Commentary on Political Economy

Wednesday 22 July 2020

Rogue tycoon shareholders spur China financial sector clean-up

Last year’s bailout of Baoshang Bank has made the issue of ‘illegal’ shareholders a top concern for financial regulators keen to ensure stability © Giulia Marchi/Bloomberg
Depositors swarmed Yingkou Coastal Bank late last year, desperate to withdraw their cash after online rumours suggested it was on the brink of collapse.
In fact, analysts had warned for years about a potential build-up of bad debt at Yingkou, a mid-tier lender based in northern China. But those longstanding concerns have been linked to the financial stability of its largest shareholder, HNA Group.
The airlines-to-finance conglomerate fell out of favour with Beijing in 2018, was forced to sell off billions of dollars in assets around the world, and has faced severe liquidity problems.
For several years before that, however, HNA had used Yingkou as a piggy bank to fund its own operations and, by the end of 2019, Yingkou was showing signs of strain.
So far, the bank has managed to pay back depositors, according to local media, but the story provides a case study for a problem Chinese authorities are increasingly focused on: the hijacking of financial institutions by fast-growing conglomerates in need of capital. 
The sprawling HNA group — best known for snapping up large stakes in Hilton hotels and Deutsche Bank — became Yingkou’s controlling shareholder in 2014. 
With HNA executives at the helm, its assets began expanding at a breakneck pace. According to corporate filings, in 2015 alone they nearly tripled from Rmb14bn to Rmb55bn, driven by aggressive sales of trust beneficiary rights — a complex and opaque type of off-balance-sheet lending used to hide bad loans. That same year, several companies connected to HNA became large borrowers from Yingkou.
As HNA fell out of favour and struggled to make good on debts, Yingkou’s fortunes suffered. At the end of September last year, the bank reported an 85 per cent increase in provisions for potential bad loans. That news, when it trickled down, helped spark the panic at bank branches across the city.
The problem started, said Li Ying, an analyst at S&P Global (China) Ratings, where shareholders were “using the banks as ATMs”.
“Sometimes they create shell companies and then take lots of loans. The loan book can look diversified but actually it’s very concentrated.”
This will have a great impact in the long run, and there may be situations where the debts cannot be paid
Liao Zhiming, Tianfeng Securities
The practice had been especially common at rural banks, where oversight was weaker, she said.
With surging bad debts threatening China’s banking sector and the pandemic expected to turn about 11 per cent, or $2.1tn, of commercial banking assets into troubled debt over the coming year, according to S&P, regulators are rushing to take action to ensure stability and that lenders are not left in need of a state bailout.
On Friday, Chinese regulators announced the takeover of nine insurers, trust companies and securities brokers connected to detained tycoon Xiao Jianhua. It was one of the most sweeping regulatory interventions in recent memory, aimed at preventing the risks of failing financial groups from spreading through the system.
Earlier this month, the China Banking and Insurance Regulatory Commission for the first time published a list of 38 “illegal” investors that it says have used banks as “ATMs”. HNA has not been dubbed an illegal shareholder in Yingkou but analysts estimate the affected banks have about Rmb1.5tn ($214bn) in assets.
“[Illegal shareholders] could have a relatively large impact on the stable operation of the banks, and may eventually create a hole in balance sheets with a large number of non-performing loans,” said Liao Zhiming, chief banking analyst at Tianfeng Securities.
The problems that can pile up from reckless lending gained wider public attention last year when the government was forced to take over regional lender Baoshang Bank, in one of the biggest shocks to China’s financial system in decades.
But regulators were already starting to take action in 2017. 
Early that year, mainland security agents kidnapped tycoon Mr Xiao from his apartment at the Four Seasons hotel in Hong Kong and whisked him back to China, where authorities had decided his financial conglomerate Tomorrow Group had become a systemic risk.
Several years before, he had taken control of Baoshang Bank and used its funds to bankroll the expansion of parts of his business. 
China’s banking bailouts
By mid-2019, souring debts forced the government to rescue Baoshang Bank — the first such direct intervention in nearly 20 years. Later that year, another bank connected to Mr Xiao, Bank of Harbin, also required a bailout.
People close to the CBIRC say the incident with Mr Xiao was what focused regulatory attention on the risks of ambitious private entrepreneurs with control over banks.
As in Baoshang’s case, many entrepreneurs have bought large stakes in banks and used them as a source of loans to their own subsidiaries, leaving them mired in debt if business sours.
The list of 38 illegal shareholders includes a handful of prominent businessmen who are accused of reckless use of bank funds and have been forced to sell of their bank stakes.
One is Chinese entrepreneur Xue Min. He controls a large medical imaging group, at least 70 other companies and owned stakes in seven financial institutions in Hainan province. Corporate records indicate he has now sold many of his bank stakes.
Hu Kaijun, an entrepreneur who controls two listed drug companies, owned a large stake in Ningbo Donghai Bank. A holding company he owns, China Grand Enterprises, was on the list of illegal shareholders but corporate records indicate he has also already divested.
Analysts believe the divestments were part of the Rmb3.3bn of bank stakes the government said were transferred to state entities as of April. The regulator has said it will continue to hunt other offenders.
But some warn that reckless lending to corporate shareholders has created a problem that will not go away in a hurry.
“For small and medium-sized banks, this will have a great impact in the long run, and there may be situations where the debts cannot be paid,” Mr Liao said.

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