Is There a Method Behind Beijing’s Bank Rescue Madness?

Bank rescues in China may no longer be isolated events. Since May, one bank has been taken into receivership by the government, two have been bailed out by central authorities, and depositors have lined up outside of two others demanding their money back. Even the chairman of China’s sovereign wealth fund recently noted that as the economy slows, the failure of financial institutions will become “a fact of life.”

The authorities seem to be handling such failures in an ad hoc fashion, having “…taken different approaches to Baoshang (taken over by the banking regulator), Jinzhou, and Hengfeng banks (both were bailed out) based on the authorities’ assessment of the institution’s specific circumstances,” as noted by a recent International Monetary Fund report. But a closer look reveals that the size of the bank appears to be a main determinant in the method by which Beijing chooses to deal with them. Let’s look briefly at what to expect as the central government tackles some of these shakier banks.

Small Banks Get the M&A Treatment

It seems that small distressed banks will get consolidated together or merged into larger, healthier banks. Although authorities have denied it, Beijing was reportedly considering a plan that would do just that for small banks with less than 100 billion yuan worth of assets. The reason for the official denial isn’t clear, but China has a long precedent of such consolidations.

Between 2005 and 2014, at least 48 local banks were merged into nine regional banks. For example, Hong Kong-listed Huishang Bank is the outcome of six Anhui banks (and seven credit cooperatives) merging in 2005; Shanghai-listed Bank of Jiangsu is the result of the merger of 10 banks in 2007; and Hong Kong-listed Zhongyuan Bank is the product of 13 Henan banks merging in 2014.

These examples highlight a main advantage of mergers: banks post-consolidation have an easier time listing publicly and borrowing from the interbank market. Another advantage of larger banks is that they are easier for regulators to monitor, and asset management companies (AMCs) are more willing to deal with them, making it easier for larger banks to dispose of nonperforming loans.

Given China has significant experience in bank consolidation—and the simple fact that larger banks are more stable than small banks on their own—it seems likely that more mergers are on the horizon.

Large Banks Get Bailouts

Beijing has few qualms about mobilizing state resources to capitalize large banks. It intervenes sooner than governments in market economies and is willing to bail out smaller banks that aren’t systemically important. And crucially, it has the potential to intervene more widely by drawing upon a range of resources typically not available to democratic governments.

When countries like the United States and United Kingdom bail out a bank—as they did with Citigroup and the Royal Bank of Scotland, respectively—they typically use tax revenues, which can invite public backlash. In contrast, when Beijing intervenes, it avoids using either the Ministry of Finance’s tax revenue or the People’s Bank of China’s printing press. Rather, intervention typically involves mobilizing state resources that don’t appear on the government’s ledger.

For example, the bailout of Hengfeng Bank in September was funded by Central Huijin, a unit of China’s sovereign wealth fund. Meanwhile, the Bank of Jinzhou was recapitalized by two centrally-owned AMCs—Cinda and Great Wall—as well as the Industrial and Commercial Bank of China. Similarly, in 2016, Beijing recapitalized Great Wall and China Orient—two of the four national AMCs—by using the National Social Security Fund, a couple of state insurance companies, and a handful of state firms. And in 2015, China Development Bank and China Export-Import Bank were recapitalized by using China’s foreign exchange reserves.

Beijing did something similar during the bank bailouts at the turn of the century, a very costly endeavor that largely remained off the government’s books. That approach allows Beijing to use all the resources at its disposal and to spread out the costs of cleaning up the banking system. It also allows the central government to maintain a far healthier balance sheet than would otherwise be the case—as long as it isn’t called upon later to bailout those institutions that have been propping up the banks on its behalf. We expect the approach will likely be a fixture of future bailouts.

Who Gets the Bailouts?

But there’s a wrinkle to the large banks: it’s unclear which banks Beijing is willing to bailout and which it is not, although that may become clearer over time. This can be seen in the divergent fates of Hengfeng Bank and Bank of Jinzhou vs. Harbin Bank and Bank of Jilin. All four are regional banks ranked among China’s biggest 100 banks by assets—with Hengfeng at 20th, Jinzhou at 31st, Harbin at 35th, and Jilin at 45th. Yet the first two banks got central bailouts and the latter two did not.

Instead, the Hong Kong-listed Harbin Bank disclosed that two companies owned by the Heilongjiang provincial government (where the bank is based) had acquired about 30% of the bank, taking their combined stake to 48%. Meanwhile, the Bank of Jilin—the product of a merger between two banks and five rural credit cooperatives in 2007—in June announced that it had raised fresh capital from a private placement of shares to the Jilin Province Finance Department, the Liaoyuan City Finance Bureau, the Baishan City Finance Bureau, as well as nine other investors. That came after the bank reported that its total assets had shrunk by 8% in 2018, a sure sign of stress. In other words, Beijing sat on the sidelines as the local government and investors intervened.

At this point, without further clarity, one can only speculate on the reasons that these banks of similar sizes received different treatment. It’s possible that Harbin Bank and Bank of Jilin’s financial conditions simply weren’t dire enough to warrant central government attention. But it also could be because Beijing regards Hengfeng and Jinzhou to be systemically important. Late last year, the central government decided that it would consider the roughly 30 biggest banks to be “domestic systemically important financial institutions,” a designation that brings greater oversight and perhaps even a willingness to bail them out. Harbin Bank may fall just outside of the cut off.

Regardless of where Beijing draws the line in the sand, it seems that in general, larger banks will be on the short list for central government bailouts, while more mergers are likely to come for small banks under distress.

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