Commentary on Political Economy

Wednesday 29 May 2019


This just in from The Financial Times – Don’t say you were not warned!

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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