Breaking News
0
Ad-Free Version. Upgrade your Investing.com experience. Save up to 40% More details

China's $40 Trillion Banking System Learns a Hard Lesson on Risk

EconomyJul 22, 2019 06:09
Saved. See Saved Items.
This article has already been saved in your Saved Items
 
© Reuters. China's $40 Trillion Banking System Learns a Hard Lesson on Risk

(Bloomberg) -- Two months after China shocked investors with the first government seizure of a bank in two decades, market confidence in the nation’s smaller lenders has yet to fully recover.

That may be just what the country needs.

When it took control of Baoshang Bank Co. on May 24 and imposed losses on some creditors, China’s government upended the long-held assumption that it would always provide banks with a 100% backstop.

The result has been a wholesale repricing of risk for all but the largest Chinese lenders, a development that analysts say was long overdue in a country rife with moral hazard. While the upheaval has underscored the fragility of some smaller banks and adds to short-term headwinds buffeting the economy, it may ultimately put China’s $40 trillion banking system on a more sustainable path by forcing markets to differentiate between weak and strong lenders.

“The long-term implications are actually very positive,” said Jason Bedford, a Hong Kong-based analyst at UBS Group AG who was among the first to highlight Baoshang’s troubles in 2017.

Before the takeover, funding costs for small- and mid-sized Chinese banks were remarkably similar to those of blue-chip names like Industrial & Commercial Bank of China Ltd., the world’s largest lender by assets.

The rationale for a lack of differentiation was simple: When times got tough, authorities would always make sure that even the smallest banks fulfilled their obligations to depositors and other creditors. That assumption kept money flowing to banks -- and by extension the Chinese economy -- even as critics warned that it was fueling excessive risk-taking and a dangerous buildup of bad loans.

Now -- even though Baoshang has reportedly made good on almost all its obligations -- a government backstop is seen as no sure thing.

“The corporate bond market is currently reducing the probability of an implicit government guarantee on all liabilities of small banks,” Kelvin Pang, a credit strategist at Morgan Stanley (NYSE:MS) in Hong Kong, wrote in a report last month. “We continue to believe that government support for banks (including small banks) remains strong, but it’s using a differentiated approach.”

The China Banking and Insurance Regulatory Commission didn’t respond to a fax seeking comment.

It’s hard to say if this is the outcome authorities anticipated. The Baoshang takeover was complicated by the fact that the bank was part of Xiao Jianhua’s Tomorrow Group, an investment conglomerate that’s under investigation in China. Regulators were at one point arranging for a state-owned firm to buy a stake in Baoshang, before realizing that the lender’s financial situation was more precarious than they thought, people familiar with the matter said in May.

A lack of detail in the government’s early communications on the takeover gave some investors the impression that it was hastily arranged. Market participants were also left guessing about the extent of losses facing Baoshang creditors, leading some to dramatically cut their exposure to other smaller lenders.

In the interbank funding market -- a critical piece of China’s financial plumbing –- some strong banks began rejecting collateral from all but the most creditworthy counterparties. Repurchase volume tumbled by 43% in a week, according to data cited by JPMorgan Chase & Co (NYSE:JPM).

Funding stress was also apparent in the market for negotiable certificates of deposit, where the interest-rate gap between lower-rated and AAA banks soared to the highest level since Bloomberg began compiling the data in 2015.

Authorities tried to ease concerns about a sudden pullback of government support, highlighting Baoshang’s links with Tomorrow Group and portraying the case as unique. They also pumped cash into the nation’s money markets to bring down borrowing costs, injecting a net 250 billion yuan ($36 billion) in a single day on May 29.

Other assistance was targeted at individual banks. To help one mid-sized lender sell bonds in June, a state-owned insurer struck a rare agreement to provide credit protection for the issuance.

As for Baoshang, officials appear to have imposed much less draconian haircuts on creditors than first feared. About 99.98% of the bank’s corporate creditors received full principal and interest payments, China’s central bank said in June. All of Baoshang’s individual savers were made whole.

Even so, creditors aren’t taking any chances. The yield gap between low- and top-rated NCDs, a key measure of the market’s wariness toward smaller Chinese banks, is still more than four times wider than it was before the Baoshang seizure.

“Although the actual loss for creditors is negligible, this is the first time in almost 20 years that a bank default in China almost became reality,” Helen Huang, a fixed-income analyst at HSBC Holdings Plc (LON:HSBA) in Hong Kong, wrote in a July 9 note. “The takeover of Baoshang Bank can be seen a big step towards more credit differentiation.”

China's $40 Trillion Banking System Learns a Hard Lesson on Risk
 

Related Articles

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind: 

  • Enrich the conversation
  • Stay focused and on track. Only post material that’s relevant to the topic being discussed.
  • Be respectful. Even negative opinions can be framed positively and diplomatically.
  •  Use standard writing style. Include punctuation and upper and lower cases.
  • NOTE: Spam and/or promotional messages and links within a comment will be removed
  • Avoid profanity, slander or personal attacks directed at an author or another user.
  • Don’t Monopolize the Conversation. We appreciate passion and conviction, but we also believe strongly in giving everyone a chance to air their thoughts. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.
Continue with Google
or
Sign up with Email