Debt equity swaps in China just a case of pass the parcel
Implicit guarantees from banks mean that when the music stops the banks are still exposed, though ordinary householders are now sharing the risk
Chinese authorities are reviving debt equity swaps to help process banks’ bad loans. However, the tangled web of the mainland financial system means that some of the risk associated with these bad debts has now passed to China’s ordinary householders, while other risks have ended up back with the banks, defeating the point of the exercise, say analysts.
In a debt equity swap, a bank that has lent to a company which is unable to repay the loan exchanges the loan for an equity stake in the distressed company.
In the late 1990s they were used as a tool to deal with debts Chinese banks issued to distressed companies, but this year they have started to be used again in the latest attempt by authorities and lenders to clean up banks’ balance sheets.
However, according to guidelines issued by the State Council in September, this time around banks are not allowed to hold the equity stake in the company directly, but rather have to sell the distressed debt to another entity. It is this entity which swaps the debt into equity, and all of China’s big five banks are creating subsidiaries for this purpose.
These subsidiaries can have a number of investors, including insurance companies, the national social security fund and individuals through wealth management products, according to a report from Natixis economists.
This meant “households have become an integral part of the clean-up process”, the economists said.