SINGAPORE—Moody’s Investors Service said a Chinese government agency may have understated banks’ loans to local governments by 3.5 trillion yuan ($541 billion), escalating its warnings that the scale of such loans could pose a threat to China’s banking system. The issue could prompt the ratings agency to change its credit outlook for the Chinese banking system to negative, Moody’s said in a Tuesday press release. In a report released Tuesday, Moody’s analyzed June data from China’s National Audit Office. The NAO concluded that Chinese banks have funded about 8.5 trillion yuan of local government debt.
"When cross-examining the findings by the June 27 NAO report–in conjunction with reports from Chinese banking regulators–we find that the Chinese audit agency could be understating banks’ exposures to local governments by as much as 3.5 trillion yuan," said Yvonne Zhang, Moody’s vice president. It’s the latest, and most severe, of several warnings Moody’s has issued recently regarding Chinese banks’ exposure to local government debt. The 3.5 trillion yuan in loans that NAO didn’t account for are "most likely poorly documented and may pose the greatest risk of delinquency," said Zhang. In light of its analysis, Moody’s estimated that the Chinese banking system’s economic non-performing loans could reach between 8% and 12% of total loans. That is closer to the 10% to 18% estimated in Moody’s stress case than the 5% to 8% that constitutes the agency’s base case.
When considering the apparent absence of a clear masterplan to deal with this issue, Moody’s also views the credit outlook for the Chinese banking system as potentially turning to negative. The ratings agency has said the problem loans could end up adding to the direct obligations of the central government, if the local banks can’t repay them. The problem stems in large part from Beijing’s use of bank lending and infrastructure spending to buffer its economy from the financial crisis.