2016-04-07bloombergview.com

... officials still say that only about 1.6 percent of commercial-banking loans are nonperforming. Some analysts put the real figure closer to 20 percent. And Beijing's primary plan to address the problem -- allowing companies to swap their debt with banks in exchange for equity -- actually creates new risks.

For one thing, while a debt-for-equity swap may help excessively indebted firms, it will wreak havoc with banks. Directly, a given bank will no longer receive the cash flow from interest and principal payments. Indirectly, it won't be able to sell equity to the PBOC or to other banks as it could with a loan.

Valuing the equity could present a bigger problem. In China, banks must count 100 percent of loans made to non-financial companies against their reserve requirements. When they invest in equity, however, they must set aside 400 percent of the value of the investment. If the debt isn't worth face value to the bank, it seems unlikely that the equity is worth far more -- suggesting that large write-downs will be required.

...

All this leads one to think that the government doesn't recognize the severity of the problem. Debt-for-equity swaps and loan rollovers simply aren't long-term solutions for ailing companies on the scale China faces.



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