Certainly it will not be the sobs they unloaded a

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Unformatted text preview: formed, it was an unsettled issue as to who is eventually going to bear the losses. Certainly, it will not be the SOBs. They unloaded a large portion of their NPLs by converting the distressed assets into bonds to AMCs implicitly guaranteed by the government. Furthermore, the SOBs also received interest payments from the AMCs based on the face value of transferred NPLs. The SOBs are very much bailed out by the government in the whole AMC scheme. It will not be the AMCs to bear the losses either because they only have ten-year duration. The AMCs' supervising structure suggests that the Ministry of Finance would possibly bear the losses at the end. The Ministry of Finance is responsible for the AMCs' administration. If the AMCs are ultimately liquidated, the Ministry of Finance, which is supposed to bear the consequences of their operation, has to take over the AMCs' bond liabilities to the SOBs. Then the loss resulted from the gap between the face and the recovered value of transferred NPLs would eventually be borne by the government from the fiscal budget. Then the whole scheme would be essentially equivalent to another recapitalization of the SOBs. Moral Hazards The one-to-one relationship between a parent SOB and an AMC might be helpful for the collaboration. However, it is likely that the parent SOB would perceive the AMC to be an outlet to which it can transfer more NPLs in the future. If the government could not make a commitment that the current NPL transfer is a once-off policy, the SOB would treat its AMC as a government agency that implicitly insures its lending activities. As a result, the SOB would be lenient both in managing the risk of commercial portfolio and in making new loans on a commercial basis. As a result, new NPLs could again mount up in the SOBs' balance sheets. If the government could not commit definitely that the debt-equity swap is a once-off policy, more SOEs may strategically default. Although the objective of this reform was to improve the capital structure of debt-burdened SOEs, the new instrument may actually encourage even profitable SOEs to stop paying interests on the bank loans so that they, too, qualify for debt relief. If these problems are not resolved, the existing NPL issue will not be dealt with effectively but more frequently, new NPLs will be encouraged through soft lending by the SOBs and strategic default by SOEs. The AMCs will be forced to take on more NPLs over time as the government will re-capitalize the SOBs again and again. Such a vicious cycle will entrench moral hazard problems and guarantee continuing deterioration of the Chinese banking assets38. John P. Bonin and Yiping Huang, Dealing with the Bad Loans of the Chinese Banks, Working Paper Number 357, 01/2001, Wesleyan University and Australian National Unviersity 38 CHAPTER SEVEN: OBSTACLES TO THE NPL ISSUE China's Immature Capital Market A well-functioning capital market that includes the mechanisms for efficient capital allocation as well as good corporate governance may streng...
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