Mortgage-Backed Sinology
Markets have been surprised by the scale of the subprime exposure some of China’s biggest banks recently disclosed, but we’re left saying “Tell us more, please.” Many other institutions have been forced to face up to the bright glare of bad publicity and stiff market discipline, but perhaps nowhere are both more needed than in China’s banks.
Bank of China, one of the country’s largest, last week announced that it is holding nearly $10 billion in various assets backed by subprime mortgages. Industrial and Commercial Bank of China followed suit by announcing $1.22 billion in exposure. China Construction Bank yesterday disclosed about $1.06 billion of subprime holdings.
Fallout will be limited largely because the banks never leveraged their holdings in the ways their American and European peers have. Although the numbers are big — Bank of China’s reported exposure exceeds its operating profit for the first half of 2007 by $3 billion — as a percentage of the banks’ portfolios, the stakes are relatively small. The banks also are unlikely to have to write off the full value of their subprime holdings since they can afford to hold onto the assets until the market improves.
One salutary result of the recent disclosures is that now the markets can, for the most part, dust themselves off and move on. Chinese banks’ subprime exposure has been a subject of intense speculation lately. And although some analysts expect the banks to eventually revise the estimates of their exposure upward, it appears that the worst is over, at least for the publicly traded banks.
All of which makes for a welcome breath of fresh air in China’s banking sector. The three banks at issue here have converted into joint-stock companies only within the past two years. Before their transformations, their books were so opaque that mysteries as basic as the severity of their non-performing loan ratios provoked heated debate, fraud was endemic, and risk controls were unheard of. Now, however, the discipline of regular financial reporting and some press scrutiny is leading to improved openness at the three that have gone public. And if, as skeptics believe, the banks haven’t been completely honest this time around, markets will punish them for that, too. These first lessons in public disclosure will serve them well as they increasingly look overseas and start adding riskier assets to their portfolios.
If only other Chinese institutions could do the same, especially since bigger subprime trouble may yet be lurking. Beijing is believed to have invested some portion of its $1.33 trillion foreign-exchange reserves in mortgage-backed securities, although no one knows how much money has been invested or whether the assets are subprime. Maybe one day government money managers will get around to reading the memo on transparency themselves.