Chinese distressed banks

Beijing's $14.5b liquidity plan to avoid Baoshang bashing

To keep debt markets stable and defaults under control, the Chinese government is injecting money to help support small and medium-sized banks
The PBOC is shoring up stability in China's financial system.
The PBOC is shoring up stability in China's financial system.

Beijing's first state takeover of a bank in 18 years is not the shape of things to come, China's central bank has sought to reassure investors after setting out plans to inject Rmb100 billion ($14.5 billion) into the Chinese banking sector.

That assumes, though, that the country's financial conditions do not deteriorate much further as economic growth slows in the face of an increasingly damaging trade war.

“Recently, some people in the market are worried whether other banks will be taken over, after Baoshang Bank. Don’t worry. Currently, there is no such plan; there is no need to take over a bank except as a last resort,” a spokesman for the People's Bank of China (PBoC) is quoted as saying on Sunday on the central bank's own website.

The comments come after the China Banking and Insurance Regulatory Commission (CBIRC) and People’s Bank of China took control of Baoshang Bank.

If any financial institution needs liquidity or a capital increase, it can do so through normal market mechanisms, the spokesman added. But to help boost the liquidity of small and medium-sized banks, the PBoC will release Rmb100 billion of long-term capital, he said.

“From a bond market perspective, the PBoC is going to inject liquidity to stabilise the aggregate yield,” Gary Ng, Asia economist at Natixis, said at a press conference on Monday. “Regulators want to keep everything stable.”

And to underscore that, said Alice Garcia-Herrero, Natixis's Asia-Pacific chief economist, the CBIRC last week approved the issue of Rmb40 billion of perpetual bonds by Huaxia Bank.

This is a strong signal of state support of the smaller banks, she said.

But much more state support may yet be needed if non-performing loans (NPLs) deteriorate substantially from here.

A JP Morgan report dated May 26, cites a worst-case scenario in which the NPL ratio of China’s city and rural commercial banks rises to 20% from 2.88% currently and the NPL loss ratio hits 70%. In those circumstances, additional provisions of Rmb2.3 trillion would be required, it said.

TROUBLED FINANCIAL INSTITUTIONS

Baoshang Bank, certainly, isn't the only Chinese financial entity facing difficulty.   

For example, private investment firm China Minsheng Investment Group late last month narrowly avoided default by temporarily missing an interest payment, according to Wind, a Chinese financial data provider.

Minsheng Investment was founded by 59 “leading private companies” on August 21, 2014 with registered capital of Rmb50 billion, according to its website. Minsheng Investment’s leadership has links to Minsheng Bank, the largest privately-owned bank in China.

China Minsheng Bank, along with Huishang Bank, is cited by JP Morgan as the type of bank with high-risk exposure that could see its borrowing costs rise as a result of the losses now faced by some  of Baoshang Bank's bond investors.

Creditors of Baoshang Bank owed less than Rmb50 million each will have their principal and interest payments fully protected, the PBOC spokesman revealed, but those each owed Rmb50 million or more will take a haircut of 10%.

And then there's Bank of Jinzhou.

On May 31, the Hong Kong-listed Chinese bank announced that its auditors Ernst & Young (EY) and Ernst & Young Hua Ming had resigned. In its resignation letter, EY said there were indications that the proceeds of some loans to institutional customers were not used in a way that was consistent with the stated purpose of these loans.

Jinzhou Bank is the weakest Chinese bank currently with US dollar bonds outstanding, given its high level of non-standard credit assets and weak capitalisation, a Nomura report said on Monday.

FALLOUT

Since the Baoshang Bank takeover, investors have turned more cautious on smaller Chinese banks, as evidenced by the three-to-five basis points pullback in city commercial banks’ additional tier-1 securities (AT1s), said said.

Signs of questionable behaviour have been uncovered at Baoshang Bank, the PBoC spokesman alleged. This includes the embezzling of funds by Tomorrow Group, which owns 89% of Baoshang Bank, he said. 

Tomorrow is a conglomerate controlled by Xiao Jianhua, a Chinese tycoon who was abducted from Hong Kong in January 2017 by Chinese security agents. Chinese state media has labelled Xiao a "financial crocodile", meaning a wealthy individual with the ability to roil the capital markets. 

The takeover of Baoshang Bank indicates the Chinese government will likely intervene in banks and also companies, if they pose any systemic risk, employ many people or belong to sectors deemed important by Beijing, Ng of Natixis said.

But it won't for anybody else. “The government won’t bail out small real estate firms,” he said.

So far this year in China, there have been defaults on 67 corporate bonds totalling Rmb46 billion, more than in any previous year except 2018, according to Wind. Last year saw a record 125 corporate bonds totalling Rmb121 billion.

The PBoC's 2018 Financial Stability Report classified 426 of 3,800 Chinese financial institutions as high risk.

While China lacks formal resolution powers for banks, its handling of Baoshang Bank opens the way for a model that will allow banks' operations to continue while having creditors share in the resolution burden, said a Moody’s report on May 28.

“Despite the negative implications for Baoshang's creditors, we expect any systemic impact from this situation to be manageable," it said.

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