This just in from The
Financial Times – Don’t say you were not warned!
Baoshang takeover spotlights China financial system perils
Baoshang takeover spotlights China financial system perils
Questions raised over
whether case is isolated or presages broader crisis The government takeover of
Baoshang Bank is the latest sign China is facing its most severe financial risk
in almost 20 years ©
When Baoshang Bank published its most recent annual
financial statement in mid-2017, it claimed to have a non-performing loan ratio
of just 1.68 per cent. Two years later, Baoshang, which has Rmb576bn ($83bn) in
assets, has been taken over by the government because of its “serious
credit risk”, the first such move in 18 years and a reminder of the hidden
perils lurking within China’s financial system. The need for a state rescue has
raised questions about financial contagion. It has also led to worries that
regulators may have allowed a destabilising build-up in bad debt to go
unchecked for far too long. “Is Baoshang part of a corruption-related clean-up
or the start of what could become a series of bank failures?” J Capital, an
independent research house focused on China, wrote in a research note. The
intervention, announced last Friday, sent a shock through markets. The
government for the first time explicitly extended guarantees on Baoshang’s
interbank debt and corporate deposits — but only up to Rmb50m per lender or
customer.
China’s interbank market has long operated under the
assumption that large debts were implicitly guaranteed by the government. But
regulators have changed tack in the case of Baoshang with the limited
guarantee. In our view, the state
takeover of Baoshang Bank suggests China will have to face the consequences of
years of rapid debt accumulation Nomura analysts “There is definitely some
short-term concern after this because the incident has broken investors’ belief
in [full] payment for interbank liabilities,” said Xie Yunliang, chief macro
analyst at Minsheng Securities. “This has never happened before in the
industry.” China’s interbank market, where most of the country’s bonds are
traded, has been prone to cash crunches when sentiment sours, even as the
People’s Bank of China has devised new ways of providing stable liquidity to
the market over the past five years.
Signalling that
pressure could build on liquidity, the central bank said on Wednesday that it
would inject Rmb270bn into the market in the biggest open markets operation
since the start of the year. Mr Xie noted that liquidity tightened slightly
in the interbank market early this week before the central bank took steps to
facilitate access to cash. But the limited guarantee given to corporate
depositors and interbank lenders in Baoshang’s case will have a lasting impact
on how investors view the market. “[This] suggests a break of the [implicit]
guaranteed payment in the interbank market,” Barclays chief China economist
Jian Chang said in a note to investors.
The Baoshang takeover
is the latest warning sign that China is facing its most severe financial
risk in almost 20 years. In February, a state-owned development
company defaulted on US dollar-denominated debt, something that has not
happened since the massive default of China’s Gitic in 1999. The last
government rescue of a bank in China was in 2001, when Beijing took over
Shantou Commercial Bank following a corruption scandal. At that time, Chinese
banks were experiencing an explosion in bad debt on their balance sheets after
having concealed the toxic assets for several years.
Many experts fear a
similar accumulation and spillover of bad debt at small lenders is happening
this year. China’s National Audit Office said in April that some banks in
central China had non-performing loan ratios of 40 per cent at the end of 2018,
the first official disclosure in decades of such high rates of toxic assets.
“In our view, the state takeover of Baoshang Bank suggests China will have to
face the consequences of years of rapid debt accumulation,” Nomura analysts
wrote in a note to investors — although they added that Baoshang was a special
case due to its connection with disappeared billionaire Xiao Jianhua and
his troubled financial conglomerate Tomorrow Group. Mr Xiao was abducted from
the Four Seasons hotel in Hong Kong in early 2017. His company, which held a
large stake in Baoshang, is also under government control. Mr Xiao, once known
for an extensive detail of all-female bodyguards, is one of a handful of
aggressive financiers who fell out of favour with the Chinese state as Beijing
cracked down on excessive financial risk.
Baoshang is the second big financial institution to be taken
over by the government in two years, after Beijing’s seizure last year of
Anbang Insurance and the sentencing of its founder, Wu Xiaohui, to 18 years in
prison for financial crimes. Baoshang Bank is thought to have lent primarily to
companies controlled by Tomorrow Group. It has also reported one of the lowest
capital adequacy ratios for a Chinese bank, impairing its ability to weather a
crisis. Experts and investors are divided over whether Baoshang’s problems are
an isolated corruption case or whether more Chinese banks are on the brink of
crisis. “While the concentrated loan books of regional banks mean they are more
vulnerable to sudden liquidity drain or sharp economic slowdowns, our current
base case is that Baoshang’s case is likely to be the exception more than the
rule,” said Liang Yu, a director at S&P Global Ratings. “While there is
scope for other individual banks to face similar problems, we do not expect
those problems to be widespread.”
Some investors are
nevertheless beginning to ask whether there are more institutions facing
similar distress. “I am not sure why the PBoC has not opted for a different
option, such as a takeover by a bigger institution,” Alicia Garcia-Herrero,
chief economist for Asia Pacific at Natixis. “Is it because there are other
cases and nobody wants to volunteer?”
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