Tackling China's Debt Problem: Can Debt-Equity Conversions Help?
IMF Blog, April 26, 2016
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Bibliographic details
- Authors: James Daniel, Jose Garrido, Marina Moretti
- Published: April 26, 2016
Overview and context
- Authors: James Daniel, José Garrido, Marina Moretti
- Date: April 26, 2016
- China’s corporate debt has risen to about 160 percent of GDP.
- The IMF’s April 2016 Global Financial Stability Report examined vulnerabilities stemming from banks’ exposures to corporate debt, finding that the share of commercial banks’ loans to corporates that could potentially be at risk has been rising fast and, although currently at a manageable level, needs to be addressed with urgency.
Techniques under consideration
- Two specific techniques reported in media coverage:
- Converting Non-Performing Loans (“NPLs”) into equity.
- Securitizing NPLs (repackaging bank loans into marketable securities) and selling them.
International experience and key messages
- Debt-equity conversions and NPL securitization can play a role and have been used successfully by other countries, but:
- They are not comprehensive solutions by themselves.
- Poorly designed implementations could worsen problems, for example by enabling “zombie” firms (non-viable firms that are still operating) to persist.
- Banks generally lack expertise to run or restructure businesses; debt-equity conversions could create conflicts of interest—banks may keep lending to a now-related party.
Design principles for debt-equity conversions
- Convert debt only of viable firms.
- Implement conversions in the context of operational restructuring plans for the firms (which may include changing management).
- Conduct conversions at fair value.
- Banks should hold the equity for a limited period only.
Design principles for NPL securitization
- Encompass a diversified pool of NPLs.
- Ensure banks retain some residual financial interest (“skin in the game”).
- Establish a legal and operational framework that allows owners of distressed assets to:
- Force operational restructuring of firms.
- Obtain the best value from those assets.
Components of a comprehensive, system-wide plan
- Assess the viability of distressed firms, restructure viable ones, and liquidate nonviable ones.
- Require banks proactively to recognize and workout NPLs.
- Implement burden sharing among banks, corporates, institutional investors, and the government.
- Enhance the framework for corporate restructuring, including the Enterprise Insolvency Law.
- Develop distressed debt markets.
- Address social consequences, especially to support laid-off workers.
Expected outcomes
- A comprehensive plan would help allocate resources—labor, capital, and credit—to more productive uses.
- Combined with the right mix of macroeconomic policies and structural reforms, it would support China’s broader economic rebalancing towards a more sustainable growth model.
IMF Blog: Tackling China's Debt Problem: Can Debt-Equity Conversions Help? — April 26, 2016
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