SHANGHAI/BEIJING Faced with a chorus of warnings that China risks choking on bad debts, Beijing is pushing banks to raise private capital in an effort to head off the need for a second government bailout in as many decades.
The hangover from a credit binge that powered China's swift recovery from the global financial crisis, combined with the economy's slowdown, has prompted expectations of a repeat of the early 2000s, when Beijing shored up its major banks with hundreds of billions of dollars.
Right now, however, authorities appear focused on pushing banks to bolster their balance sheets by aggressively enforcing new international bank capital requirements, known as Basel III.
Some analysts say warnings of an impending crisis are overdone.
"We've done some stress test analyses, which find that even under fairly stressed scenarios, the banks - especially the larger banks - will still be making a marginal profit," said Grace Wu, head China bank analyst at Daiwa Capital Markets in Hong Kong. "So in that sense, they won't even eat into their reserves."
Twelve of China's 17 listed banks have already announced plans to raise around 425 billion yuan ($69.47 billion), largely through subordinate debt.
On Friday, the securities regulator said banks - and other listed firms - could also issue non-tradeable preferred shares. That offers another avenue for banks to bolster their balance sheets with funding from commercial investors, and possibly a way for the government to inject capital directly if private funds aren't enough.
In an article published last week, China's central bank governor, Zhou Xiaochuan, cited the U.S. government's rescue in the global financial crisis of American International Group Inc as a positive example of how preferred shares could be used.
Whether that will be necessary depends on how big China's bad debt pile really is. This is a matter of guesswork, given that analysts think the official non-performing loan ratio of less than 1 percent is a considerable understatement.
Most analysts put it in the 3 to 6 percent range, but Reuters estimates based on official data shows that their current capital and loan-loss provisions would suffice even if more than a fifth of their loans went bad.
But much of the potential risk lies outside of the official banking system.
Goldman Sachs has said that under its worst-case scenario credit losses for the entire system could reach $3 trillion, or a fifth of forecast GDP in 2016, though actual losses would probably be considerably lower.
That is comparable to bad loans estimated at 16 percent of GDP in 1999 that Beijing cleared from the balance sheets of its top banks between 1999 and 2008 in preparation for their stock listings.
Former deputy central bank governor Wu Xiaoling believes another bailout on that scale is unlikely, although she sees the possibility of targeted aid from Beijing for highly indebted local governments.
"But I don't think it will happen on a large scale. And the Chinese government won't provide this help easily. If you do it easily, then it creates very large moral hazard," she told Reuters on the sidelines of a conference.
How China tackles its debt challenge will largely determine the extent to which the financial system is able to support the transition Beijing is engineering to turn the economy away from one driven by investment-heavy industrialization to one more reliant on development of consumption and services.
A debt workout by the banks would avoid the upheaval of a government-led bailout, but could weigh on economic growth for longer as banks work through their pile of non-performing loans.
A muddle-through option with limited debt write-offs and disposals would also spare the cost and political embarrassment of a bailout, but could lead to a Japan-style scenario in which banks continue to roll over bad loans to "zombie companies", crowding out more worthy borrowers.
But Wu said that extending the maturity of loans is sometimes appropriate.
"The vast majority is investment debt, like public infrastructure. It will eventually be a functional asset," she said.
Apart from the fiscal cost and moral hazard associated with a bailout, banks themselves are not currently clamoring for help.
"I don't think it's likely to happen this time around. At that time banks wanted to reform in order to list. They needed to remove bad debts. But now large and middle-sized banks have already listed, so the pressure is not there," said a loan officer at Bank of Communications in Shanghai.
There is also a sense within the financial community that things are just not as bad as last time, when according to Beijing-based consultancy GK Dragonomics half of bank loans were non-performing.
"Fifteen years ago it was the accumulated impact of the whole economy for the past half century. The banks were all technically insolvent. There was no liquidity in the market," said Jimmy Leung, lead partner for China banking and capital markets at PwC in Shanghai, who counts China Construction Bank, China's second-biggest lender, among his clients.
Still, those who fear a crisis, point to a rapid rise in off-balance sheet lending, known as shadow banking.
Charlene Chu, China bank analyst at Fitch Ratings, said banks are involved in 75 percent of all non-traditional lending, so they are more exposed to shadow credit than their balance sheets suggest.
"A 1 percent non-performing loan ratio has little signaling value when 36 percent of all outstanding credit resides outside Chinese banks' loan portfolios," she said.
A severe cash squeeze in June suggested starving the market of liquidity was how the authorities wanted to tackle shadow lending, but August data showed the central bank had turned on the taps again to boost sagging economic growth.
Now, Beijing wants to develop an alternative to shadow banking and the risky wealth management products it has spawned with a market for asset-backed securities. The idea would be to offer attractive returns but also provide more clarity on risks.
There are doubts though that securitization could scale up fast enough to challenge what Fitch says is a $2 trillion market for wealth management products. Only about $5 billion in securitized products are currently outstanding.
Ultimately, whether China's debt pile becomes a crippling drag on growth may depend less on moves to shift the burden around within the financial system and more on efforts to kick the credit addiction.
Goldman's analysts calculate that China's total debt-to-GDP ratio has surged by 60 percentage points since the global financial crisis. It says such a rapid increase is often associated with financial crises, even if the absolute level of debt is not excessive.
"China must get to a point where it can get back on a healthy growth path that is not dependent on massive amounts of credit every year," said Fitch's Chu last month.
"Absent this, everything else is secondary, including policies to improve the soundness of shadow finance or financial sector liberalization."
(Additional reporting by Lu Jianxin, Shanghai Newsroom and Zhao Hongmei in HONG KONG; Editing by Tomasz Janowski and Neil Fullick)