(Agencies)
Updated: 2008-01-23 10:08

SAN FRANCISCO -- The US subprime crisis may be able to help accomplish what China's central bankers have yet to do -- rein in China's banking industry and its fast-pitched economic growth and inflation.

Adding to recent reports of a big subprime write-down at Beijing-based Bank of China Ltd., a Chinese senior economist on Tuesday said he expected rising nonperforming assets at China's biggest lenders, fueled by their subprime exposure and tighter domestic credit.

"With the spreading of the US subprime crisis and a slew of tightening measures to stop economic overheating and rising inflation, the bad assets ratio in the banking industry and the risk of fluctuations in the capital markets are growing," said Zhong Wei, an economics professor at Beijing Normal University, in an interview with the Financial News.

He said the ratio of bad loans on the books of China's major banks fell to below 7% last year but is rising, and he said the central bank should increase its holding of foreign reserves. In the past, China has used its immense holdings of foreign currency to recapitalize struggling, state-owned banks.

The latest worries about the health of the banking system in the world's fourth-largest economy come on the heels of steep sell-offs in Chinese and other stock markets, sparked by fears the United States is on the brink of recession.

Asian markets on Tuesday extended heavy losses from the prior session, derailed by concerns that exporters would get hit by a retreat in US spending. China's Shanghai Composite Index lost more than 5%, adding to a 7.2% loss in the prior session. Hong Kong's Hang Seng Index fell 8.7% after tumbling 5.5% the prior session.

Losses from holding soured subprime investments have already hit large US, British and European institutions but have yet to dog Chinese banks and the economy to the same degree. China could still get bruised by a wider subprime fallout, says China specialist Nicholas Lardy, but only indirectly.

"If the subprime crisis puts the US further into recession, that will affect China the most," said Lardy, a senior fellow at the Peterson Institute of International Economics in Washington, DC. He said he would be surprised if a big write-down in subprime loans at the Bank of China led to a contraction in credit across the country, as it has in the United States and Europe.

But subprime could still leave its mark on China's economy. Since exports have been such a large driver of growth, the country is particularly vulnerable to recession in the United States and other developed economies. Almost one quarter of its economic growth stems from the expansion of its trade surplus, the world's largest.

So if export growth does sputter, the Chinese economy could slow, cooling lending and inflation. That's a task China's central bankers have struggled to achieve.

Analysts anticipate gross domestic product in China rose at about 11% in the fourth quarter, in keeping with previous quarters and topping the country's prior growth projections. Inflation reached nearly 7% in November.

Among China's biggest banks, Bank of China is seen having the most exposure to international assets. Shares fell sharply Monday after the South China Morning Post, citing unnamed sources, said the lender may post severely reduced 2007 net profit or even a loss after writing down part of its nearly $8 billion in securities backed by subprime mortgages.

The Hong Kong-listed bank responded to the article with a statement that it still expected to increase profits for the year ending Dec. 31, notwithstanding provisions and disposal losses for the bank's exposure to subprime related securities. It did not specify the size of the losses.

"Rumors were that they could write off $2 billion," said Todd Lee, managing director of the Greater China group at Global Insight.

A multi-billion write-off would top the bank's previous estimates of its subprime problem. If subprime write-offs spread to other institutions, these could trigger a more prolonged decline in the high-flying Chinese stock market.

Still, said Lee, the more likely threat to the country's banks and economic growth stems from domestic efforts to curb inflation. To tighten up credit, the People's Bank of China is raising interest rates and requiring banks to hold more reserves. Those measures are coinciding with a slowdown or even recession in the United States and Europe, increasing pressures on the economy.

Before, "they could afford to tighten domestic investments and still see exports support growth," said Lee. "Now they're facing a real risk of recession."