China’s Bank Bailouts Are Even Scarier Than They Look: The financially weak, state-owned rescuers would be dangerous in good times. This is the Covid-19 era.

by NineteenEighty9

www.bloomberg.com/opinion/articles/2020-04-26/china-s-scary-bank-bailouts-rely-on-state-owned-shareholders

Banks are being bailed out in China, raising alarm. How they’re being rescued is even scarier.

Acknowledging the growing balance sheet problems among small and medium lenders, China’s banking and insurance regulator says it’s working on a reform plan and will become more vigilant about shareholders. That’s all good until you see what’s happening in reality: The state is effectively replacing precarious, often private, shareholders with financially weaker state-backed ones, or giving them a larger say. That rarely instills confidence, even in good times. These are anything but.

In the latest string of rescues, Beijing is stepping in to back Hong Kong-listed Bank of Gansu Co., which in addition to deteriorating finances has also found itself on the hook for overdue debts of one of its shareholders. All of that was made worse by a collapse in its share price earlier this month due to margin calls on stock pledged as collateral. As part of a plan announced April 18, state-backed equity holders will raise their stakes to own almost half of the bank, up from around 28%. The largest, a highway operator, is expected to pay around 1.5 billion yuan ($212 million) to subscribe to 40% of the new shares, raising its stake to 18.3%.

It’s an odd choice of rescuer. Gansu Provincial Highway Aviation Tourism Investment Group Co.’s balance sheet is already stretched. Its operating cash flow is insufficient to cover expenses and interest payments, according to S&P Global Ratings.

That the owners are struggling with liquidity issues is problematic. Their equity is part of the bank’s capital, and the uncertainties bleed over. Small and mid-size lenders are already facing a shortage of this and market confidence, with big banks unwilling to supply them with credit. The rise of non-performing loans on the back of Covid-19 will erode their buffers further. To help them cope, regulators recently loosened regulatory limits for NPL coverage ratios, the loss reserves that need to be set aside against bad loans, to release around 200 billion yuan of capital.

Isn’t that what got Chengdu Rural Commercial Bank Co. where it is today? It was owned and funded by Anbang Insurance Group Co., 1 famed for its foreign-asset buying binge that included New York’s Waldorf Astoria. At one point the lender, with around 40 subsidiaries across rural China, depended on its shareholder for 40% of deposits while Anbang accounted for 80% of related-party transactions that were short-term money market loans. The bank also paid Anbang close to 5% interest on its deposits and held its debt. When the insurer was dismantled by regulators, Chengdu found its owners changing hands to local government financing vehicles, with uncertainty around major shareholders.

Then there was Baoshang Bank Co., which last year became the first seized by the government in decades. Its shareholder, Tomorrow Holding Co., was caught up in Beijing’s corruption crosshairs, with founder Xiao Jianhua abducted from Hong Kong’s Four Seasons Hotel by Chinese agents in 2017. It gets even messier: Troubled Baoshang was a major shareholder of Bank of Gansu, with an 8.4% stake at the end of 2019.

The tight relationships and deep co-dependence with shareholders is at the heart of the weakness: Who is funding who, or what? Related-party transactions flourish. For instance, Bank of Gansu entered into a property-leasing arrangement with an asset management company majority-held by the highway operator and pays rent to it at commercial terms. Small as that is, the money is still not being used productively.

It also opens up the one topic regulators hate to think about: direct contagion. Billions of yuan of assets are due from financial institutions to their peers in the interbank market and through repurchase agreements. More are in the form of deposits at other banks, from which lenders earn interest income of their own. Jitters in money markets, where leverage is building up as policymakers cut rates, could compound these problems.

The need for outside capital and fresh equity couldn’t be stronger. The only executable way to untangle these relationships and break the cycle is to bring in outsiders. But who is an outsider in China?

With Beijing looking to open its financial sector to foreigners, one way may be to ease licenses, allow majority control at the small-bank level, and incentivize the investment by agreeing to grant more access to millions of consumer deposits and borrowers. Without commercial, strategic investors — rather than financially embattled ones with vested interests — it’s hard to see how Beijing’s reform plans make headway.

Brace yourself. This frightening tale may go on for a while.