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Will bad loans from China’s east coast turn into a tsunami?

Reuters Breakingviews delivers agenda-setting financial insight. Its global correspondents react to stories as they develop, delivering sharp and provocative commentary on big financial news as it breaks.

Credit alarm bells are ringing in China's east. Earnings from three of the country's top four lenders show that while the national ratio of bad debts to loans is still falling, stress is building in coastal regions. Problems in an area rich in private sector businesses and manufacturing could be a national concern.

Agricultural Bank of China, China Construction Bank and Bank of China, which collectively account for a third of the country's bank lending, flagged a 26 per cent increase in bad loans for the area around the Yangtze River Delta, which centres around Shanghai, between June and December, while their total loans to that part of China increased just 3 per cent.

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Things may yet worsen. AgBank and CCB doubled their annual credit impairment charges for the region. And overdue loans, a less discretionary measure of credit quality, have been increasing. CCB said loans more than three months past due in the Yangtze region increased by 47 per cent in the last half of 2012.

Measuring Chinese banks' bad debts is a subjective business. Dodgy loans can be written off, or handed on to state companies that specialise in working out problem credits. Increased new lending also makes the pile of non-performing loans look smaller. But borrowers lacking state support are likely to be most at risk. All three banks showed a pick-up in bad loans to manufacturing and retail sectors.

Some companies' debt problems are highly visible, like those of Suntech, the bust solar panel maker based in the Delta which at one point owed AgBank 1.6-billion yuan ($261.6-million). But banks' balance sheets don't tell the whole story. Many small private businesses, frozen out by banks and bond markets, have turned to less formal credit channels. Local, non-bank lenders lack the huge balance sheets to easily absorb defaults.

Local problems are unlikely to stay local. Company loans are often guaranteed by subsidiaries or agencies far away. The coast is also crucial for creating employment, and is a symbol of China's vibrant private sector. If the credit cycle turns down in earnest, distress in the east will be felt by the rest.

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