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  • 1 0000000404811396 Monetary Fund
  • | 2 0000000404811396 Monetary Fund

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Asia and Pacific Department, Legal Department, and Monetary and Capital Markets Department

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This technical note and manual (TNM) addresses the following issues:

  • It is welcome that the government is focusing on the problems of excessive corporate debt and the corresponding burden on banks of impaired assets.

  • Converting NPLs into equity or securitizing them are techniques that can play a role in addressing these problems and have been used successfully by some other countries.

  • But they are not comprehensive solutions by themselves—indeed, they could worsen the problem, for example, by allowing zombie firms (non-viable firms that are still operating) to keep going.

  • Getting the design right is thus critical:

    • – For debt-equity conversions, this includes converting debt only of viable firms in the context of operational restructuring for the firms (which may include changing management), at fair value, and with banks holding the equity for a limited period only.

    • – For NPL securitization, this includes securitizing a diversified pool of NPLs, banks keeping some residual financial interest (“skin in the game”), and creating the legal and operational framework that will allow owners of distressed assets to force operational restructuring of firms and obtain best value from those assets.

  • For these techniques to help address the systemic problem of excessive corporate debt and impaired bank loans more generally, they need to be nested within a comprehensive, system-wide, plan that should involve:

    • – Assessing the viability of distressed firms and restructuring the viable and liquidating the nonviable;

    • – Requiring banks to proactively recognize and workout NPLs;

    • – Burden sharing among banks, corporates, institutional investors, and the government;

    • – Enhancing the framework for corporate restructuring, including the Enterprise Insolvency Law;

    • – Developing distressed debt markets.

Debt Equity Conversions and NPL Securitization in China: Some Initial Considerations
Author: Mr. James Daniel, Jose M Garrido, and Ms. Marina Moretti