China tries to clean up its shady regional banks
IIT WAS A bad year to be a big cheese in China. Billionaire entrepreneurs have been hunted down. Overly extravagant artists have disappeared from the Internet. Now a new kind of tycoon is feeling the heat. The latest regulatory crackdown on what the government views as private sector misconduct extends to businessmen with overly comfortable ties to banks. The fear is that insider trading, preferential access to credit, and lax corporate governance pose threats to stability, especially in the regional and local underbelly of China’s financial system.
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The most prominent red flag is Evergrande, a collapsing debt-ridden real estate company that until recently held a 36% stake in Shengjing Bank, a local lender based in Liaoning Province, in. northeast. Authorities are reportedly investigating whether Evergrande, which is run by billionaire Hui Ka Yan, took control of Shengjing, with around 1 billion yuan ($ 156 billion) in assets, using illicit means, as well as ‘by leading some 100 billion yuan in related operations. – transactions between the parties.
Another notorious case concerns HNA Group, an acquiring conglomerate that bought Yingkou Coastal Bank in Liaoning in 2014 (see graph 1). HNA put new leaders in the bank and turned it into a factory of shadow banking products that provided it and related groups with abundant credit. Its assets tripled in 2016, making it the fastest growing bank in China that year, before it nearly collapsed. Since february HNA has been bankrupt. Chen Feng, its co-founder and chairman, was arrested in September, along with his CEO.
The malaise goes much further, posing a potential threat to economic stability in some Chinese provinces, especially those in the Rust Belt like Liaoning. The 134 metropolitan commercial banks and some 1,400 rural commercial banks in China represent about 32% of its commercial banking sector, with total assets of about 90 billion yuan, or $ 14 billion. This is almost the size of the entire UK banking system. They exist in the shadow of the six major Chinese banks nationwide and the 12 joint-stock banks, which are majority state-owned and have the highest visibility. Unlike the big banks, for most of the past decade many of the lower tier banks have sold stakes to large private investors, to the point of being under their influence. In recent years, some have become cesspools of bad debt, insider trading and risk management failures, which are often attributed to misaligned homeownership incentives.
This has raised concern among regulators. The central government is speeding up reform to drive out what it calls “problem shareholders” from banks. On October 15, the China Banking and Insurance Regulatory Commission introduced rules expanding oversight of those it considered to be controlling shareholders of banks. According to China daily, a government spokesperson, which extended to anyone with a stake of 10% or more in a city or local bank, or those with the largest stake in a bank or insurance company, with a participation of at least 5%. The objective is to eliminate the too cozy interests of companies.
If corporate shareholders are indeed the problem, the authorities will have their hands full. The Economist calculates that of the city’s 107 commercial banks that disclosed financial information for 2020, 72 with around 20.2 billion yuan in total assets had large corporate shareholders, many of which were real estate developers and manufacturers. Twenty-two of this group were wholly controlled by corporations and tycoons, or had been until recently forced to restructure. But even those with more than one significant shareholder have caught the attention of regulators. Authorities are likely to take a close look at how investors compete for preferential treatment.
The level of business ownership in rural commercial banks extends even further â to the point that it has shocked some researchers. Wang Chunyang of Peking University investigated 1,295 rural banks and found that 1,122 of them, or about 87 percent of them, had private companies as major shareholders. According to our calculations, this level of private ownership implies that up to 39.4 billion yuan of rural bank assets could be controlled or influenced by private interests. For these banks, identifying problems early is a challenge. Small lenders are more likely to hide their bad debts, says Ruan Tianyue of the National University of Singapore, creating a regulatory blind spot.
Private ownership of banks, in and of itself, is not the cause of the problem. Some private banks, such as the newly established Zhongbang Bank, have performed well. For their part, many small government-controlled lenders have demonstrated catastrophic risk control. But in banks without corporate governance, the risk is that owners will use their influence to obtain concessional loans, compromising prudent risk management and increasing the level of bad debts.
This could have economic consequences. Some experts compare the state of small Chinese banks to that of the more than 1,000 savings and loan institutions that collapsed in the United States in the mid-1980s due to deregulation and lax lending controls. They say bad debt problems among urban and rural banks could hurt regional economic growth.
Another problem is more political in nature. As the evidence for the tycoons’ murky relationship with the banks grows, the more it plays into President Xi Jinping’s narrative that socialist command and control policies do a better job than private capital in allocating money. economic resources.
Signs of misconduct seem to be on the increase. In addition to Evergrande, which was forced to sell some of its shares in Shengjing, the Hong Kong-listed Bank of Gansu requested a bailout last year after lending and investing heavily in the debt securities of one of its shareholders, which ultimately defaulted. . Bank of Jinzhou, a lender in the northeast, demanded an emergency restructuring after its largest shareholder, to whom it had granted numerous loans, was unable to repay its creditors. Anbang Insurance, the bulky conglomerate best known outside of China for buying the Waldorf hotel in 2014, controlled Chengdu Rural Commercial Bank until 2020. Xiao Jianhua, a tycoon kidnapped by Chinese agents from a Hong Kong hotel in 2017 , controlled two lenders, Baoshang Bank and Bank of Harbin, both of which demanded costly state bailouts.
These problems are unlikely to abate as the Chinese economy slows and more businesses default. In September, shares of Fuxin Bank were put up for sale in an online auction meant to help raise capital for the struggling lender after a real estate developer with shares in the company could not. no longer pay off debts. Bank of Langfang faces a potential increase in bad loans after its second-largest shareholder, China Fortune Land, a developer, defaulted on a 5.3 billion yuan bond earlier this year.
Regulators take several approaches to weeding out disbelieving landlords, of varying severity. One is to drive out problematic shareholders. In mid-2020, the banking regulator published a list of 38 âillegal shareholdersâ that it had forced to divest. Another is detention. Mr. Xiao, for example, is reportedly currently being held in Shanghai, where he is helping to unwind his business operations. A third is the death penalty. Cai Guohua, former chairman of Hengfeng Bank, which needed a bailout in 2020, received a suspended death sentence for, among other things, taking out illegal loans.
The authorities do not intend to force all private shareholders out of the banks, but they are taking action to ensure that the biggest shareholders come from the state, said Lian Ping of Bank of Communications, a large bank. Chinese. This will mean upheaval across the industry, given the prevalence of large private shareholders in recent years. These regulatory measures will take time and should avoid undermining the confidence of depositors in banks.
In some areas, such as the northeast, the government has sought to restructure a handful of banks at a time, perhaps worried about a regional concentration of debt problems. S&P Global, a rating agency, says nearly 8% of the loan portfolios of the Northeast’s largest urban and rural lenders were non-performing or of questionable status in 2020. The figure was only 3% for creditors. loan portfolios of similar banks in eastern China (see Chart 2).
The northeast has one of the highest rates of private ownership in the country. In Liaoning Province, for example, eight of the city’s 15 commercial banks are privately owned. This gave rise to a dynamic of consolidation. After the HNA debacle, the Yingkou Coastal Bank has become the central pillar of an effort to merge Liaoning banks. At first, regulators went so far as to try to bring together 12 of Liaoning’s banks. But later, this ambition was reduced to two, including Yingkou.
Despite all the regulatory overdrive, the most appropriate solution continues to elude Chinese regulators: to allow banks to fail and exit the market. Since the collapse of the Hainan Development Bank in 1998, no lender has been allowed to go bankrupt. And it was a complicated bankruptcy that still drags on to this day. Rural banks would be fertile ground for such tests. â
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This article appeared in the Finance & Economics section of the print edition under the title “Attack Against the Magnates”