Chinese banks could face negative credit outlook: Moody's

China's local government debts may exceed the state auditors' estimates by a whopping $540 billion (3.5 trillion yuan), said Moody's Investors Service on Tuesday.

The ratings agency warned in a new report, Growing Size of Local Government Debt Burden Challenges Chinese Banks, that the credit outlook for China's banks may turn negative if China fails to come up with a clear master plan to deal with this issue.

It warned, "that the potential scale of the problem loans at Chinese banks may be closer to its stress case than its base case, according to an assessment that the rating agency conducted following the release of new data by China's National Audit Office (NAO)."

Another ratings agency, Standard & Poor's, said last month that up to 30 per cent of loans to Chinese local government bodies could potentially sour, accounting for the biggest source of banks' non-performing assets.

"We assume that the majority of loans to local governments are of good quality, but based on our assessment of the loan classifications and risk characteristics, as provided by the NAO and other Chinese agencies, we conclude that the banks' exposure to local government borrowers is greater than we anticipated," says Yvonne Zhang, a Moody's vice president and one of the authors of the report.

Of the approximately $1.6 trillion (RMB 10.7 trillion) of local government debt examined by the Chinese audit agency, $1.3 trillion (RMB 8.5 trillion) was funded by banks. However, Moody's has identified another potential 540 billion (RMB 3.5 trillion) of such loans that the Chinese auditors did not discuss in their report.