Loans to leasing firms stoke bad debt risks at mainland banks

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, the mainland'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.