Banking & Finance

A mini-Lehman moment?

Bank runs expose strains on China’s $41 trillion banking system


Postal Savings Bank’s Shanghai IPO has been postponed

The wads of red Rmb100 bills stacked at the counters at a branch of the Yichuan Rural Bank last month were not meant to be part of the decor. As speculation about its insolvency ran high – especially when its chairman went missing – the cash was parked there to quash rumours about a liquidity crunch as panicky depositors swamped its branches to demand their savings back.

There is normally no smoke without fire. Local credit rating agency China Chengxin has downgraded the Henan-based lender’s creditworthiness twice since July last year. This happened after the lender recorded a 15-fold increase in non-performing loans and a 50% shrinkage in its deposit base between 2016 and 2018. Worse still, 12 of its 116 shareholders were placed on a government blacklist for defaulters, meaning that large amounts of the bank’s shares could be subject to forced disposal by creditors. The recent run on the bank was only resolved after a Rmb30 billion injection from local government.

China’s Rmb285 trillion ($40.5 trillion) banking sector is once again in the spotlight after not just Yichuan but another regional lender in Liaoning struggled too with mass withdrawals, this time over a span of nine days.

Despite local governments’ insistence that the panics were just one-offs, fanned by fear-mongers (a claim later reinforced by 10 arrests), the events are increasingly viewed as symptoms of concern about the financial system. Some observers worry about a nightmarish risk that contagion could spill over from marginal players to the broader sector.

China currently has some 4,500 banking institutions, of which over 88% are small or medium-sized. Typically characterised by low profitability, poor capitalisation, heavy local government influence and huge exposure to opaque investments (which understate actual asset quality), these minor players are often seen as the weakest link in the banking system. Combined, they represent up to 25% of banking assets.

The Sino-US trade war and a slowing rate of GDP growth aside, their financial woes have been heightened since 2017 when Beijing made a bigger push with its deleveraging drive.

That campaign involved policies that squeezed the incomes of smaller banks because they derived a sizable portion of their revenues from selling now unfavoured asset management products. At the same time the government measures increased their credit costs through more stringent requirements for bad debt recognition.

Last week Harbin Bank became the fifth bank in six months to get a state bailout. The Hong Kong-listed lender had earlier attributed declining profits for the first half to more aggressive write-offs. The latest $2 billion recapitalisation will effectively see Harbin Bank 48%-controlled by state-owned entities. The lender did not provide reasons for the change in ownership, though the move is believed to be linked to the unravelling of Tomorrow Group, controlled by detained financier Xiao Jianhua (see WiC354).

At its height, Tomorrow Group owned stakes in at least 10 listed regional banks, including Baoshang Bank, which in May was also made a state ward due to serious credit risks – this time triggered by a misappropriation of funds (see WiC454). In the ensuing months Bank of Jinzhou likewise tapped three state-controlled financial institutions, including bad-debt managers, for its credit enhancement programmes, while sovereign wealth fund China Investment Corp emerged as a strategic investor of Hengfeng Bank.

Failures of regional players could have serious consequences because a lot of local companies – which are also major employers and taxpayers in the cities where they’re based – sometimes rely on borrowing for their survival. More significantly, these banks are key nodes in the interbank market, where they’ve sold negotiable certificates of deposit (NCD) to bigger banks to boost their liquidity. If they go bust, larger banks will have to incur losses, and overall funding costs will spike as a result of stronger risk aversion among market players.

In the week after Baoshang Bank was nationalised, for instance, the volume of NCDs issued fell nearly 90%. Small banks were only able to sell 20-50% of their NCDs, versus up to 75% before Baoshang’s takeover, prompting the People’s Bank of China to pump nearly Rmb2 trillion into the interbank market, the South China Morning Post reported.

In the wake of the recent bank runs, the China Banking and Insurance Regulatory Commission (CBIRC) is mulling a number of measures to help “improve the mechanism of liquidity risk management for small and medium-sized lenders” with the aim to “fend off systemic financial risks”.

A key plank will be to encourage more mergers, as well as restructurings for troubled banks with assets of no more than Rmb100 billion. Other proposals include holding local governments responsible for dealing with messy lenders – independently of the central bank – and making existing shareholders buy perpetual bonds to shoulder potential losses. Zhou Liang, the CBIRC’s vice chairman, emphasised that the regulator would avoid using “a scalpel” on individual banks, because the risk of contagion could be high even if a failed lender seems small.

Fitch Ratings considers the policy constructive, given a lot of the existing banks lack the resources to make sufficient investments in compliance and risk controls. Yet it also believes that the plan might face “operational hurdles”.

For one thing, local governments – usually the largest shareholders in city-based commercial lenders, as well as rural banks – might not want to give up control over their closest financial allies. For another, larger banks, faced with mounting bad debts, generally lack the capital for aggressive mergers and acquisitions and will struggle to absorb a large number of small banks as part of any consolidation process.

Even if these smaller banks are trying to recapitalise through issuing Additional Tier 1 (AT1) perpetual bonds, says Fitch, the larger banks are unlikely to invest in these instruments directly due to considerations over their risk-weighting status. Overall AT1 issues by Chinese banks have more than tripled to a record $55 billion since 2014, data from Dealogic shows. “We expect most demand to come through banks’ wealth-management products, insurance funds and asset management companies,” the credit rating agency commented.

Neither is it easy for the regional banks to raise funds through share sales, even though regulators tend to put their IPO applications on a fast track and encourage those listed overseas to return to the domestic market for another flotation. China Zheshang Bank, for example, saw muted response to its recent onshore IPO, where subscriptions for 13 million shares were cancelled. Analysts blamed the poor performances of peers such as Chongqing Rural Commercial Bank, which went public on November 1 and is now trading below its IPO offer price.

So far 22 banks have raised a total of $13 billion on mainland bourses and via Hong Kong IPOs this year. Yet many have seen their stock price trade below their net asset values per share.

Cautiousness about the sector is putting a dampener on what is poised to become the largest A-share IPO since 2015. Early this month Beijing-based Postal Savings Bank of China decided to postpone the launch of its Rmb28.5 billion IPO in Shanghai. The reason was a local regulation that forced Postal Bank to disclose that its price-to-diluted-earnings ratio – at 9.6 times – was far higher than the average of its listed peers’ 7.1 times in the past month.

For investors the differential flags the risk that they could incur post-IPO losses, given this divergence does not look sustainable.

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