China's Banks May Be Troubled, But Nobody Knows The Trouble Ernst & Young Has Seen
A few weeks ago, I did a post, entitled, "Troubled Loan Trail Leads To China -- Do Not Try This At Home." In that post, I talked about a recent Ernst & Young report detailing over $900 billion in non performing Chinese bank loans (NPL) and we also talked about a company we know personally, DAC Management , that has been buying up distressed Chinese assets for the last five years.
Today, Forbes Magazine reports that Ernst & Young has retracted that report and admitted it was in error:
"Upon further research, Ernst & Young Global finds that this number cannot be supported, and believes it to be factually erroneous," the global accounting firm said.
"The NPL report did not go through our normal internal review and approval process before it was released to the public and, as it contains errors, we are withdrawing the report."
The firm's decision to disown the document comes after the People's Bank of China website said last week that the report's findings were seriously distorted.
The PBOC said that domestic commercial banks' NPL ratio at the end of the first quarter of this year stood at eight pct or about 1.31 trln yuan.
The latest Ernst & Young statement backed the official figure of 133 bln usd [as opposed to its earlier report which put this figure at 358 bln usd] in NPLs released for the country's four major state-owned banks, noting that it was calculated on standards that reflect 'objective evidence of impairment."
"We sincerely regret any misleading views that the report conveyed," Ernst & Young said.
One of our regular readers and commentators (used here to mean someone who writes comments to our posts), Joseph Wang, immediately questioned Ernst & Young's $900 billion figure (here and here) accusing the venerable Big Four accounting firm of double counting. Mr. Wang deserves massive kudos.
We really do welcome your comments!
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China's Banks May Be Troubled, But Nobody Knows The Trouble Ernst & Young Has Seen:
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Comments
You and Joseph are probably both more knowledgable about China then me, but as someone who works in banking, and knowing China and knowing what I have read over the last few years about their loan situation, I cannot help but wonder if perhaps E&Y was actually correct.
Is China reacting this strongly because E&Y is closer to the truth then they want to admit? Especially when they move to the "official number". I dont know the numbers myself but have read several times that the bad loan figure is thought to be much higher then is officially admitted. This seems like exactly the kind of move China would make towards the bearer of bad news.....
Posted by: JB | May 15, 2006 8:59 AM
JB --
Thanks for checking in. I fear we are just going to have to put China's bad loan numbers into the already large bin of China numbers that cannot be accurately determined due to Chinese government secrecy. I am working on a new post on the issue of Ernst & Young's retraction that will be up shortly. Unfortunately, it will mostly just be a throwing up of hands, without any strong conclusions. It may take years to know the truth, but either way, I see this leaving a black mark on Ernst & Young.
Posted by: China Law Blog | May 15, 2006 9:19 AM
I outlined the problem with the E&Y numbers. Some of the numbers you can argue back and forth, but the major problem is that the report double counted $250 billion. That's not arguable, it is just wrong.
E&Y looks really bad, because it's been one of the auditors for the big four banks. If it really believed that there were off-book NPL's in the big four banks (and I don't think there are), then it shouldn't have signed the accounting certifications.
Also, the trouble with NPL numbers isn't government secrecy at all. The problem is that it often isn't clear what constitues a NPL. If I miss a credit card payment by one day, that isn't an NPL. If I miss one by one year, that is. Somewhere in between is a fuzzy line. There are a lot of accounting rules and standards that make this determination, but applying them involves pretty much examining line by line every transaction of a multi-billion dollar corporation. That is not easy, but it was done with the big four banks. The status of pre-1998 loans is not a topic for which you can argue very much over.
Some of the numbers involved are "hard" numbers (i.e. the amount that was transferred from the banks to AMC's). Some of the numbers are "soft" (i.e. what are the probable losses due to real estate loans made in 2004). Some are in between (what are the NPL's resulting from SOE's issued in 1994).
But you can get a handle on even the soft numbers. For example, I'd argue that it is unlikely that there is much in the way of pre-1998 NPL's on the books of the banks, because there is no reason for the government not to have transferred those to the AMC's. I'm also an optimist on the level of NPL's resulting from the post-2001 credit boom, (and I can go into some detail as to why if anyone is interested). But since those numbers are soft, people can have legitimate disagreements (and I can also go into detail about why my arguments could be broken).
But the mistake that E&Y did was to add 1 and 1 and get three. It's unfortunate that E&Y isn't going to publish a "post-mortem" explaining why the numbers are off. It's even more unfortunate that E&Y isn't going to publish a "post-mortem" explaining how a bad mistake like this slipped through.
I should point out that in arguments like this it is really important to go in and get your fingers dirty with the details. If you don't dig into the numbers and figure out where they came from and what they mean, it is really hard to figure out what to believe.
This is bad because in the case of E&Y you are forced to throw out some good stuff. The NPL report had the best summary of Western investments in Chinese banks I've ever seen, and they also have a report next to it on Chinese real estate loans which seems really good.
Posted by: Joseph Wang | May 15, 2006 10:02 AM
Mr. Wang --
Thank you so much for checking in again on this. I completely agree with you on the importance of getting ones "fingers dirty with the details" on something like this as it is only in the details that the answers will be found.
I also concur with you in hoping E&Y will issue a full "post-mortem" on this, but I am not expecting it.
Posted by: China Law Blog | May 15, 2006 10:49 AM