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Slow growth exacerbates China’s financial stability risks
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upamfva
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#1
09 Sep 2022, 04:05

China’s growth has nearly halted as its GDP edged out a 0.4% year-over-year increase in the second quarter of 2022. The slowdown will threaten the country’s 2022 growth target of around 5.5%, especially since Omicron infections have flared up again in several cities, necessitating local lockdowns. Many international financial institutions have downgraded China’s growth estimates for 2022 to a range of 3.5%-4.3%, and projections are not optimistic for a rebound in 2023.To get more finance news China, you can visit shine news official website.

More importantly, visible growth slowdown has spread losses in the real estate property sector to the banking sector, mostly among small and medium-sized provincial banks. For now, the magnitude of damages is manageable, but a sustained period of slow growth would generate greater losses in more economic sectors, banks, and companies. This pattern raises the risk of a financial crisis and economic recession, unless authorities act now to resolve, recapitalize, and consolidate weak, small banks and highly indebted developers. China’s government should also establish a robust resolution and recapitalization framework for banks and companies to replace the current ad hoc approach.
China has a large banking sector with assets amounting to 336 trillion yuan ($50 trillion), or almost 300% of its GDP, compared with a bank asset-to-GDP ratio of 75% in the US. Four large state-owned banks dominate China’s banking scene: Industrial and Commercial Bank of China (ICBC), Construction Bank of China (CBC), Agricultural Bank of China (ABC), and Bank of China (BOC). At the end of 2021, by international standards these banks were adequately capitalized (with Tier 1 capital ratios averaging above 12%) and profitable (with returns on equity ROE more than 9%). Both measures are comparable to those of US banks, while European banks are better capitalized but have a lower ROE of 4%. China has a non-performing loan (NPL) ratio of 1.72%, in between the US, with 0.84%, and the Euro Area, with 2.32%. In short, the dominant players in the Chinese banking system look healthy at present.

However, the Achilles’ heel of China’s banking system is its 4,000 small and medium-sized provincial banks. All together, they have about 77 trillion yuan ($11.5 trillion) in assets, slightly less than a quarter of total assets of the Chinese banking system. The weaknesses stem from their flawed business model, in which small banks are often thinly capitalized, rely on costly and volatile interbank markets for funding, and lend to small and medium-sized enterprises (SMEs) – which tend to have high credit risks and high non-performing loan ratios. Moreover, small banks have been plagued with corruption and other wrongdoing.

This was typified by the case of Baoshang Bank. The bank grew 30-fold from its founding in 1998 to 2019 thanks to a policy-driven lending boost to SMEs and was seized by the authorities in May 2019 due to “serious credit risks”. Baoshang Bank was then declared to be bankrupt and was liquidated a year later (the first Chinese bank to have been liquidated two decades) after it was uncovered that the bank made 150 billion yuan of related loans, which became non-performing, to billionaire Xiao Jianhua’s Tomorrow Group Holdings—Tomorrow had a 89% stake in the bank and Xiao is now on trial. This episode created a hiccup in China’s interbank repo market when even some short-term AAA bank debts were refused as collateral due to market participants’ fears of counterparty risks. The People’s Bank of China (PBOC) had to inject a net 250 billion yuan to the financial system to restore market liquidity.

Since then, many small banks have gotten into trouble and had their problems resolved by Chinese authorities. The process is non-transparent, by which an ad hoc group of provincial and local governments, state-owned banks, and companies is put together to buy out the failing banks. The practice is referred to as the “one bank, one policy” approach, associated with Guo Shuqing, the Chairman of China Banking and Insurance Regulatory Commission (CBIRC). More recently, several small banks in the provinces of Henan, Anhui and Liaoning ran into severe cashflow problems and in mid-April had to significantly limit, or to freeze, withdrawals by depositors. Those banks have suffered from the practice of offering high interest rates to attract depositors from afar through digital channels, some operated by China’s big social media platform companies; and then invest the proceeds in Wealth Management Products (WMPs) in the hope of generating high returns to pay back depositors—something the authorities have tried to discourage. The slowing economy since the beginning of this year has caused many WMPs to underperform expectations, rendering many small banks (like those mentioned above) unable to generate sufficient income to meet withdrawal demands—hence the need to limit withdrawals.

Small banks have also been hit by the refusal of a growing number of home buyers to pay interest on mortgages taken from banks to buy unfinished housing units, which have remained incomplete due to the construction slowdown and many developers being embroiled in debt crises. At present, 28 of the top 100 developers have negotiated a debt restructuring with their creditors or have defaulted outright on both onshore and offshore obligations. These developers have left about 100 projects in 50 cities identified so far as unfinished. Mortgage loans on these projects are estimated to be about 1.5 trillion yuan ($222 billion)—a miniscule amount in terms of China’s total bank assets. However, the amount of high-risk credit can grow quickly amid speculation about which banks are going to be hit next—fostering a sense of crisis and undermining public confidence in the Chinese banking system, especially its small banks. Deterioration of the property sector—which accounts for almost one-third of China’s GDP and a quarter of all bank loans—could snowball into a banking and economic crisis.
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