Commentary on Political Economy

Wednesday 5 June 2019


A $647bn blind spot in financial reporting by China’s city and rural commercial banks is fuelling investor concerns that more of the country’s lenders face government intervention or collapse in the wake of the state takeover of Baoshang Bank. Baoshang was one of 19 banks with a combined Rmb4.47tn ($647bn) in assets that have yet to publish 2018 financial results, according to a list compiled by Barclays.  The delays are a potential sign of a build-up in non-performing loans and leave investors blind to how many of those assets may have turned into bad debt, as was the case with Baoshang, analysts said. 

 Inner Mongolia-based Baoshang Bank published its most recent annual report in mid-2017. Citing “severe credit risks”, the government took over the institution late last month, the first such intervention in 18 years and a sign that some banks in the country are experiencing a severe deterioration in asset quality. Investors and market watchers are now questioning whether more banks that have yet to disclose their latest financials could be facing similar problems. “This does have some impact on investors’ confidence in the market,” Dong Ximiao, vice head of Renmin University’s Chongyang Financial Institute, said of the banks that have delayed their financial reports. He added that it was important to know why the banks have not released their annual reports.

But some of the explanations have not filled investors with confidence. Hong Kong-listed Bank of Jinzhou, which has not published 2018 annual results, said last week that its auditor Ernst & Young Hua Ming resigned after it found that the some of the bank’s loans to institutional clients were not used for their stated purpose. The Bank of Jinzhou statement said EY requested evidence of “the customers’ ability to service the loans, particularly the collateral that could be enforced” — a sign the auditor was concerned about the bank’s credit quality. EY resigned when Jinzhou could not provide the evidence. Bank of Jinzhou lent $440m to once high-flying Chinese solar group Hanergy, which experienced a collapse in its share price in 2015.

A series of investigations by the Financial Times that year into the company’s business model highlighted suspicions because of its revenue coming almost entirely from sales to its parent. Shandong-based Hengfeng Bank, with Rmb1.42tn in assets — by far the largest Chinese lender yet to disclose 2018 earnings — has been facing funding difficulties for several years. The bank was flagged in UBS research last year for its heavy reliance on funding from negotiable certificates of deposit and the interbank market, which makes it more susceptible to liquidity shocks. Barclays analysts said they expected more fallout: “We expect more ‘exits’ of smaller banks or non-bank financial institutions (likely through takeover or M&A with bigger parties), most likely with some regional significance.”

The banks that have postponed their financial reporting represent a fraction of China’s banking system. But the crisis at Baoshang, which had just Rmb576bn in assets as of mid-2017, shows how troubles at a small bank can send a shock through the interbank market. The People’s Bank of China was forced to release Rmb430bn in short-term liquidity in the week following the takeover.

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