KUALA LUMPUR (Oct 20): Hidden bad debts are worrying for Chinese banks, as the sector’s finance is already in a mess, according to The Economist.

In a report last Sunday, the magazine said local governments are struggling to repay lenders at least 65 trillion yuan (RM42.8 trillion) in off-balance-sheet debts.

It said many of the country’s big property developers have already defaulted on offshore bonds and owe trillions of yuan-worth of unbuilt homes to local residents.

The Economist said China’s largest wealth-management firms have started to default on payments owed to investors.

It said problems with loans to the smallest firms began with Covid-19.

It said as China shut down, the central bank put a moratorium on the repayment of loans for small- and micro-enterprises until June 2020 in order to halt a wave of defaults.

The magazine said after less than three months, officials estimated that 700 billion yuan in payments had been deferred.

The moratorium has been extended several times since then, with officials citing the continued impact of Covid.

No estimate for the total amount of unpaid loans exists and banks will not be required to disclose them publicly until next year, said the magazine.

It said the moratorium has also coincided with another state initiative.

In order to stimulate the economy, the central government has leant on banks to extend loans to the smallest firms, and to do so at the lowest possible interest rates.

Although such policies have been attempted for years, banks have been resistant, preferring to lend to the large, often state-owned companies with which they have relationships already.

This time the policy has worked, however, it said.

The Economist said a crackdown on the banking industry, culminating in the arrest of the president of one of China’s largest commercial banks last year, has made bosses more willing to follow official edicts.

As a result, at the beginning of the year, about 28% of all loans in China had been given to small- and micro-enterprises, up from 24% at the end of 2019.

Many of these loans represent simply the renewal of older, unpaid debts.

It is well known that small firms struggled during the pandemic, said the magazine.

The Economist said another result has been what some view as a catastrophic mispricing of assets.

It said small firms are usually judged to pose the greatest risks, but loans to small- and micro-enterprises have nevertheless been provided at rock-bottom interest rates.

It said banks have offered them at an average of 4% annual interest, down from 6% or so in 2019.

To make matters worse, a recent surge in long-term deposits, which are remunerated at higher rates, means banks’ margins have been squeezed even tighter, it said.