China

China Banks Crisis: 40 Disappear, Jiangxi at the Forefront

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BusinessUS & World

In recent years, the phenomenon of disappearing banks has emerged as a pivotal challenge within China’s banking sector, underscoring vulnerabilities in the global financial ecosystem. The startling disappearance of over forty financial institutions has ignited widespread concern, spotlighting the fragility of Chinese banks and their ripple effects on commodity markets, emerging markets, and global supply chains.

This crisis lays bare critical issues surrounding bad loans, non-performing loans, and the adequacy of regulatory oversight and deposit guarantees in one of the world’s largest economies. The significance of this unfolding situation extends beyond national borders, influencing financial institutions worldwide and underscoring the interconnected nature of modern financial systems.

Overview of Disappearing Banks

The phenomenon of disappearing banks in China has reached alarming proportions, with 40 banks vanishing in a single week as they were absorbed into larger institutions. This rate of consolidation surpasses even the height of the Savings and Loan (S&L) crisis in the United States, where over 1,000 small lending institutions collapsed or consolidated due to aggressive lending, poor risk controls, and a property market downturn .

Statistics and Data

China’s banking sector is facing a full-scale crisis, with approximately 3,800 troubled institutions holding 55 trillion Yuan ($7.5 trillion) in assets, constituting 13% of the total banking system . These banks have been poorly managed for years, accruing vast amounts of bad loans, often lending to real estate developers and local governments, thereby gaining significant exposure to China’s property market downturn .

Many small banks have non-performing loans comprising up to 40% of their books . For example, the Bank of Jiujiang recently disclosed that its profits might fall by 30% due to poorly performing loans, a rare and alarming transparency. The four state Asset Management Companies (AMCs), created to manage bad debts, are now struggling themselves, with one requiring a $6.6 billion bailout in 2021.

Geographical Spread

The geographical spread of the disappearing banks is noteworthy. Of the 40 institutions that vanished recently, 36 were in the Liaoning province and absorbed into a new lender, called Liaoning Rural Commercial Bank, which was created as a receptacle for bad banks. Since its establishment in September, five other institutions have been established to do similar work, with more expected .

The crisis has also hit Jiangxi province hard, with the Jiangxi Bank of China going under, further escalating the situation. The authorities are pushing for more disclosure, but the true extent of the bad debt problem is still emerging. China’s main way of dealing with small, feeble banks is by making them disappear. This regulatory vanishing act is expected to pick up pace, with S&P Global, a rating agency, estimating that it will take a decade to complete the project. While fewer bigger banks are easier to regulate, combining dozens of bad banks only creates bigger, more problematic banks .

Root Causes Of The Crisis

The root causes of China’s banking crisis can be traced back to a combination of factors, including the downturn in the real estate market and the accumulation of non-performing loans.

Real Estate Market Downturn

China’s real estate sector, once a pillar of economic stability and growth, is now facing a crisis of unprecedented scale. The industry, contributing to nearly a third of the nation’s GDP, is witnessing the collapse of its leading giants, Evergrande and Country Garden, amidst a broader market downturn .

There are several factors that have led to the downturn in China’s housing market:

  1. Potential homebuyers are increasingly pessimistic about job security and future earnings, with a survey indicating a sharp decline in the intent to purchase homes in 2024 .
  2. The market is rife with caution due to the instability of real estate developers, many of whom are defaulting on project deliveries, eroding consumer confidence in the sector .
  3. China’s demographic challenges, particularly its ageing population, are leading to a natural contraction in demand for new housing .

Non-Performing Loans

China’s banking sector is facing a full-scale crisis, with approximately 3,800 troubled institutions holding 55 trillion Yuan ($7.5 trillion) in assets, constituting 13% of the total banking system . These banks have been poorly managed for years, accruing vast amounts of bad loans, often lending to real estate developers and local governments, thereby gaining significant exposure to China’s property market downturn.

Many small banks have non-performing loans comprising up to 40% of their books. For example, the Bank of Jiujiang recently disclosed that its profits might fall by 30% due to poorly performing loans, a rare and alarming transparency.

The collapse of Evergrande, once the world’s most valuable real estate company, marked the beginning of China’s real estate crisis. Founded in 1996, Evergrande targeted the upper-middle class, but excessive borrowing and overbuilding led to its downfall. By 2021, the company defaulted on over $300 billion, with assets insufficient to cover the liabilities. These events have not only shaken the domestic market but also raised concerns about the solvency of other major players, signaling deep systemic issues within China’s real estate sector.

Case Study: Jiangxi Bank Collapse

The insolvency of Jiangxi Bank, a local bank in China, has caused significant hardship for the Chinese middle class under the rule of the Chinese Communist Party (CCP). The collapse of Jiangxi Bank is part of a broader trend of small, rural banks languishing as they bear the brunt of the economic crisis in China .

Since 2019, several mid-tier banks have collapsed, and powerful investment managers and state financiers have melted down. However, small, rural banks, which provide the most complex problem, have been particularly affected. Data indicates that 3,800 such institutions map the Chinese countryside, holding 55 trillion yuan ($7.5 trillion) in assets, which constitutes 13% of the total banking system. These banks have long been mismanaged, accruing vast amounts of bad loans, with many lending to real estate developers and local governments, thus gaining exposure to China’s property crisis .

The fiasco is worsening over time, as many banks established to serve small businesses, especially in China’s poorest areas, are stuck in a toxic debt trap cycle and struggling to supply firms with new loans. This exacerbates the condition of vulnerable companies and hurts local economic growth.

The worst-performing small banks have already threatened social stability. Large-scale fraud caused several banks to freeze withdrawals in 2022, drawing depositors onto the streets of a provincial capital. One solution has been steady but meager recapitalization, with local governments issuing special-purpose bonds to bail out banks.

And Poof It’s Gone

Liaoning, in China’s northeast, has been at the center of China’s main approach to dealing with small, feeble banks: making them disappear. Of the 40 institutions that vanished recently, 36 were in Liaoning and absorbed into a new lender called Liaoning Rural Commercial Bank. Since its establishment in September, five other institutions have been set up to do similar work, with more expected .

This regulatory vanishing act is likely to accelerate, with supporters arguing that fewer, bigger banks will be easier for regulators to oversee. Critics, however, contend that it is little more than sleight of hand, as combining dozens of bad banks only creates bigger, more problematic banks. As China’s economic growth slows further, the country’s obsession with outshining everyone in its path appears highly unrealistic when struggling to handle the basic units of the economy properly. The lowest rung of China’s banking system needs more than a wave of a wand to resolve its problems.

Expert Opinions And Future Projections

As some of the largest banks in the world, any significant problems in the Chinese banking system would reverberate throughout the global financial system. China is a key player in global supply chains, with many multinational companies outsourcing production to Chinese manufacturers. A banking crisis could disrupt these supply chains, leading to potential delays in production, increased costs, and supply shortages for businesses worldwide. This could impact industries ranging from technology to automotive to consumer goods, all of which rely on China as “the world’s factory.”

Moreover, financial markets are highly interconnected, and a banking crisis in China could trigger a contagion effect, spreading panic and instability to other parts of the world. Investors may become more risk-averse, leading to selloffs in global equity markets, increased demand for safe-haven assets, and disruptions in credit markets.

The performance of Chinese banks is integral to the country’s economic competitiveness. A banking crisis would have significant implications for both domestic businesses and consumers due to the central role of the banking sector in the economy – and the government’s influence over it. A crisis would likely result in tightened credit conditions as banks become more cautious about lending due to heightened risk aversion and capital constraints. This could make it difficult for businesses to access financing for investment, expansion, or day-to-day operations, potentially stifling economic growth and job creation.

Other Economic Slowdowns

Furthermore, uncertainty and financial instability could dampen consumer confidence and spending. Faced with job insecurity or reduced access to credit, consumers may cut back on discretionary purchases, leading to a slowdown in domestic consumption and overall economic activity. China is already experiencing deflationary pressures, with consumer prices falling at their quickest annual rate in 15 years in January. That may, in turn, impact demand for goods and services from other countries, affecting global trade flows and economic growth.

Another risk is that the Chinese government may prioritize stabilizing the banking sector during a crisis, potentially diverting resources and attention away from other areas of the economy. This could result in delayed or limited support for struggling businesses and consumers, exacerbating the economic impact of the crisis.

Different Than the West

Unlike in some Western countries where businesses can turn to public debt markets for financing, China has a less developed bond market. This means that businesses may have limited alternative sources of funding during a banking crisis, further exacerbating their financial challenges. What’s more, the performance of Chinese banks influences international perceptions of the country’s economic stability and reliability as an investment destination. A banking crisis could dampen investor confidence, leading to reduced investment in the Chinese market.

By examining the cataclysmic amalgamation of bad loans, regulatory insufficiencies, and the real estate market’s downturn, the analysis offers a nuanced comprehension of the predicaments bedeviling one of the world’s largest economies and its banking sector. This discourse not only sheds light on the immediate financial turmoil but also crafts a lens through which the global implications of such a crisis on financial stability, market confidence, and economic policies can be discerned.

It’s clear that the ramifications of the banking crisis in China ripple far beyond its national confines, touching upon the interconnected spheres of global finance, supply chains, and economic stability. These insights propound the urgent need for robust policy measures, rigorous regulatory frameworks, and international cooperation to preempt the proliferation of such crises. Furthermore, by signaling the critical areas for future research and policy intervention, including the exploration of sustainable financial practices and the reinforcement of banking systems, calls for a concerted effort towards ensuring economic resilience and stability in the face of evolving financial landscapes.

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