Euromoney, June 21 2019
Is China heading for a Lehman Brothers moment? No, but that doesn’t mean its debt position isn’t a mess, and it’s going to get worse.
Concern over whether China is heading for a Lehman moment stems from the failure of Baoshang, the biggest lender in China’s Inner Mongolia province with Rmb536 billion of total assets, and the market reaction to it.
To deal with the headline first: talk of a Lehman moment for China is not the right comparison. China’s financial system, while certainly interconnected, doesn’t operate like the US one, and while counterparty suspicion certainly exists – we’ve seen it in recent weeks as banks have been unwilling to lend to smaller, apparently risky banks – ultimately the state controls the entire sector and can order even its private sector institutions to do what it wants if stability is at stake.
There are certainly problems in China. The thing is, Baoshang is something of a red herring. The bigger issues are elsewhere.
Baoshang’s problems were not a surprise to anyone who has been paying attention: Euromoney wrote about them in September 2017, citing the research of UBS analyst Jason Bedford.
Bedford used Baoshang to illustrate a problem with vehicles called trust beneficiary rights (TBRs) and directional asset management plans (DAMPs), which are basically loans with investments wrapped around them from fund managers or brokerages.
Their purpose – perhaps not their official purpose, but certainly the real one – is that they allow banks to book loans as investments, freeing them from the loan impairment standards that apply to straight loans, and also from single-borrower exposure limits.
The distinctive thing about Baoshang was that a huge amount of its exposure was to a single borrower, reportedly Tomorrow Group, a Chinese conglomerate whose chairman Xiao Jianhua was abducted from the Hong Kong Four Seasons in 2017 and has not been seen since. Baoshang stopped filing financial results shortly afterwards.
All of this sounds like a one-off; Bedford reckons it isn’t, quite, but it’s not systemic either. He points out that plenty of Chinese banks don’t file audited financials at all, or are habitually late; the red flag instead is banks like Baoshang who used to file accounts promptly and now don’t.
He identifies three others in particular that are a worry: Hengfeng or Evergrowing Bank, which hasn’t disclosed results since the third quarter of 2017, has large TBR and DAMP books and, worryingly, is three times the size of Baoshang (and has UOB as a strategic shareholder); Jinzhou, an H-share listed (and now suspended) bank which made the headlines last month when its auditors, Ernst & Young, resigned because it couldn’t agree with the client on the documents that were required to ensure that loans went where they were supposed to; and Chengdu Rural, whose largest shareholder you might be familiar with: Anbang.
None of that is great, but the very specific set of circumstances for each bank, from reporting habits to the composition of the books, makes Bedford doubt there will be a run. As he says, seven other bailouts and restructurings took place between 2015 and 2017; what was actually distinctive about this one was that it was publicly announced by the banking regulator, the CBIRC, whose leader Guo Shuqing has tried to bring about greater transparency.
The thing is, even if there hasn’t been direct contagion, there has been an impact. Funding costs have gone up, meaning that counterparty risk, while theoretically something that the state can intervene in (notably it has ordered China Construction Bank to be the administrator to Baoshang), is tangible, and so is solvency risk.
Also, the Chinese media group Caixin reported in June that financial regulators have asked large brokerages to take over the role of financing SMEs since lower-tier banks have backed away from doing so in order to protect their risk profile. Caixin says brokers have been told to issue financial bonds eligible for use as collateral, increase quotas for short-term debt and ease funding pressures for non-bank financial institutions.
If this is true, it’s a worry: Chinese brokerages have a long habit of facilitating boom and bust behaviour, and they are simply not banks.