Hidden Non-Performing Loans in China

We study non-performing loan (NPL) transactions in China using proprietary data from a leading market participant. We find these transactions – driven by tighter financial regulation – are consistent with banks concealing non-performing assets from regulators as (i) transaction prices do not compensate for credit risks even though the transactions are supposed to transfer risks; (ii) banks provide funding for the NPL transactions and remain contractually responsible for debt collection for the NPLs removed from their balance sheets; and (iii) over 70% of NPL packages are re-sold at inflated prices to third-parties who are mostly borrowers of the banks and are in the same local areas as the original banks. Altogether, these results imply the transactions do not truly resolve NPLs and raise the question how exposed banks remain to the hidden NPLs. Recognizing these hidden NPLs implies the total NPLs in China is two to four times the reported amount. We discuss implications for financial stability.