Henan Banking Mess Raises Stability Concerns

THIS BYSTANDER BELIEVES that there is more to be discovered about the banking scandal in Henan that led to violent clashes between depositors and police on Sunday and now to financial regulators ordering the banks involved to start releasing funds to their depositors.

Earlier this month, hundreds of depositors in four rural banks in Henan had the health codes on their smartphone apps used to enforce Covid-19 quarantines suddenly turn red, despite testing negative for Covid-19. Five local officials were subsequently disciplined for a brazen effort to stop the disgruntled depositors from travelling to the provincial capital Zhengzhou to petition authorities for redress.

The scandal had come to light in mid-April after the four rural banks and another in neighbouring Anhui suspended their online banking services and froze an estimated 400,000 customers out of their accounts containing tens of billions of yuan. The purported reason was for the banks to conduct a systems upgrade, one that seemingly never ended. 

Depositors at Yuzhou Xinminsheng Village Bank, Shangcai Huimin County Bank, Zhecheng Huanghuai Community Bank and New Oriental Country Bank of Kaifeng in Henan province and Guzhen Xinhuaihe Village Bank in the neighbouring Anhui province were affected. 

In May, banking regulators launched an investigation into Henan Xincaifu Group Investment Holding, a private investment firm with stakes in the rural banks involved. By then, (peaceful) protests demanding the accounts be unfrozen had started to be held outside Zhengzhou offices of the China Banking and Insurance Regulatory Commission (CBIRC).

At the start of this week, police arrested what were described as members of a ‘criminal group’ said to be involved in taking over the rural banks and making illegal transfers through fictitious loans. Authorities say they are looking for a man identified as Lu Yi, accused of being the mastermind who controls Henan Xincaifu.

Bank deposits of up to 500,000 yuan ($73,500) per depositor per bank are covered by deposit guarantees, although there is some ambiguity over which rural bank accounts are protected. Nonetheless, the CBIRC says that bank customers with up to deposits of 50,0000 will be repaid from July 15.

It is not yet clear what will happen to deposits of more than 50,000 yuan, although the CBIRC has said it will not reimburse accounts with a whiff of suspicion about them.

This has the look of a central government bailout, perhaps buy-off would be more accurate. It is difficult to escape the thought that, however described, the action was prompted by fears of bank runs on other small lenders and the threat to social stability they would pose.

China has some 4,000 rural banks, many of which have one foot in the murky world of shadow banking and whose ownership structures allow shareholders to gain significant control without regulatory approval and put themselves in a position to syphon off cash through loans.

Bank regulators have been tightening up on rural banks for more than a year. The Henan banks scandal will likely lead to a further turning of the supervisory screw. 

In the Henan banks case, one question is whether local officials or regulators were turning blind eyes to whatever was going on, and whether they were benefiting from it.

With central government putting a premium on economic and social stability, this could easily become an exemplary case to demonstrate how local officials are now expected to have ditched the old ways. Protestors’ banners accusing the provincial authorities of corruption that appeared last weekend will be disconcerting to Beijing.

China’s Financial Regulators’ 2014 Priorities

CHINA’S FOUR MAIN financial regulators have outlined their legislative priorities for the year: No great surprises. The introductions of catastrophe and food liability insurance, probably the least discussed reform proposals to date, are in line with the Party’s overall top priorities for the year, food security and improving the rural environment. In summary:

People’s Bank of China: Expand cross-border use of the yuan; maintain steady credit growth; improve the multi-tier capital market; and engage further in international financial regulation policy-making.

China Banking Regulatory Commission: Pilot three to five private banks, opening up the banking sector to domestic and foreign private capital; gradually reduce the threshold for foreign banks to enter the banking sector and ease their RMB operation requirements; keep a close eye on big housing developers, and reduce the risk of default through weak links in the construction industry’s money chain; restructure overcapacity industries, liquidating their assets and reducing the risk of default.

China Securities Regulatory Commission: switch IPOs from the current approval system to one based on registration; let the timing of IPOs and how shares are issued be determined by the market, as long as issuers disclose all relevant information as required; abolish approval requirements on 21 items over the next three years starting from 2014.

China Insurance Regulatory Commission: work with the finance and other ministries to implement catastrophe insurance; set up food liability insurance, given the importance of food safety in China.

Banking On Privately Owned Banks

THE ANNOUNCEMENT EARLIER this week of a pilot programme to establish three to five private banks this year is a tiny first step towards providing competition to China’s giant state-owned banks and easier access to mainstream banking services for small businesses. Don’t forget that many of China’s 3,000 banks are already majority privately owned but they collectively account for just 11% of the banking sector, underlining the embedded advantage the big state-owned banks derive from their national branch networks and the immense deposit bases those provide, as well as from their political connections and implicit state guarantees.

The pilot scheme is another piece in the mosaic of financial reform that is itself part of the grander design for rebalancing China’e economy. It starts to fulfill one of the pledges made at last November’s Third Plenum policy meeting, though the qualification requirements to establish one of these new banks remain unclear. But broadly what will make them different from existing private banks is that they are intended to be entirely privately financed, and would “bear their own risks” — no de facto policy role nor implicit state safety net.

Another way to further open up the financial sector, increase competition, and provide small businesses with an alternative source of finance to the shadow banking system would be to make it easier for foreign banks to enter or expand in the industry. The state’s banking overseer, the China Banking Regulatory Commission, is looking at that but it wants to let some home-grown “trusties” to get established first.

That could include restructuring some existing state owned local and regional banks under new private ownership. A range of non-financial sector players have expressed interest in getting into banking since the possibility was floated last year. Among them are Wang Jianlin, chairman of Dalian Wanda, one of China’s biggest property developers. Others include another developer, Macrolink Real Estate, retailers Shanxi Baiyuan and Suning, which already has millions of customers using its online payments system and a network of 1,700 stores, and Internet giant Tencent.

China Said Set For Big Boost To Muni-Bond Market

China looks set to give a big boost to its nascent muni-bond market this year. The Finance Ministry is to quintuple the quota for local government bond issuance to 250 billion yuan ($40 billion) this year, Caixin reports.

In addition, more provinces will reportedly be added to the list of those able to issue bonds directly. Since 1994, the ministry has done that on behalf of local governments but started an experiment in direct issuance in October last year with Shanghai, Shenzhen, Guangdong and Zhejiang. That privilege will be extended to six more provinces and municipalities. The ministry is expected to maintain the close control over the bond issuance by the larger group that it has exercised over the trial quartet, including having a big say over what the funds raised can be used for.

Expanding the muni-bond market is both part of the broader reforms of the financial system and local government finances. The latter are teetering under the burden of 10.7 trillion yuan of debt, at least 3 trillion yuan of which falls due by the end of this year. Much of the debt piled up as a result of the stimulus spending in the wake of the 2008 global financial crisis. Much of it is infrastructure loans, for things like toll roads to nowhere, that are weighing heavily on the creditworthiness of China’s banks.

Earlier this month the China Banking Regulatory Commission ordered banks to clean up their balance sheets with regard to local government lending. It first told them to do that in June last year, but progress clearly hasn’t been rapid enough, or, as a result of the cooling of both the economy and the property market, problem loans are mounting. Good and bad loans alike were probably rolled over when banks tackled the 2 trillion yuan of local government loans that fell due last year. Another red flag raised by China’s audit office: irregularities it has found with 530 billion yuan worth of the lending. Taken together, an estimated 2 trillion-3 trillion yuan of local government lending has soured, which would be sufficient to raise the banks’ non-performing loan ratios to 5% from their current average of 1.1%.

The new quota of 250 billion yuan for bond issuance won’t wipe away the problem but every little bit helps–though places like Greece serve as a reminder that bond issuance is not an infallible inoculation against the highly contagious disease of government fiscal profligacy. Yet while the immediate priority is to deflate China’s local-government debt bubble before it can go damagingly pop, an expanded muni-bond market also pushes provincial and municipal governments in three other desirable directions: less reliance of land sales to raise revenue, less need for the off-balance sheet financing via captive investment vehicles that local authorities have resorted to get round restrictions on official borrowings, and more transparency generally about their finances.

More Signs Of Concern Over Bad Bank Loans

China’s banks face a new round of stress tests to see how their loan books would withstand the measures to cool the property market actually succeeding. State media report that the China Banking Regulatory Commission ordered the tests on Tuesday and instructed banks to strengthen their risk management over loans to property developers and to the off-balance sheet investment companies local governments use to circumvent restrictions on raising capital.

The banks faced a similar round of testing last year, which reportedly showed that they could stomach a 30% decline in property prices. The new round suggests growing nervousness among banking regulators about the health of the banks’ loan books and the potential for more lending to turn sour as a result of the property bubble going pop or a crisis in local government financing.

China Presses On With High-Speed Rail

It appears that it is full steam ahead for China’s high-speed rail network despite the bribery and corruption investigation around sacked railways minister Liu Zhijun. His replacement Sheng Guangzu says development will continue to plan. Shen also said that the ministry’s affiliated railway companies were holding 1.8 trillion yuan ($275 billion) in debt, which amounts to 56% of their assets–within “the safety zone”, according to Sheng. That said, the bank regulator, China Banking Regulatory Commission, has told banks to review their lending to high-speed rail projects.

Footnote: Our man in New York reminds us that America’s railway building boom in the 19th century, and particularly the transcontinental Union Pacific Railroad, was afflicted by bribery and corruption. The most notorious incident was the Credit Mobilier of America scandal in the 1860-70s in which 13 members of the U.S. Congress were implicated.

The Two Instabilities

As the 11th National Committee of the Chinese People’s Political Consultative Conference, the country’s top political advisory body, meets in Beijing to ratify a new five-year plan to rebalance the economy and to tackle inflation and rising property prices, two comments from western China illustrate the Morton’s fork China’s economic policymakers find themselves somewhat uncomfortably stuck by.

The first occurred at a recent meeting of regional managers from one of the large state-owned banks. A manager from Xinjiang, we are told, complained that credit quotas imposed by the banking regulators were constantly tightening in the cause of the national fight against inflation, making his bank’s branches unable to meet the local demand for loans, demand that was rising because of the development priority now been accorded to the region by Beijing.

The central bank is repeatedly dabbing up as much of the excess liquidity in the economy as it can through interest-rate hikes, higher capital reserves requirements on banks and administrative measures such as new-loan quotas. The goal is to dampen inflation and to let down the asset bubbles inflated by the lending spree triggered by the post-global-financial-crisis stimulus.

Yet it is precisely through fixed-asset investment that the government has been able to deliver the constant economic growth that the Party sees as essential to legitimize its monopoly on power. The second comment, from Xinjiang regional chairman Nur Bakeri just this week, spells out how raising living standards through economic development is key to maintaining social stability. “Development is our top priority and stability is our greatest responsibility. Without development, there would be no stability and vice versa,” he said.

Such local political pressures lie behind not just the continued pace of new bank lending this year, but also the discovery in February by the banks’ regulator, China Banking Regulatory Commission (CBRC), that more than half of new bank lending wasn’t meeting its new credit rules designed to mitigate the fear that China’s banks are sitting on a potential dung heap of bad loans. The rules require banks to meet tougher credit and risk standards with new loans. As far as the banks are concerned it is a case of old habits die hard. For years and years and years, China’s growth has been fueled by fixed asset investment financed through government-directed bank lending. Flash the cash and the devil take the hindmost.

Beijing had to bail out the big banks once to cleanse their loan books. After a couple of years of stimulus fueled record lending, it worries it may have to do so again. The recent turn to the capital markets by the big four state-owned banks has been in part to replenish threadbare capital cushions.

The CBRC has recently read the riot act to the banks for their continued lax lending. More detailed — for which read, stricter — regulations on things like capital adequacy and leverage ratios are likely to be announced later this month or early next, once the horse trading between the regulators, the industry and the myriad of official agencies with an oar to shove in to in these particular waters, has been completed. These will bring China broadly in line with international standards, and in some cases be much tougher.

They won’t completely mitigate the regulators’ darkest fears about bad loans. The CBRC is still acutely concerned about banks’ lending to the captive investment vehicles of local governments intended to get round restrictions on direct capital raising from banks. Banks had lent at least $1.2 trillion this way to local governments as of June 30th, with 23% not backed by cash flows. The CBRC’s new rules in February were particularly tough in this regard, as they were for real-estate lending. As we noted earlier, regulators have reportedly told banks to recalculate their capital levels using higher risk weightings for their loans to local governments via captive investment vehicles. It will be a nervous-making wait for the results. As the finance ministry noted in its budget report, “local governments face debt risks that cannot be overlooked”.

How much the Party can risk slowing down the economy  to minimize the risk of a hard landing if bubbles go pop and yet still keep real living standards rising is the calculation that now has to be made in Beijing. Late last month Prime Minister Wen Jiabao set an expectation that annual growth rates will slow. He said the government would target 7% annual GDP growth for 2011-15, though it wasn’t so long ago that growth of 8% a year was said necessary to generate sufficient jobs to absorb new workers coming onto the labor market and thus ensure social stability. Diverting GDP growth into social services and income-tax cuts to offset the effects of inflation is now seen as a greater guarantor of stability than providing jobs, it appears, to a government that is seemingly increasingly if unnecessarily rattled as it enters a period of economic, political and foreign-policy transition.

China’s Bank Regulators Stockpile Some Props Just In Case

Around the world, central bankers, bank regulators and finance ministry officials are working on national implementations of the international rules strengthening capital requirements announced by the Basel Committee on Banking Supervision earlier this month and which are due to be presented to G20 leaders at their Seoul summit in November for ratification. The China Banking Regulatory Commission says its version will be announced at the end of the year after the Seoul summit and that it expects the new rules to have limited impact on Chinese banks in the near term.

Regulators have already started on constraining the big banks’ risk-taking in response to concerns about their lending fueling asset bubbles that, should they burst, could leave the banks carrying mountains of bad debts, especially if the shadow secondary banking system blows up. China’s banks made a record $1.4 trillion in new loans last year, and they have previous when it comes to lending standards. The government had to pour billions of capital into the big four banks earlier in the decade to clean up bad-debt encrusted balance sheets.

The current capital requirements on the big banks (11.5% capital adequacy ratios) and small and middle-sized bank (10%) are stricter than the new Basel rules will require and China’s banks already meet them for the most part. The commission says, as of June 30, China’s banks averaged 11.1% capital adequacy ratios and 9% core ratios. Yet the commission is likely to give itself the option of making the capital adequacy ratios stricter yet when the it announces its new rules at the end of the year.

These will mirror the structure of the new Basel capital adequacy hierarchy, a core (“Tier 1”), capital adequacy ratio, an overall ratio, which can count some riskier assets as capital, a new additional capital buffer depending on economic conditions and an extra buffer for banks considered to be systemically important. The Basel rules propose an eventual overall ratio of 7%, a capital buffer of 2.5% and leave the extra for the systemically important banks to be determined. China’s new rules are likely to set the core ratio as 8% and the overall ratio at 10%. So no nominal change (as state media is emphasizing), and most Chinese banks as we have said are already there, which is why the commission can make the point that its new rules will have little impact in the near term.

However, word is that the capital buffer, which regulators would have a lot of flexibility over imposing on individual banks, could be set at up to 4% with an extra 1% for systemically important banks. In theory, the big four state owned banks could be looking at an effective 15% capital adequacy ratio, though things would have to be pretty rocky for the regulators to imposing it to its full extent. What is more interesting is that the regulators think they need to tuck that much in their back pockets just in case.

SOE’s Getting Lion’s Share Of New Loans

This Bystander has noted before that it is state-owned enterprises rather than the private sector that is getting the lion’s share of the stimulus money being channeled through bank lending. The Economist puts some flesh on that particular bone in a note on April’s new bank lending.

The government is keen to see lending extended to a broader range of sectors—the China Banking Regulatory Commission has required banks to open up lending departments to target small and medium-sized enterprises. However, such steps have had limited effect, partly owing to banks’ reluctance to shift lending towards firms that are not in effect backed by the government, and partly because of weaker demand for borrowing amid the economic downturn.

The National Association of Industry and Commerce says that short-term lending to private firms dropped by 700 million yuan between December 2008 and January 2009, to 421 billion yuan, despite a surge in total lending.

Bloomberg recently reported that the biggest borrower in the first quarter of 2009 was AVIC, the SOE that is the country’s largest aerospace company, which got 336 billion yuan in credit lines from 11 banks in January-April.

To counteract the trend (and to promote domestic demand), look for an expansion of consumer finance. The CBRC is prepping trials in Beijing, Shanghai, Tianjin and Chengdu of personal loans to buy consumer durables and to fund travel and education, though not car or home purchase loans.