The Problem of Non-Performing Loans: Normalising Bad Behavior

Non-performing loans have been a widespread problem both in developed and developing countries. One of the most striking examples came from China, where they accounted for 35 per cent of state-owned bank loans in 1999. What is the best way to deal with such a problem?

The conventional approach has been to focus on creditors and their inadequacies in such things as credit risk assessment and enforcement. But Jiatao Li and Carmen K Ng argue that that leaves out an extremely important factor: the social identity of the debtor.

When non-performing loans are prevalent, it is likely they have become the accepted norm of doing business. The authors set out to show that was the case in China in the late 1990s, and also to identify alternative self-images that ran counter to the norm and pointed the way to reducing the problem.

“Non-performing loans hinder economic growth and increase the risk of a financial crisis, yet the proposed remedies have not considered the institutional logic associated with carrying these loans. The problem in China may be a reflection of an institutional logic that regards non-performing loans as legitimate,” they said.

To investigate this, they used the findings of government-funded surveys of entrepreneurs from 1998-2000 to study 3,751 Chinese firms, 59 per cent of which had overdue outstanding loans.

The findings showed, first, that if non-payment was more prevalent among a firm’s industry peers, it increased the likelihood that the firm would not repay its loans, supporting the idea of a normalization process at work.

The authors hypothesized that two factors would help a firm to resist to this normalization process: CEO moral identity, and firm identity. On this first point, while CEOs with strong ethical traits relied less on late payments, this did not translate into a reduction of normalization.

Rather, what mattered was firm identity. Private enterprises had an overall 29.8 per cent lower likelihood of having non-performing loans than did state-owned firms. Moreover, private enterprises were less prone to the normalization process than state-owned enterprises. That is, the prevalence of non-performing loan in an industry caused a significant incrase in a state-owned firm’s odds of having a nono-perofrming loan, but the effect was smaller for private enterprise..

Enterprises with market-selected CEOs were also less prone to the normalization process than enterprises with politically appointed CEOs.

The authors’ interpretation of this was that private firms without political connections had less favorable access to funds and, hoping to bargain for more financial liberalization and fairer lending decisions, they formed a collective identity of “liberalists, supporting a capitalist market logic”. Through this identity, they became less prone to follow the norm of loan defaults than state-owned enterprises and those with politically-appointed CEOs.

“Successfully countering the normalization of deviant borrowing practices apparently must be accompanied by a change in attitude and the emergence of a viable anti-deviance identity. The results show that firms with a liberalist identity were less prone to accept carrying nonperforming loans, and suggest private enterprises, as well as those without political connections, were perhaps dissatisfied with the statist logic underpinning deviant payment practices,” they said.

Measures that help to change perceptions about the acceptance of non-performing loans could help to deal with the shortcomings of traditional remedies, and thereby help to minimize this problem, they added.

LI, J. T.

Lee Quo Wei Professor of Business, Chair Professor, Director of Center for Business Strategy and Innovation

NG, Carmen

Adjunct Assistant Professor