UPDATE 2-China local govt debt plan a quick boost for banks, economy

Wed Jun 1, 2011 5:53am EDT

Related Topics

* China plans to shift $300-$470 bln in local govt debt -sources

* Local govt debt a "time bomb"; plan positive for economy - analyst

* Concerns still linger over impact of post-crisis lending spree

* China big bank shares move in line with market (Adds more analyst comment, closing share prices)

By Kelvin Soh and Terril Yue Jones

HONG KONG/BEIJING June 1 (Reuters) - China's top banks and its economy should benefit from a plan by Beijing to write off hundreds of billions of dollars in local government debt, although uncertainty over sharing the costs and concerns about the impact of the country's lending spree remain.

China's banking regulator plans to shift 2-3 trillion yuan ($300-$470 billion) in debt off the books of local governments, Reuters reported on Tuesday, reducing the risk of a wave of defaults that would threaten the stability of the world's second-biggest economy. [ID:nL3E7H101J]

The sweeping plan underscores China's desire to act before the bad debt problem facing local governments becomes untenable, analysts said on Wednesday.

"Local government debt is a time bomb in the longer run, so it's positive for the whole economy," said Stanley Li, a Chinese banking analyst with Mirae Asset Securities.

Many local governments in China set up special financing vehicles to get around rules forbidding them from borrowing directly from banks.

China's top banks provided many of the loans as part of a huge economic stimulus programme launched by Beijing in late 2008 to counter the global financial crisis.

Chinese authorities had worked out that local governments had borrowed around 10 trillion yuan, Reuters said in its report on Tuesday.

Local and provincial administrations may default on around 2 trillion yuan of loans, many of which were used fund uneconomic real estate and infrastructure projects, Chinese media have reported.

"There has been concern over asset quality risk, especially (to the financing vehicles)," said Victor Wang, an analyst with Macquarie Securities. "I think it's the right move -- it removes uncertainty, and helps the banks operate on a more clear and sustainable basis."

Industrial and Commercial Bank of China and China Construction Bank are the world's two biggest banks by market capital. Agricultural Bank of China and Bank of China are Nos. 3 and 4 in China and among the world's top ten.

None of the four banks had immediate comment on the government's plan.

Government assumption of the debt would take a bulk of the burden off the books of the major banks at a time when China's red-hot economy has begun to slow.

"We believe this would be a general positive for the Chinese banks as we consider their local government financing vehicles' exposures to be the greatest risk to the banks' credit quality," Bernstein Research Analyst Mike Werner wrote in a research note.

There will be some "short-term pain" and banks' profitability this year could be hit by 20 percent, depending on how the loss-sharing is split, Mirae's Li said.

The overhaul includes the central government paying off some of the local government loans, while some state-controlled banks would be forced to take losses on the sour debt, people familiar with the plan told Reuters.

QUESTIONS LINGER

Hong Kong-listed shares of China's big four banks moved largely in tandem with the broader market on Wednesday. ICBC closed down 0.3 percent and CCB was down 0.8 percent, Agriculture Bank of China was down 2.7 percent and Bank of China closed unchanged.

The scheme would be the second time China has stepped in to reshape its banking system since the late 1990s.

Then, with the Chinese banking system almost insolvent after decades of government-directed lending, the authorities transferred the banks' bad debts to asset management companies backed by sovereign bond issues in preparation for their eventual listings.

The government eventually got its money back when ICBC and the others listed in Hong Kong and Shanghai, through multi-billion dollar IPOs in the two cities.

"The previous clean-up was different because the government eventually got its money back from investors like you and me," said Dorris Chen, an analyst at BNP Paribas in Shanghai. "It's not sure how the government can get its money back this time."

Getting bad debts out of the system allows banks both big and small to keep the lending flow going. The fear is that bad debts over time will pile up if economic growth slows.

"We've always felt that such rapid loan growth in the past few years will eventually bring trouble to the sector," Standard & Poor's analyst Liao Qiang said.

"It was probably wrong to use the banking system to push the country out of the global financial crisis anyway, and this is probably one of the side effects we have to live with." (Additional reporting by Kevin Yao in BEIJING; Editing by Michael Flaherty and Lincoln Feast)

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