Despite their credit risks, the Chinese government’s bailout of a modest commercial bank highlights Beijing’s support for Chinese financial institutions. Institutional investors of Baoshang Bank, however, may have to take a haircut.
“The People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBIRC) continue to provide policy support to small and medium banks and push them to improve their corporate governance, to foster healthier growth in small and medium banks,” said the PBOC on Sunday.
The CBIRC and PBOC have taken over Baoshang Bank for one year, until 23 May 2020, the CBIRC announced. The financial regulators have entrusted China Construction Bank, one of the Big Four state-owned banks, to manage unlisted Baoshang Bank. This is the first state takeover of a bank in China for 18 years.
Regulators administered Shantou Commercial Bank in 2001 and Hainan Development Bank in 1998.
The financial watchdogs cited Baoshang Bank’s “severe credit risks”. The PBOC said the reason for the takeover was to “curb systemic financial risks” and moral hazard; to give “maximum protection” to depositors and other clients; and to ensure that Baoshang Bank does not halt operations.
Numbering 958, over the past year, finance sector bonds in China have had the most rating risk warnings, followed by the manufacturing sector at 424, according to Chinese financial data provider Wind.
“While it is hardly a surprise that some of China’s smaller banks are facing challenges, it has been very rare for the regulator to step in and take control,” said James Dilley, a Hong Kong-based associate director of deals at PwC.
The takeover has opened the possibility that institutional investors and larger inter-bank creditors will face haircuts on their debt from Baoshang Bank.
According to CBIRC’s announcement, the principal and interest of depositors and creditors with up to Rmb50 million ($7.3 million) each in Baoshang Bank are fully guaranteed, but the public deposits and inter-bank liabilities of more than Rmb50 million “shall be negotiated by the takeover group and creditors on an equal footing”.
The banking regulator did not explicitly say that larger creditors will suffer losses, but it does clearly differentiate their treatment compared to smaller creditors. The Chinese government has a vested interest in protecting the savings of ordinary citizens, for fear of social unrest.
As of the end of 2016, Baoshang Bank had total assets of Rmb418.3 billion, total deposits of Rmb182.1 billion and a total loan balance of Rmb144.8 billion. The bank has not published its 2017 and 2018 financial results.
The bailout of Baoshang Bank is a good test of how regulatory Tier 2 capital instruments (term subordinated debts) would function under a regulatory takeover scenario in China, according to an S&P Global report. “China's recent bailout of a troubled commercial bank is a clear signal that it remains highly supportive of the banking sector,” it said.
Investors maintain high interest in the loss-absorption abilities of the Basel III-compliant Tier 2 instrument issued by Baoshang in late 2015, S&P said. The instrument contains a mandatory non-viability contingent capital feature, which provides for a write-down of the principal if a trigger event occurs.
The PBOC and CBIRC intend to provide liquidity support and inject funds in a timely manner into Baoshang Bank to maintain its normal operations. The takeover will strengthen protection of Baoshang Bank’s rural branches, the PBOC added.
Baoshang Bank, headquartered in Baotou city in Inner Mongolia, has 18 branches in major Chinese cities like Shenzhen and Beijing, as well as 291 outlets in other areas, according to its website.
Much like European bank bailouts a decade ago, the CBIRC appears to have applied a broadly similar set of priorities. The Chinese regulator has reassured small- and medium-sized depositors that their savings are safe, while also being very clear that it is willing to provide liquidity into the system if needed.
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"Aggressive and small to midsized banks like Baoshang are susceptible to an economic slowdown because their risk management capability can't keep up with their breakneck pace of growth," said S&P Global Ratings credit analyst Ryan Tsang. "In certain cases, questionable governance intensify the risks a bank faces when aggressive private shareholders exert significant influence over the institution's credit decisions."
Baoshang Bank is linked to Xiao Jianhua, a Chinese tycoon who was kidnapped by Chinese state security agents from Hong Kong to mainland China in January 2017. Quoting an unnamed source, a Xinhua article in January last year said that although Xiao did not own many shares in Baoshang Bank, he regularly headed the bank’s meetings in previous years. The state news agency labelled Xiao a “financial crocodile”, meaning a wealthy individual with the ability to wreak havoc in capital markets.
Calls to Baoshang Bank were not answered.
