Euromoney, January 15 2019
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Something interesting is happening in Chinese bank regulation: it is getting a lot tougher. New research by UBS, led by analyst Jason Bedford, shows that the amount of bank fines issued under the new head of the regulator, Guo Shuqing at the China Bank and Insurance Regulatory Commission, last year showed a 14-fold increase over 2017, and in fact amount to almost six times the total of the previous 14 years put together.
Genuinely stinging penalties are being awarded for the first time in years. Guangfa Bank, an unlisted institution whose major shareholder is China Life, was fined RMB722 million last year, equivalent to 7.1% of the bank’s full year net profit for 2017. Pudong Shanghai Bank has received a range of fines approaching RMB2 billion in total.
But what impresses Bedford is not so much the scale of fines as the nature of the overall approach. “Lots of people use the words deleveraging and credit tightening synonymously,” he says. “But they’re not the same thing.
“Some regulators just slap loan quota on, but the problem with that is it doesn’t differentiate between good and bad banks, those that have prudent policies and those that have no discipline and lend to insolvent steel companies.”
Rather than just clamp down on credit extension overall, Guo has focused instead upon the existing stock of debt. So this is deleveraging, but without forcing good banks not to extend credit to those who both need and warrant it. This nuance is something new in Chinese bank regulation.
The vast majority of penalties to date have been for disguising bad loans. “It is aimed at dissuading banks from extent and pretend type activities to keep credit lines open to defaulted companies,” Bedford says.
This should be seen in the context of efforts to rein in shadow banking, and changes to loan recognition rules, which Euromoney examined in July. UBS says that, implemented properly, this shift should lead to an accounting change increase in total system NPLs of 14% for 2018, although Bedford says that based on first half 2018 numbers it has been inconsistently implemented: he calculates that Hubei Bank, for example, should have seen a 416% increase in official NPLs, but has not yet implemented the new rules.
As banks do implement these rules, under the gaze of a regulator that clearly now means business, some ugliness is inevitable. Fines themselves, some individual names apart, are not the main issue. “The bigger hit we expect will come in the form of increased NPL recognition as banks tighten up recognition and unwind problematic structures that could draw the ire of regulators.”
Still, the issue is not universal. Euromoney has noted before the increasing differentiation between the big four banks and the rest; they are already advantaged by their huge deposit bases and access to funding, and it also appears that their claims to be more sensible and prudent lenders were legitimate.
China Construction Bank, ICBC and ABC in particular appear seldom in the fines list. UBS says that the big five, adding Bank of China and Bank of Communications to those three, account for only 10% of all fines ever issued, which is far below the proportion of the overall sector they represent.
That’s not to say, though, that they’re automatically great banks. They’re certainly not daring banks, and perhaps that’s the right way to be, but that does mean a lot of credit is not getting where it needs to go.
It also appears that they won’t be pushed to do what the state wants them to – you still don’t see the state-owned commercial banks on the funding list of major Belt and Road projects, instead favouring advisory or ancillary roles; and it is notable that of all the debt to equity swaps the state wanted banks to implement in order to clean up bad corporate debt, about one fifth of announced swaps have not yet been implemented in any meaningful way. (CCB is an outlier here, having implemented about 80% of its swaps.)
Chinese banks do, though, face a problem when clients turn sour, and in this respect the Guangfa situation is illustrative. Guangfa’s fines related to Cosun Group, a fixed-line phone manufacturer from Huizhou and a key borrower from the bank. When Cosun got into trouble, Guangfa knew that unless it lent more money, there was no way Cosun would be in a position to repay any of its loans at all, rendering the whole exposure non-performing.
That would be impossible under CBIRC loan scoring standards. “This led Guangfa Bank down the rabbit hole of initially underwriting and providing illegal guarantees over a series of more than RMB2 billion of private placement bonds,” Bedford says. It then syndicated around RMB10 billion of loans reclassified as trust beneficiary rights and directional asset management plans across 13 different banks.
That illustrates another problem: what you might call cross-pollination of problems. “A bit like peeling an onion, an investigation into one incident can lead to discovery of other violations,” Bedford says.
So there is going to be pain ahead. But the result should be a stronger banking system. It is to be hoped that the slowing economy caused by the trade war with the US does not lead to anyone telling the regulator to change tack.