This paper examines the phenomenon whereby state-owned banks in China tend to not only reduce their non-performing loans(NPLs ) through accepting settled assets, but also overvalue and delay liquidating settled assets. The results imply that the state-owned banks exhibit an obvious book loss aversion behavior when disposing their NPLs, i.e. they minimize book loss and hide real credit loss by settling their NPLs with overvalued assets. This paper suggests that this results mainly from improper regulations, weak financial strength, and over-restrictions on NPL disposition. Since introducing a valuation allowance on settled assets, as suggested by the regulatory body, will not produce the desired effect, this paper proposes that a performance measurement and penalty mechanism based on non-performin gassets instead of NPLs will change the banks' attitude towards NPL-asset settlement. In addition, a new internal control method governing the entire process from settlement to liquidation is also suggested.
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