As if the Evergrande crisis wasn’t enough to put China’s financial system to the test, Chinese protesters took to the streets once more, in what appears to be a rare occurrence for China. This time, its citizens are protesting against the freezing of their assets by four rural banks in Henan Province, where most of them are located.
In this post, we will examine the impact of the event and determine if China bank stocks, particularly the big four, are still safe to hold.
China’s Banking Scandal
The protest began due to a scandal involving the disappearance of 40 billion yuan (S$8 billion) in deposits from four rural banks, an incident that local authorities blamed on a criminal group falsifying records and siphoning off monies. Depositors of these banks subsequently could not withdraw their funds as the banks froze their assets. Ultimately, this culminated into the protest we now see as depositors demand for their money.
This episode was not without controversy as well. Aside from censorship, depositors have accused local officials of tampering with health codes, a digital tracker used in China to track coronavirus infection, preventing people from entering public spaces, resulting in even more public outrage.
Then again, what we see on the ground is that these protests are often staged to express dissatisfaction with the local authorities and not the central government. Protesters could be seen waving Chinese flags and using Mr Xi’s slogan of the “Chinese Dream” to persuade the central government to intervene.
To some extent, their voices were heard when the China Banking and Insurance Regulatory Commission initiated a disciplinary investigation into Li Huanting, a senior inspector formerly in charge of inspecting the banks in question. Aside from that, regulators have announced two rounds of payouts of up to 100,000 yuan to customers whose funds were frozen by Henan’s four rural banks.
On the whole, things appear to be calming down. However, the banking scandal has uncovered broader structural flaws in China’s financial system, ranging from alleged corruption to lax regulatory control of rural banks. As a result, confidence in these approximately 4000 small and medium-sized lenders is beginning to dwindle, with some afraid that it will harm China’s four big banks.
This is a valid problem, so let’s see if we should be concerned as investors of the big four.
Will this happen to the big banks?
To begin, we must distinguish between the rural banks in question and the four major state-owned commercial banks: Bank of China, China Construction Bank, Industrial and Commercial Bank of China, and Agricultural Bank of China.
For starters, rural banks are more prevalent in less developed parts of China to address the gaps in financial service. More often than not, to compete with the big four, some engage in extremely risky lending methods, provide unusually high-interest rates, and are sometimes rife with corruption. Of course, this is not to imply that the big four do not engage in risky lending practices or even corrupt practices, but with the checks and balances in place, the likelihood of such an event occurring is lower.
Another element that distinguishes these rural banks from the big four is that the big four are state-owned, or at least the Chinese Communist Party has a considerable stake in them, whereas rural banks are typically privately controlled. Because of this form of relationship, the CCP is indirectly liable for what happens to the big four. Any blunder would inevitably cast doubt on the CCP’s competence, resulting in a loss of public trust.
Back to the issue at hand, whether or not this incident will have an impact on the major banks is dependent on the ultimate cause of asset freezing. Was it because of the criminal gang falsifying data and siphoning monies from banks, as the local police claimed? Or is there an underlying structural problem caused by the property industry crisis and the general macroeconomic factor in China?
One-off problem
If the local police claim is legitimate, this event can be seen as a one-off occurrence that will have little bearing on the big four banks. This sentiment is echoed by the Chinese central bank, which has downplayed the idea of a greater threat to the financial system by emphasizing that 99% of its banks assets are within a safe range.
Of course, it has still created concerns among its citizens about bank liquidity. If taken to the extreme, such a situation could result in a bank run, in which large numbers of depositors withdraw their money from banks at the same time out of fear of the bank being insolvent.
Is this, however, likely? As previously stated, these banks are state-owned, and I am convinced that the CCP would intervene before such a scenario transpire.
Structural problem
Another perspective to consider is whether the problems these rural banks are experiencing are the result of a systemic issue. A problem induced by the property sector’s downturn and China’s slowing economic growth.
If you follow China news closely, you may have noticed that the country’s mortgage boycott is intensifying. Evergrade suppliers have stopped paying banks, as have homeowners concerned about developers such as Evergrande failing to complete their housing projects. To give you an idea of the extent of this, in just a few weeks, the boycott has spread to over 300 incomplete projects in over 90 locations.
All of this highlights the ever-increasing risk on housing mortgages, which are frequently viewed as a safe asset for Chinese banks, so it is understandable that you are concerned.
Ultimately though, the situation remains under control, as China’s financial regulator, the China Banking and Insurance Regulatory Commission (CBIRC), has once again assured homebuyers that incomplete housing projects will be delivered. Furthermore, while mortgages account for 20% to 40% of existing loans for the big four, estimates reveal that up to $1.5 trillion yuan (S$307 billion) of mortgage loans are tied to unfinished housing projects, accounting for only around 4% of total outstanding mortgages. This figure, while sizable, will not have such a severe impact on the big four that they will need to seek assistance from the central government.
Conclusion
So, which is it? A one-off problem or a structural issue? We can’t be sure, but I’m inclined to believe this was a one-time occurrence caused by corruption and incompetence at the local government level. According to this logic, this incident is unlikely to have a significant impact on our four major banks.
Nonetheless, the underlying structural risk remains. While it may not have been the primary culprit, the risk lurks for Chinese banks, big and small, and investors who hold shares in these institutions should keep an eye on the situation. While mortgage loans tied to incomplete housing projects remain low, the impact of the housing crisis on the Chinese economy cannot be underestimated. That said, at the moment, all four major Chinese banks have reasonably healthy credit quality, a low nonperforming loan percentage, and continue to meet capital adequacy ratios, indicating that the Chinese banks are still doing well.
Of course, the other risks we discussed previously are things investors should keep in mind. But ultimately, the Chinese big four remain appealing in terms of risk-reward ratio.
Do keep in mind that the China stock markets are vastly different from that of the US, we share more in our Guide to Investing in China.
