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Why the huge write-off by China banks is positive

Thursday, 24 Oct 2013 | 3:43 AM ET
Philippe Lopez | AFP | Getty Images

While the huge write-off in bad debt by China's top five banks in the first-half is being regarded as a red flag for the world's second-largest economy, some experts say it should be seen in a positive light.

The country's five largest banks wrote off a collective 22.1 billion yuan ($3.65 billion) in bad debt in the first six months of the year compared with 7.65 billion yuan in the same period a year earlier, according to a report by Bloomberg on Wednesday. The lenders are Industrial & Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank and Bank of Communications.

"While it reveals some of the country's deeper problems, the write-offs are also part of the new government's overall strategy to clean up their books and bring default ratios to international standards," said Kathy Lien, managing director of FX Strategy at BK Asset Management.

(Read more: China stocks sink after major banks write off debt)

"There is no doubt that slower growth has increased the amount of bankruptcies and failed businesses in China but the government is also pressuring its banks to take write offs now to avoid a surge in non-performing loans later," she added.

With some of China's largest lenders achieving record profitability, now is the right time for them to take write-downs because profits can still be preserved, Lien noted. Total earnings for the top five banks rose to a record $76 billion in the first six months of the year.

(Read more: China money market rates spike, but don't panic)

While the tripling in the write-off of non-performing loans (NPLs) may appear alarming, Ting Lu, chief China economist at Bank of America Merrill Lynch says it was mainly due to a very low base, and should be welcomed.

What's behind all the fear in China markets?
Yao Wei , China Economist at Societe Generale says since China economic growth has been positive, Beijing is using this time to clean up credit.

"NPLs have risen in the past few years along with the rapid credit growth and they are yet to be written off, the rise of write-offs is inevitable and should be welcome," said Lu.

Given Chinese commercial banks have high provision coverage ratio at 290 percent, above the required 150 percent, there is enough room for writing off bad loans, he added.

(Read more: Agricultural Bank of China eyeing Wing Hang)

Andrew Sullivan, director of Asian Sales Trading at Kim Eng Securities noted that in the past, banks have put the loans into their non-performing portfolios, rather than actually writing them off. Thus, acting upon the bad loans helps to improve the health of the banks, he said.

—By CNBC's Ansuya Harjani; Follow her on Twitter @Ansuya_H

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