China’s $3 Trillion of Hidden Bad Debt Prolongs Economic Pain

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“Kicking the can down the road just prolongs the pain,” said Wolfe. He said it weighs on bank earnings and limits credit for more productive firms, “which will ultimately undermine GDP growth.”

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Fed Study

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A study by the Federal Reserve Bank of Dallas found that these so-called zombie firms accounted for 16% of assets at non-financial companies in China in 2024, up from just 5% in 2018. While the real estate sector has the highest rate, the manufacturing and services sectors are rising, too, the report found.

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Even Chinese officials have gloomy estimates. A recent paper by the European Union Institute for Security Studies cited an anonymous interview with mid-level government officials saying that their estimates of the true NPL ratio are 15% to 20%. Shih at the University of California also pegs the rate at closer to 20%.

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Assuming a 10% bad loan ratio, that would equal about 17% of China’s gross domestic product. By comparison, some analysts projected non-performing loans reached about one-third of Japan’s GDP during the early 2000s.

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Hu, 48, should be squarely in that NPL category, operating a hollowed-out enterprise in the manufacturing province of Zhejiang, near Shanghai. The combination of weak domestic demand and volatile exports has forced him to slash his workforce by 90%. Since the post-pandemic reopening in late 2022, his plastics facility has teetered on the brink of insolvency, generating just enough cash to cover basic operations.

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“I’m just playing it by ear, no real plans,” Hu said, asking that his lender not be named for fear of reprisals. “If the bank calls the loan, I’ve got no way to pay back the principal right now.” 

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China’s official NPL ratio has always been a bit of a mystery. In good times and bad, it’s rarely wavered much from 1.5%, and most economists say it greatly understates the true stress in the system. The figure captures only loans officially classified as “substandard,” “doubtful,” or “loss.” 

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In reality, the classification is often a subjective assessment and banks have different internal criteria. A much larger pool of troubled credit remains in the “special mention” — those that may have already become overdue but yet to be categorized as nonperforming — or “normal” categories, thanks to an aggressive use of leniency known as forbearance.

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Existing rules stipulate that when repayment on a loan is overdue by more than 90 days and the borrower can’t fully repay the amount, it should be marked as nonperforming. 

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Economists including Wolfe estimate that about 40% of loans are either eligible or already in some sort of forbearance program, where banks are strongly discouraged from seeking repayment or recognizing losses.  

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The bad loan risk “could have led to a financial crisis if not for the forbearance policies and the government’s intervention,” said May Yan, head of Asia financials research at UBS Group AG. The fact that China is not in crisis speaks to the success of these measures, she said.

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In other words, rather than cracking down on deadbeat borrowers, China’s banks are encouraged to cut them some slack. Regulators have for years urged the big banks to keep their reported bad loan ratio under 2%, according to people familiar with the guidance. 

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With the forbearance policy — a legacy of Covid support programs that’s been extended to property developers and other firms — Beijing is signaling its desire to maintain financial stability. It wants to avoid a rash of bank failures that would follow a surge in reported bad credits and company defaults.

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A leniency policy for small businesses that was introduced during the pandemic was extended in 2024 to encourage banks to roll over loans for companies enduring temporary difficulties. This policy is effective until late next year, and applies to 9.4 trillion yuan ($1.38 trillion) worth of loans, according to officials.