Beneath the surface of the global financial system lurks a multitrillion-dollar problem that could sap the strength of large economies for years to come. The problem is the giant, stagnant pool of loans that companies and people around the world are struggling to pay back. Bad debts have been a drag on economic activity ever since the financial crisis of 2008, but in recent months, the threat posed by an overhang of bad loans appears to be rising. China is the biggest source of worry. Some analysts estimate that China’s troubled credit could exceed US$5 trillion, a staggering number that is equivalent to half the size of the country’s annual economic output.
Official figures show that Chinese banks pulled back on their lending in December last year. If such trends persist, China’s economy, the second-largest in the world behind the US, might then slow even more than it has, further harming the many countries that have for years relied on China for their growth. However, it is not just China. Wherever governments and central banks unleashed aggressive stimulus policies in recent years, a toxic debt hangover has followed. In the US, it took many months for mortgage defaults to fall after the most recent housing bust — and energy companies are struggling to pay off the cheap money that they borrowed to pile into the shale boom.
In Europe, analysts say bad loans total more than US$1 trillion. Many large European banks are still weighed down with defaulted loans, complicating policymakers’ efforts to revive the continent’s economy. Italy, for instance, announced a plan last week to clean out bad loans from its plodding banking industry. In theory, it makes sense for banks to swiftly recognize the losses embedded in bad loans — and then make up for those losses by raising fresh capital. The cleaned-up banks are more likely to start lending again — and thus play their part in fueling the recovery. In reality, this approach can be difficult to carry out.
Recognizing losses on bad loans can mean pushing corporate borrowers into bankruptcy and households into foreclosure. Such disruption can send a chill through the economy, require unpopular taxpayer bailouts and have painful social consequences. And in some cases, the banks might find it extremely difficult to raise fresh capital in the markets. Even so, the drawback of delaying the cleanup is that the banks remain wounded and reluctant to lend, damping any recovery that takes place. Japan, economists say, waited far too long after its credit boom of the 1980s to force its banks to recognize huge losses — and the economy suffered for years after as a result. Now, many banking experts are beginning to worry about China’s bad loans.
Fears that the country’s economy is slowing have weighed heavily on global markets in recent months because a weak China can drag down growth globally. Many of these concerns focus on China’s banking industry. In recent years, banks and other financial companies in China issued a tidal wave of new loans and other credit products, many of which will not get paid back in full. Although there is not enough official data to come up with a precise figure for bad loans, some analysts have come up with estimates of around US$5 trillion.
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