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May 15, 2006

Ernst and Young Retracts China Bad Loans Report

Last Friday, in a stunning turn of events, Ernst and Young announced the retraction of its May 3 report on China's NPL (non-performing loan) exposure. Claiming that the report had not gone through internal review, Ernst and Young further stated that the report "contained errors" requiring retraction of the study in toto. In doing so, E&Y has bowed lower than any western firm one can remember in recent times, offering in addition to the public shame of retraction, its profuse apology as well as sincere regrets.

And what errors, if errors they be. But are they? The global accounting firm had estimated NPLs for the four largest banks (CCB, ICBC, ABC, BOC) at US$358 billion. The press release notes that the "official level" of NPLs, that issued by the Central Bank, is but US$133 billion, a third of the E&Y figure. An error that large in official Chinese statistics is entirely believable -- the Chinese government recently revised upwards its GDP statistics by 16.4%. But when studied by professional economists at a respected global company?

Here's what Jack Rodman, a managing director at E&Y, said when the report was issued, before the retraction:

"I think the numbers will be a big surprise because China has been giving the impression (with its banks listing overseas) that the problem is behind us," said Jack Rodman, a managing director with E&Y. "China has not really resolved the issue - they have just moved it from one state enterprise to another."

Wow! It was refreshing to hear so bold a comment uttered by an executive representative of a major western business operating in China. (We have been writing in a similar vain for a number of years.) But then came the muzzling of those who felt it safe to speak in earnest. What happened?

Read the press release carefully, as it appears to have been drafted with great care. Within this work of fine draftsmanship (I heartily commend the writer), one finds an explanation to its global readership. May I paraphrase?

"We, a global leader in professional services committed to restoring the public's trust in financial accounting, told the world Chinese big four NPLs hit 358, but we were on the receiving end of some serious heat from the central bank the week it was issued, even though they characteristically didn't announce us by name. And, anyway, we're auditors for two of those banks, so what could we do? We haven't any choice but to kow-tow if we want to keep the business -- this is China and we're in it up to our double chins. Ok, here's the official number: $133 billion. We're not saying explicity that we avow the truth of that number, but it is the official version. Can you dig it?"

Sadly, none of the western press seems to have picked up on anything but the exact wording of the press release, making it appear as though E&Y was entirely at fault. At least, in the near term, their bold assertion may work to harm their reputation in the eyes of those who without China business experience. E&Y press relations people outside of China may wish to pitch the rest of the story, off the record, to their media contacts at some point.

[UPDATE (May 16, 2006): Bloomberg discusses why this is such a sensitive issue for the Chinese government here. A quote from the article:

"Chris Ruffle, a Shanghai-based fund manager, won't buy Bank of China shares when the nation's No. 2 lender goes public this month. As a Bank of China customer, he's all too familiar with the bank's failings...Banks are the weakest part of the Chinese economic system, so buying into them doesn't make sense to me.'"

Comments

Posted by: Dan Harris at May 15, 2006 4:42 PM

Posted by: JVizer at May 16, 2006 10:19 AM

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