellows of Harvard College. The content reflects the views of the authors, who are responsible for the facts and accuracy of the research herein, and do not represent the official views or policies of the REAI.

NPL Resolution in the Context of Chinas Transitional Economy, Bing Wang and Richard Peiser

Real Estate Academic Initiative at Harvard University

and banking expertise to China as part of its restructuring process. Analyzing Japans and Koreas starkly different strategies for dealing with their NPLs affords a better understanding of Chinas approach to its NPL crisis. The Japanese and Chinese governments respective degrees of aggressiveness in dealing with their NPL crises, and the effectiveness of their strategies, are illustrative of Japans and Koreas endemic societal constructs and corporate cultures. During the Asian Financial Crisis, both countries were saddled with NPLs that threatened their economic recovery, but took dramatically divergent approaches to resolving these loans. The countries differing reactions to the regional financial crisis and to resolving their respective NPLs largely determined their ability to recover from the financial crisis and to reinvigorate their economies. Koreas and Japans respective approaches to dealing with their NPLs in the context of the Asian Financial Crisis offer an informative perspective on Chinas strategy for resolving its NPLs in the mid-1990s. Japans response to its NPL crisis was marked chiefly by the governments reticence to react aggressively to the banks NPLs, and by a corporate culture that resisted not only taking action to restructure the loans and transfer them off of bank ledgers, but also acknowledging the extent of bad debts held by Japanese banks. The Japanese governments apparent incomprehension of the extent of its economic malaise, and the need for it to lead the recovery effort, resulted in what is infamously known as the lost decade of stagnant economic growth during the 1990s. Several reasons have been cited for the governments, and the private sectors, sluggish response to

resolving the NPLs. Foremost is an entrenched conservative corporate culture which resists change and has been reluctant to redefine its relationship to the central government. Japanese banks have historically functioned as a means of financing the Japanese economy, with few incentives to function as profit-driven commercial lenders. In keeping with a Japanese aversion to losing face, when confronted with increasing NPLs, banks were reluctant to acknowledge loan failures, or to cede their perceived role in propping up, however artificially, the countrys economy. In addition, banks close ties with corporate borrowers and regulators discouraged profit maximization. Rather than pressuring borrowers to repay loans, or foreclosing on NPLs, banks instead continued to prop up defaulted loans, rather than face the embarrassment of reporting bad loans. The Japanese government in turn encouraged banks lenient loan policies, reasoning that supporting faltering corporations was preferable to allowing widespread bankruptcy that would further impair public confidence. After five of its largest financial institutions went bankrupt in 1997, the Japanese government established the Industrial Resolution and Collection Corporation (RCC) and the Revitalization Corporation of Japan (IRCJ), but the damage to the economy was already severe. Based on the United States Resolution Trust Corporation (RTC) model arising out of the early 1990s savings and loan crisis, both the IRCJ and RCC were designed to buy and resolve NPLs from banks. The program, however, was not effective in liquidating or restructuring the bad loans. The same corporate culture that contributed to Japans NPL crisis disincentivized banks from attracting

private international investors for NPLs, and discouraged private investors from bidding aggressively for the loans. Japans economic growth therefore continued to be stubbornly sluggish, leading to its lost decade of growth. In stark contrast to Japan, Koreas response to its NPL crisis was swift, pragmatic and aggressive. Following the 1997 financial crisis, the Korean government immediately established two entities to deal with and sell the NPLs, the Korean Asset Management Corporation (KAMCO) and the Korean Deposit Insurance Company (KDIC). While KAMCO was originally the only seller of NPLs, banks eventually auctioned the NPLs themselves, resulting in a fairly quick price increase for secured loans in NPL auctions. By 2001, prices had risen to 50-70 percent of their original value, compared to roughly 10 percent at the same time in Japan. The Korean government also solicited foreign investors to purchase the NPLs at auction, injecting muchneeded capital into the Korean economy. While these foreign investors initially acquired NPLs at very low prices, as the market matured domestic investors were able to outbid foreign investors, though with somewhat lower rates of return. The crucial impact of attracting investors from outside the country, however, was to increase competition for the NPLs and jumpstart the loan resolution process. This approach contrasts sharply to the Japanese governments lack of action to attract capital from within or outside of its economy, and its propensity to maintain the statusquo and avoid dealing forthrightly with its banks bad debt.

Chinas Strategy
Chinas strategy for dealing with its NPLs has, like Koreas,

NPL Resolution in the Context of Chinas Transitional Economy, Bing Wang and Richard Peiser

Real Estate Academic Initiative at Harvard University

Figure 1 Korean Ratio of NPL Sales Prices to Outstanding Principal Balance (OPB) 1998-2003

Figure 1 shows that recovery ratios -NPL sales price/OPB - have been cyclical, with peaks occurring every six months. In the beginning, KAMCO was the only seller of NPLs. Later, banks held auctions themselves. The average recovery ratio was 34.48 percent, with the winning bid prices totaling US$92 billion on NPLs with a face value (OPB) of $295 billion. Compared to the beginning of the NPL resolution process following the economic crisis, volatility has increased after 2001.

been remarkably pragmatic and aggressive. While the government was swift to act in the face of financial fragility during the Asian financial crisis, it has also been nimble in readjusting its approach when necessary, and cautious about implementing new economic policies. Although the majority of Chinas NPLs, unlike Japans and Koreas, were not backed by commercial or residential real estate, the state-owned enterprises (SOEs) to which they were tied were also unprofitable and of little value to investors. Under Chinas planned economy, the state-owned banks functioned primarily as funddisbursement agents to state-owned institutions and projects that were

not expected to turn a profit. While Korea and Japan were alternately working to, or failing to, address their NPL crises, China chose to address its NPLs as part of a largescale restructuring of its financial institutions and economic system. In progressive and gradual stages, the Chinese government set about transforming its four state-owned banks to private entities, created four asset management companies (AMCs) to handle the SOE-backed NPLs, and invited foreign investors to inject capital and financial expertise into its banking system. The Chinese governments financial restructuring in the 1990s was a key component of its efforts to transition the planned economy to

a market-driven capitalist system, while also addressing the NPL crisis. The governments cautious, trialand-error approach to privatizing its banks illustrates the extent to which the government has learned from the experiences of other communist planned economies, and from its own mis-steps. Rather than attempting a large-scale transformation of the state run banks, the Chinese government instead started by privatizing small banks on a local scale before expanding the program countrywide. For example, the government typically chose an individual bank in a carefully selected Chinese city to implement its privatization scheme, perfecting the banks restructuring

NPL Resolution in the Context of Chinas Transitional Economy, Bing Wang and Richard Peiser

Real Estate Academic Initiative at Harvard University

before expanding to other banks in that city, and eventually to an entire region. With the adoption of the 1995 Commercial Bank Law that separated commercial lending from policy lending, and an injection of capital into the four state-owned banks, these financial institutions were gradually transformed from a planned economy model. Chinas commercial banks began initiating independent credit approval, rather than operating as policy lenders, and adopted the international fivetier categorization of NPLs. Today three of Chinas state-owned banks have been completely privatized. Chinas efforts to restructure its financial system were an integral component of the governments strategy for transitioning its economy from a planned to market-driven system, and allowing financial institutions to operate independent of state intervention. While the Chinese government responded aggressively to its NPL crisis by implementing a dramatic transformation of its financial infrastructure, it also implemented these changes carefully, evaluating and modifying its approaches when necessary. This cautious philosophy has characterized every facet of Chinas strategy for resolving its NPLs and transitioning to a marketdriven financial structure. The second phase of Chinas strategy for dealing with its NPLs was its establishment of four AMCs to move the NPLs off the ledgers of Chinese banks and resolve the loans. These corporations, Cinda AMC, Huarong AMC, the Great Wall AMC, and the China Orient AMC, were based primarily on the RTC model. The purpose of the AMCs, established by the government with predetermined ten year life spans, was to relieve Chinese banks of their NPLs, thereby freeing up capital for

new lending to commercial loans. The AMCs were funded by bonds issued under the guarantee of the Ministry of Finance, which then purchased bad loans directly at book value from designated banks. These assets were of limited value to private investors, being constituted primarily of loans to large stateowned enterprises and capital construction. When the Chinese government invited international institutional investors to bid on the NPLs at auction, however, MorganStanley, Goldman-Sachs and Lone Star were among the bidders. The loan sales prices from the auction were much lower than the government had anticipated five cents on the dollar. These investors were interested primarily in reselling the SOE-backed NPLs, not in taking possession of and restructuring the SOEs as private enterprises. Given the associated obligations to workers pensions and severance funds that buyers of the SOEs would inherit, and the institutional investors lack of experience with SOE restructuring, Lone-Star eventually withdrew from the bidding process. In another example of the Chinese governments nimbleness in executing its economic transformation, the government shifted its approach and offered international institutional investors shares in the SOEs, rather than outright sales of the SOE-backed NPLs. By subsidizing the transfer of its banks NPLs to government subsidized AMCs, the Chinese government accelerated the resolution of SOE-backed bad loans, allowing the banks to free up capital and operate as profitdriven commercial lenders. The Chinese governments move to quickly acknowledge the NPL crisis and establish the AMCs parallels the RTC model followed by Koreas

creation of KAMCO and KDIC, and contrasts sharply with Japans excruciatingly slow progress in transferring NPLs off of bank ledgers and into asset management vehicles. Chinas relatively quick resolution of the NPLs, like Koreas aggressive approach, highlights the effectiveness of following the RTC approach in resolving NPLs. Chinas third-phase in resolving its NPLs is particularly interesting because it departed from the traditional RTC model, illustrating Chinas experimental approach to transforming its financial system. Rather than simply attracting capital from international investors, the strategy followed by both Korea and the United States, China also sought banking expertise to help transition its financial system to a market-driven model. To induce greater transparency and efficient bank management, the government listed the state-owned banks publicly on the stock exchange, after injecting $45 billion into the CCB and BOC from Chinas foreign exchange reserves. After dressing up the CCB and BOC for capital market competition by issuing bonds to clear NPLs from their balance sheets, the Chinese government carefully selected international shareholders to inject capital into its state-owned banks, based on investors management expertise and institutional nature, in addition to their capital capability. In an example of the governments pragmatic approach to restructuring its banking system, the share purchase of BOC by Temasek Holding, Singapores government investment arm, was reduced from its initial 10 percent to 5 percent because Temasek Holding did not have enough expertise and experience in bank risk management and credit control. The Chinese government has continued to

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attract international investors to take minority stakes in smaller state and city commercial banks in an ongoing campaign to force these institutions to modernize their management systems. The success of Chinas and Koreas resolution of their NPLs in the late 1990s, particularly compared to Japans long and slow recovery from its non-performing loans, illustrates the importance of two primary factors in dealing effectively with and resolving NPLs. First, the speed with which a given government acknowledges and addresses the crisis and devises a strategy for resolving its NPLs, and the governments commitment to implementing necessary banking reforms, is critical. The process for resolving the NPLs is less important than how quickly the government crafts a mechanism for moving bad debts off of banks ledgers, thereby enabling the banks to recapitalize and start lending again. In both Koreas and Chinas case, the respective governments promptly established an asset-management vehicle to transfer the NPLs off of banks books and resolve the loans. Japan, in contrast, was very slow to take this measure, thereby significantly delaying the countrys NPL resolution and associated economic recovery. Second, utilizing the private sector to recapitalize the banks and, when appropriate, lend financial management expertise, is crucial. While capital may come from internal or foreign investors, the most important factor is the role of the private sector in the NPL resolution. While Korea chose to follow the United States RTC model by seeking foreign investments solely to purchase NPLs and help recapitalize its banks, China recognized the need for institutional expertise as well as capital to help restructure its banking system.

As part of Chinas transition to a market-based economy, the government solicited involvement from the private sector to contribute short-term capital injection, as well as restructuring and financial management expertise. Both this tactic, as well as the governments quick and aggressive action to address the NPL crisis and devise a solution for resolving those SOE-backed loans, illustrates the importance of a multi-pronged approach to dealing with NPLs. Examining Chinas strategy for resolving its NPLs in the latter half of the 1990s offers valuable insight into the importance, for any country, of recognizing the need for institutional and financial reforms as part of its NPL resolution. Chinas restructuring of its banking system, as a fundamental component of its NPL resolution, fits into the context of the countrys transition from a planned economy to a capitalist system. It also signals the governments recognition that transforming its planned economy requires essential changes to Chinas societal and economic foundation. In the case of Chinas SOEs, the worker pension and severance obligations inherited by the purchaser of an SOE-backed NPL existed because of Chinas lack of social infrastructure. The Chinese governments comprehensive approach to resolving its NPLs, including soliciting expertise from institutional investors, indicates its recognition of the need to strengthen not only its financial infrastructure, but its social systems as well. This approach contrasts acutely with Japans lack of attention to reforming its banking practices, or to recognizing the intransigence and inefficiencies of its corporate culture. Rarely is an NPL crisis not indicative of wider weaknesses in a countrys financial

system, a lesson China has applied to its own NPL resolution strategy. While it may be too soon to determine whether Chinas efforts to privatize its banking system have been successful, Chinas strategy illustrates the extent to which the government has observed and learned from other countries approaches to, and mis-steps in, dealing with NPLs and associated financial infrastructure weaknesses. Chinas pragmatic, gradualist strategy for transitioning from a planned economy, privatizing its banks, and addressing the lack of social systems once filled by the SOEs, reflects a cultural propensity for careful and cautious progress. It also provides lessons for other countries burdened with rapidly expanding NPLs in the aftermath of the current economic crisis.

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UPDATE:

NPL Resolution in the Context of Chinas Transitional Economy1

By Bing Wang
Since the year 2006 when the above NPL research concluded, the big-5 Chinese banks have dramatically reduced the total amount of their non-performing loans (NPLs), and thus decreased the NPL ratio as a proportion of all loans on their books accordingly, from the ratio of 10.49% in 2005 to only 1.80% in 2009 (see Table below).

income ratio, return on assets, and return on equity for 2007 and thereafter. Secondly, the quality of Chinese bank credit risk management and the rigor of regulatory oversight have become more seasoned and sophisticated. Discipline and due diligence on loan issuance improved, partly as the result of increased operating transparency and efficiency of Chinese banks that came with the public listing and sale of strategic ownership stakes to Western banks and sovereign funds, some of whom brought credit risk management and other industry best-practice resources to bear. And thirdly, the overall amount of the Chinese bank loans increased significantly, for example, up 21.3% y-o-y to RMB 84.3 trillion, or about US $12.4 trillion at March 2010.3 The surge in bank lending has had the effect of increasing the denominator in the NPL ratio (non-performing loans/total loans), further improving the NPL ratio as an observable statistical metric. However, the absolute quantum of Chinese non-performing loans could actually increase going forward. The promising prospects for Chinese banks that came with the reduction of NPL ratios could fade dramatically in the near term. As the Chinese government launched its fiscal stimulus program in response to the global financial crisis, Chinese banks extended RMB 9.6 trillion (or about US $1.4 trillion) in new loans in 2009 alone, double the amount of all Chinese bank lending for all of 2008.4 And, in January 2010, the torrid pace of bank lending continued despite early Chinese government steps to dial-back
3 China Banking Regulatory Commission website 4 Peoples Bank of China website: www. pbc.gov.cn.

its economic stimulus program and economic growth in general. According to the World Bank, Chinas banks extended another RMB 1.39 trillion in new loans (US$2.4 billion) in January, nearly 20% of the RMB 7.5 trillion (US$1.1 trillion) of new loans budgeted for all of 2010. Rapid loan growth should always be a concern for any banking system, as the crystallization of loan delinquencies and defaults lags the booking of new loans. As a generalization, it may take up to two or three years before new loans become seasoned and for the credit review process to recognize portfolio delinquencies or losses for a class or vintage of new loans, and for loans to be sequentially degraded from traditional categories of pass to sub-standard to doubtful to loss. All things being equal, it may only be a matter of time before NPLs increase after a spike in loan growth. Standard & Poors believes a potentially steep rise in NPLs will be a challenge for the banking sector, with the NPL ratio rising to as high as 10% over the next two years.5

Year

2005 2006 2007 2008 2009

Amount of NPL (RMB billion) 1,072.48 1,053.49 1,114.95 420.82 362.73

NPL ratio (%) 10.49% 9.22% 8.05% 2.81% 1.80%

Note: Chinas Big-5 Banks include Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank and Bank of Communications 2

The significant reasons for this rapid reduction of NPL ratios in the top five Chinese banks can be summarized as: First, and most importantly, Chinese banks were beneficiaries of a booming economy and positive operating leveraging that comes with scale. Their profitability and balance sheet improved significantly as reflected in stronger conventional measures of bank performance, including net interest margins, cost/
1 The author would like to thank Jack Rodman and Yi Zhang for their research support, and for providing timely materials that made this update possible. 2 China Banking Regulatory Commission website: www.cbrc.gov.cn.

Local Government-owned Financing Platforms (LGFP) and Real Estate Loans

Among the potential NPL increases for Chinese banks, the most worrisome are loans to local government and municipal investment vehicles and those backed by privately-owned real estate properties. Rapid booking of Local Governmentowned Financing Platforms (LGFP) -- local government and municipal investment vehicles that sponsored large local infrastructure and
5 Standard & Poors, Ryan Tsang, March 18,2010.

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public works projects -- took place mostly in the 2008 to 2009 time period. Many of these projects have uncertain cash flow generation to support the underlying bank loans, which are generally secured by property or local government guarantees. Reflecting its concern, the central government ordered a review of all LGFP loans by the end of the first half 2010. As local government projects get deferred or terminated due to lack of funds, and as the value of land collateral falls as a result of an induced property correction, bank NPLs will increase. Victor Shih of Northwestern University estimates that total LGFP loans made between 2004 and 2009 equaled RMB 11.4 trillion (US$1.7 trillion), more than the RMB 7.4 trillion reported by the China Banking Regulatory Commission as outstanding at the end of 2009. As the government takes steps to induce an economic slowdown, reign-in liquidity, and tighten measures on the property sector, the asset quality of the banks could also deteriorate over the medium term. During the first half of 2010, the government became increasingly assertive about reducing soaring property prices in major cities in order to dampen property speculation, ease social tensions, and orchestrate a soft landing in the economy. The government measures included: January 12, 2010: Peoples Bank of China (PBOC) increases reserve ratio requirements by 50 basis points; February 12, 2010: PBOC again increases reserve ration requirements by 50 basis points. China Banking Regulatory Commission (CBRC) monitors loan proceeds to real estate developers; March 10, 2010: Ministry of Land and Resources increases residential land supply and tightens supervision

of land resources; March 18, 2010: Stateowned Assets Supervision and Administration Commission (SASAC) bars real estate loans to 78 state-owned enterprises whose core business is not real estate development; April 13, 2010: Ministry of Housing and Urban-Rural Development issues commitment to increase supply of social housing; April 13, 2010: CBRC restricts lending to buyers of second or multiple housing properties; April 14, 2010: CBRC issues requirements for higher down payments and interest rates; April 21, 2010: CBRC issues stricter definition of second homes. Banks encouraged to reject mortgages to buyers of multiple housing properties; Trial house property tax in Beijing, Chongqing, Shenzhen and Shanghai.6 As property prices and transaction volumes fall with tightened liquidity, the property market could grind to a near standstill in the immediate term, causing more real estate backed loans to become NPLs.

the consent of the guarantors in order for the guarantee to be effective.7 Recently, the Court issued an internal draft ruling for review and comment that may provide procedures for distressed loan investors to ensure the validity of the guarantees they hold. Resumption in NPL transactions between banks and AMCs may occur when the Court ruling is resolved, and that might encourage Chinese banks to classify more distressed loans as non-performing and package them for sale to the AMC marketplace.

Summary
Generally speaking, compared to any time in its history, the Chinese banking system is currently in a stronger position to withstand an increase in its non-performing loans, particularly to the property sector. First of all, it should be noted that Chinese banks are less exposed to the property sector than regional Asian bank peers. Its mortgage loans account for 14% and real estate loans 7% of the total loan issuance. Regional Asian bank peers are respectively 25% and 10%.8 There is low risk exposure attributed to bank lending policies that require down payments of no less than 20%; low loan/valuation of roughly 50% for mortgage loans; as well as to banks relatively cautious lending strategy towards real estate developers, as a recent implementation policy measure.9 Moreover, Chinese banks have built up strong capital adequacy that
7 Internal Circulation: Notice of the Supreme Peoples Court on Validity of Guarantees in Cases Involving the Use of Foreign Captial In the Disposal of Non-performing Loans by Asset Management Companies dated 9 December (No. 39 or 2009) 8 Deutsche Bank, China Banks Macro risks - Implications & Reality checks, May 4, 2010, page 3. 9 Deutsche Bank, China Banks Macro risks - Implications & Reality checks, May 4, 2010, page 3.

NPL Resolution Process

In the meantime, the China NPL resolution process has become more complex and protracted, if not quiet, with few transactions by the four government-owned Asset Management Companies (AMCs). Foreign distressed loan investors have been on the sidelines following the Supreme Peoples Courts July 2009 decision against UBS, in which it ruled that not only must NPL investors register the details of each guarantee they hold with State Administration for Foreign Exchange (SAFE), but they must also obtain
6 Dr. Boaz Boon, CapitaLand Economic Research.

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will allow them to absorb a large increase in non-performing loans. In most cases, the larger Chinese banks far exceed the traditional Bank of International Settlements standard of 4% Tier 1 equity. Against recent pressures from regulatory bodies and supranational bodies like the IMF and G-20 to increase bank capital, Chinese banks have also completed about 24% of approximately RMB 447 billion of announced capital raising,10 which will shift some of the non-performing loan cost to international capital market and equity investors. Most recently, China announced a near $22 billion global equity offering for the Agricultural Bank of China. Nonetheless, much uncertainty still lies ahead for China as it takes on the conflicting roles of propping up domestic and global economic growth while at the same time curbing exuberant property market speculation. If properly executed, China will enjoy more moderate and sustainable GDP growth and a price-corrected residential property market that is more affordable to the masses. A miss-step in the execution, however, could lead to flagging confidence in Chinas near -term prospects, which, in turn could lead to an increase in Chinese banks NPLs and further stall the ability of the markets to dispose NPLs effectively.

Postscript: This Update was prepared in July 2010. Since then, the banking regulators have taken steps to identify the Chinese banks exposure to Local Governmentowned Financing Platforms, as well as to off-balance sheet bank lending trusts. Moreover, Chinese authorities have sought to dampen the continued rapid growth in bank lending by raising bank reserve requirements and by introducing a framework for property taxes in key Chinese markets to slow speculative property investments. While such regulatory action could accelerate the crystallization of non-performing bank loans, the leading Chinese banks successfully completed a round of large capital funding in the second half of 2010, and continue to post strong capital adequacy ratios. Chinas banking system at this moment continues to be in a strong position to withstand an increase in its non-performing loans.Bing Wang

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10 Goldman Sachs, China Banks, Relative value in A-shares; progress made on sector overhangs, June 11, 2010, page 7.

NPL Resolution in the Context of Chinas Transitional Economy, Bing Wang and Richard Peiser

Real Estate Academic Initiative at Harvard University