BEIJING - Signs that Chinese lenders will postpone taking losses on trillions of yuan in loans made to local governments may undermine investor confidence in the country's banking industry, Standard & Poor's Financial Services LLC (S&P) said on Thursday.

Regulators may permit banks to reschedule loans they have made to local government-financing vehicles, which would be a "backward step" and threaten a decade of increasing transparency, according to an e-mailed report from the ratings company on Thursday.

"Such a policy change, if it materializes, could undermine the Chinese banking sector in the long run despite its possible short-term relief," Liao Qiang, a Beijing-based director of financial institution ratings for S&P, said in a conference call after the report was released.

Thousands of local governments borrowed money to finance building projects as part of an economic stimulus started in November 2008. Financing companies enabled provinces, cities, counties and townships to bypass rules barring those entities from making direct bond sales.

Local governments had debt totaling 10.7 trillion yuan ($1.69 trillion) by the end of 2010, according to a June national audit.

"Refinancing risks for heavily leveraged financing platforms are looming large," Liao said.

Honoring debts

The report said about 30 percent of loans to local government companies may sour in the next three years if the government does not extend any support. The ratio of non-performing loans in the banking system may increase to about 10 percent from the current 1 percent.

"Creditors have now started to doubt the capacity and willingness of local governments to honor their debts, given the sheer size of the debt and unevenness of fiscal strength across regions," the report said.

The nation's banking regulator is under pressure to ease rules on local lending after tightening them in the past few years, Liao said.

Zhou Mubing, vice-chairman of the China Banking Regulatory Commission, said in October that the regulator may allow banks to reschedule certain loans made to local government financing vehicles, the report said.

A call to the banking regulator on Thursday seeking comment on the report went unanswered.

As much as 3 trillion yuan in loans, accounting for 5 percent of the banking industry's total lending at the end of this past year, may be eligible for extension, S&P said. That would reduce credit losses by 80 billion to 100 billion yuan each year for the next three years.

Bloomberg News

(China Daily 01/13/2012 page15)