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Chinese banks pile up risks through loans to financial leasing firms

[SHANGHAI] Chinese banks scrambling to meet capital adequacy rules have stepped up lending to financial leasing companies in the past year as they move away from traditional corporate loans that require them to set aside more funds as provisions.

Under global regulations known as Basel III introduced last year, China's biggest banks have to increase their capital as a percentage of their assets. To help free up funds to meet the rules, banks are looking for ways to cut provisions for some loans - even if they have to lend to companies leasing ships, tractors and building equipment in some of China's most vulnerable sectors.

The provisioning for certain leasing companies owned by financial institutions is lower as they fall under the official category of safe borrowers. Provisioning for direct loans to heavily indebted corporate borrowers such as shipping companies and property developers is higher as the economy slows and default risks increase. "Lending to a bank-owned leasing company with a guarantee from the parent means a lender only has to set aside capital for 25 per cent of the loan, whereas for straight debt, it is 100 per cent," said Michael Hu, a financial services assurance Partner at PwC China.

But lending to leasing companies does not totally shield the banks from defaults in the economy's underperforming sectors.

Leasing companies buy big-ticket assets like ships, planes and heavy machinery and lease them out to the very firms that would have tried to borrow money straight from banks, according to bankers and leasing company employees.

Among leading lenders to financial leasing firms are Export-Import Bank of China (EXIM), China Development Bank and Industrial and Commercial Bank of China , according to lawyers and bankers. "We have increased lending to leasing companies by 10 per cent this year," Gao Zefeng, assistant general manager of transport finance at EXIM, China's top lender to the shipping sector, said on the sidelines of the Marine Money conference in November.

At the conference, bankers from Industrial and Commercial Bank of China Ltd , Bank of China Ltd and China Development Bank Corp said they would be supporting lending to financial leasing companies.

Compounding the risks for lenders, leasing companies are not afraid of leasing assets to companies in volatile sectors, with the shipping industry being a prime example. "Sometimes banks use it as a means to lend to borrowers that aren't qualified," said an analyst with a western credit rating agency.

Since 2008, the shipping sector has been wallowing in a slump, leaving Chinese banks stuck with defaulting shipyards. Yet ICBC Financial Leasing Co, China's largest lessor, increased its number of vessels by 50 pe rcent in 2013 from 2012, according to data on its website.

At the end of the third quarter of 2014, the value of assets held by China's leasing companies rose 45 per cent to 1.22 trillion yuan (US$196.91 billion) from the end of the first quarter of 2013, banking regulator data reported in official media shows.

There are other reasons why banks extend loans to leasing companies.

Banks lend to their own lessors, according to bankers and leasing company employees, despite rules restricting that practice, magnifying the lenders' exposure to the country's underperforming sectors. "Banks have an unofficial agreement with each other. They will say, we lend to leasing companies whose holding banks have lent to us," said an official at a bank-owned leasing company, declining to be identified because he is not authorised to speak to the media.