Offshore haven

Hainan: the ‘Hawaii of China’ would also like a little bit of Wall Street too

When Angela Merkel presented an 18th century map to Xi Jinping earlier this year it portrayed a world in which China’s southernmost frontier seemed to end at Hainan Island. For much of Chinese history this was the most distant place that wayward officials and scholars could be exiled by the Imperial court – a tropical equivalent of being sent to the Siberian wastes.

But a huge and largely uninhabited island has its own appeal to economic planners – things can be started there from scratch. In the 1940s TV Soong, brother-in-law of Chiang Kai-shek and also his finance minister, had tried turning Hainan into a special economic zone (SEZ). Hong Kong’s richest man Li Ka-shing proposed the same to Beijing in 1986, offering to invest HK$10 billion ($1.28 billion) to develop the island. But the idea wasn’t realised until 1988 when Hainan was made not only one of China’s provinces but also the country’s largest SEZ in land area terms. The island would also pioneer many financial reforms. In 1995 it even established one of the first joint-stock banks, known as Hainan Development Bank (HDB).

However within three years Hainan would become the only province without its own commercial bank.

Why? In 1998, a combination of fraud and property-related bad loans saw HDB become the first commercial bank to fail since paramount leader Deng Xiaoping launched China’s open door policy.

Its collapse was subsequently eclipsed by the even bigger implosion of GITIC a year later (see WiC176) but for Hainan the consequences have been longer-lasting.

The provincial government has spent more than a decade trying to get another bank off the ground. As one official recently told 21CN Business Herald: “Hainan spent many years promoting HDB’s restructuring, but central bank officials just remained tightlipped. HDB’s standing as the first bank to go down made Hainan a high-risk, financial no-go zone as far as they were concerned. The Hainan government became so frustrated it has ended up proposing another bank as an alternative.”

21CN now reports that this new bank, called Hainan Bank, could be up-and-running before the end of the year. It appears to have benefited from recent moves to liberalise the banking sector by allowing private companies to establish banks (see WiC230).

The first signs of a regulatory change of heart came in 2012 when the banking regulator the CBRC finally allowed Hainan to form a task force to lay the groundwork for a new bank. Then in April the Hainan government said it hoped to gain regulatory approval by the end of the first half of the year to open a new local lender.

Like China’s other 144 city-level commercial lenders, it will have a mix of state and private-sector shareholders. According to 21CN, Hainan Luhuitou Tourism will be a major sponsor from the state-owned sector, alongside pharmaceutical company Hainan Haiyou and private sector software developer DHC Software (ranked by Forbes in Asia’s best 200 small caps).

The new bank will have registered capital of Rmb3 billion ($480 million), with Hainan Haiyou and DHC Software both investing up to Rmb210 million for stakes of about 5% each.

One of the driving forces behind the CBRC’s decision to engage once more with Hainan has been the on-the-ground presence of its former vice chairman Jiang Dingzhi. In 2010, he became acting governor of Hainan. Since he took up full office in 2012, Jiang has actively promoted the island as a hub for offshore financial services. Speaking to reporters this March, Jiang said Hainan is preparing the infrastructure it needs to develop financial services and attract private equity investment. The former banker talked of his wish to see two new rural commercial banks, a restructured HDB and a commodities futures trading centre in operation before the end of the year.

If successful, these ambitions would help finance the island’s other grand plan to become a major international tourism destination by 2020.

However, when that blueprint was first unveiled in late 2009 it prompted a property frenzy, which left commentators wondering whether history would repeat itself on the island. It was a real estate free-for-all in the early 1990s that caused HDB’s problems in the first place. By elevating Hainan’s status from a Guangdong prefecture to a provincial SEZ, Deng Xiaoping threw open the saloon doors to what many in the media subsequently described as China’s own Wild West.

In their book Red Capitalism, the authors Fraser Howie and Carl Walter recall how Hainan’s property prices doubled twice in the space of three years. More than 20,000 real estate developers set up shop – one property broker for every 80 inhabitants of the island. Servicing them were 2,068 financial institutions including 24 trust companies and 30 urban credit cooperatives. By 1992, Hainan’s GDP growth hit 41.5% compared to the then 14.2% average for the country as a whole.

But the economic mood darkened when the central government started to rein in credit. HDB was tasked with clearing away the worst of the failed trust and investment companies, with the provincial government taking a 30% stake. But as CBN recalls, it ran into trouble from the very start. HDB had been established with equity capital of Rmb 1.7 billion, but within the space of its first five months the young lender had issued Rmb920 million in loans to its own shareholders who used them as a way to withdraw their own capital. As the fallout from the implosion of the property bubble got worse, HDB was then forced to absorb 28 failing credit cooperatives. The People’s Bank of China issued new loans of Rmb3.4 billion to help HDB absorb the worst candidates, but this failed to make much difference as the new funds only accounted for a third of HDB’s loans at a time when two-thirds of its loans were non-performing.

When it became public that many real estate developers were going under, HDB then found itself the victim of a major bank run.

In June 1998 it was all over. The central government stepped in, subsuming HDB’s operations within ICBC, one of China’s largest lenders.

China’s big four commercial banks now dominate lending on the island and are probably not too keen at the idea of having a new, local competitor in Hainan.

For the central bank HDB has provided many lessons, including the need for a deposit insurance scheme, which Governor Zhou Xiaochuan has been reiterating as a top priority for the country’s banking reforms.

And as Hainan Bank’s new shareholders get accustomed to their role as bank sponsors, the government will also be watching to make sure they avoid the mistakes of some of their predecessors.

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