On Monday, we noted that NPLs in China saw their biggest quarterly increase on record in Q1, jumping 141 billion yuan sequentially to 983 billion. We also discussed why the proliferation of property loans is spreading real estate risk to the larger economy before outlining several reasons why the “official” data on bad loans may severely understate credit risk in much the same way that “official” data out of Beijing on economic output probably grossly overstates GDP growth. As a reminder, here is what we said:
One might be tempted, upon reading this, to point to "official" data on bad loans at Chinese banks on the way to concluding that "modest loss-absorption capacity" or not, sub-2% NPL ratios certainly do not seem to portend an imminent catastrophe. However, given the official figure is just 1.39%, and given what we know about the state of China's economy, one could be forgiven for wondering if NPLs at China's biggest lenders are grossly understated. To let Fitch tell it, determining the true extent of China's NPL problem is complicated by a number of factors and the 'real' data might be just as hard to get at as an accurate reading on Chinese GDP.
In order to truly understand how exposed China’s lenders are to potentially toxic “assets”, it’s worth taking a closer look at all of the different non-standard channels through which the banks have taken on credit risk. 
At the outset it should be noted that it is virtually impossible to determine how many of the traditional loans banks carry on their books would actually be impaired were it not for what Fitch calls “centrally managed NPLs.” Put simply, the government has a tendency to ‘influence’ banks’ decisions when it comes to rolling over problem loans. Here’s Fitch:             
It is not uncommon for the authorities (central or provincial government, PBOC, or China Banking Regulatory Commission; CBRC) to encourage banks to roll over loans to support the broader economy. Such influence from the regulators is common in China, but less so in more developed markets as it runs counter to the principle of strict prudential oversight. (In addition, in some cases in China the regulator has lowered risk weights to encourage banks to lend to potentially riskier borrowers.)...            
                                         
Where a bank agrees to provide additional funding to prevent default, i.e. by rolling over the loans and requiring more collateral as credit enhancement, this exposure and/or other loan exposures relating to the same borrower may not be recognised as impaired. The level of disclosure of widely reported corporate defaults (or near defaults) is low, and there is no information available on the amount of debt renegotiations that are unreported by the media.                          
In other words, there’s no way to know how pervasive Beijing’s practice of forcing banks to roll-over problem loans truly is, meaning that even if we ignore the fact that quite a bit of credit risk is obscured by the practice of shifting it around, moving it off balance sheet, and reclassifying it, (i.e. if we just look at traditional loans) it’s still difficult to know what percentage of loans are actually impaired because it’s entirely possible that a non-trivial percentage of sour debt is forcibly restructured and thus never makes it into the official NPL figures. 
Fitch goes on to note what we mentioned earlier this week, namely that the percentage of  loans which are not yet classified as non-performing but which are nonetheless doubtful is much higher than the headline NPL figure and in fact, the ratings agency seems to suggest that some Chinese banks (notably the largest lenders) may be under-reporting their special mention loans:
Banks in China have remarkably similar NPL ratios and performance trends, which suggests little or no difference in risk appetite despite large differences in ownership and systemic importance, and varying levels of investment in their risk-management systems. However, state banks’ capital adequacy ratios have clearly benefited from having greater access to capital markets due to their much larger franchises. 
 
There are more notable differences in special-mention and overdue loan trends, implying that loan classification standards, which in principal are on a par with international practice, may not be applied consistently and uniformly across all banks in China. For example, loans overdue for more than three months are not always classified as NPLs at some banks. The only common trend is that all banks’ provision coverage ratios fell during 2014 as the increase in loan provisioning was insufficient to offset the NPL increases, even as NPLs have been partly offset by write-offs and/or disposals