Without Loan Favors, Chinese SOEs Would Have no Profits, Leaves Banking System Exposed

January 6, 2011

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  • We find that the costs of financing for SOEs are significantly lower than for other companies after controlling for some fundamental factors for profitability and individual firm characteristics.
  • Our research shows that If SOEs were to pay a market interest rate, their existing profits would be entirely wiped out.
  • Previous study shows that SOEs have not been consistent in honoring their obligations vis-à-vis bank debts, as SOE lending was perhaps the main source of non-performing loans (NPLs) at state-owned commercial banks(SOCBs) in past crises (Zhou 2004)
  • Continued inferior creditor right protection could lead to repeated large write offs of bad loans as experienced in some other transition economies that experienced a large downturn
  • It is well known that SOE’s in China are quite reluctant to pay back their loans to SOCBs due to politicial influence as forbearance is the rule and not the exception
  • SOE’s contribution to the Chinese GDP was around 25%, but they received 65% of SOCB bank loans in a 2004 study
  • Xian (2006) study of 20,000 large and medium sized firms for the period between 1995 and 2002, show that SOEs are much more likely to generate bad debt than private enterprises
  • History Squared Notes
    • The assumption is that politicians are ordering banks to lend to SOEs at below market interest rates
    • Thus, Banks with exposure to SOE’s are vulnerable, since they are lending money to SOEs at below rates that risks and costs would indicate, to politically connected firms that in the past have shown a lack of willingness to pay back loans even at favorable interest rates.
    • SOCBs exposed are Commercial Bank of China, Bank of China, China Construction Bank, and Agricutual Bank of China
    • Capital injections may dilute foreign shareholders ownership
  • Source Hong Kong Institute for Monetary Research April 2009
  • Further Reading : The Emperor Wears No Clothes

Are the Profits of State Owned Enterprises Real

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