The Economist UK - 07.09.2019

The EconomistSeptember 7th 2019 Finance & economics 65

2

W

orking atHengfeng Bank, an em-

battled Chinese lender, requires a

thick skin these days. On August 30th the

bank’s Communist Party committee sum-

moned its members, including top execu-

tives, for a self-criticism session, of the sort

common in the Maoist era. “No one talked

about their achievements. They talked only

of their shortcomings and problems. They

pointed the knife blade at themselves,” the

bank reported afterwards. “Blushing and

sweating, they expelled their poison.”

The revival of self-criticism under Xi

Jinping, China’s president, has raised

alarm about the direction in which he is

steering the country. Other banks have also

conducted similar sessions, a testament to

Mr Xi’s assertion of party control over the

economy. But in the case of Hengfeng, rav-

aged by corruption scandals and bailed out

last month by the government, the sight of

its employees examining their misdeeds

was, in a way, reassuring. It suggests that

officials are getting a handle on one of the

worst actors in the banking system, even if

their techniques sometimes owe more to

Lenin than to Dodd or Frank.

The question now is how many more

Hengfengs there are. It was the third bank

to be rescued in the space of three months.

In May regulators took over Baoshang Bank

in Inner Mongolia. In July Industrial and

Commercial Bank of China (icbc), a state-

owned giant, propped up the Bank of Jin-

zhou in the north-east. Then in August

Hengfeng, based in Shandong province, re-

ceived a cash infusion from China’s sover-

eign-wealth fund.

Officials have portrayed these troubled

banks as peripheral to the economy. The

assets of Hengfeng, the biggest, peaked in

2017 at 1.4trn yuan ($210bn at the time), just

0.5% of the total for Chinese banks. Regula-

tors have also been prompt in fixing holes.

When the Baoshang rescue spooked inves-

tors as the first instance of losses on inter-

bank loans, the central bank quickly

calmed them by injecting cash into the

banking system.

Nevertheless, many financiers suspect

that the rot is deeper. Their nerviness is vis-

ible in two ways. The first is small banks’ el-

evated funding costs. For years they paid

roughly the same interest rates as big

banks to borrow from each other. Since

Baoshang’s rescue, their costs have been

half a percentage point higher (see chart).

The second is the 10% fall in icbc’s

shares since its Jinzhou investment, a per-

formance that has fallen short of other

banks. An auditor who worked with icbc

says the bank was surprised by the blow-

back. It had used a subsidiary to support

Jinzhou, hoping to quarantine the rest of

its balance-sheet. But investors did not see

it that way. As analysts with China Mer-

chants Bank said, it looked as if icbcwas

performing “national service”. The fear is

that big banks will be conscripted into ser-

vice again and again.

Many more banks do indeed need help.

By the central bank’s count, 420 of China’s

4,327 lenders are at high risk of distress.

However, all but nine are puny rural lend-

ers, so it should be possible to mop up their

messes. To get a sense of the scale, Jason

Bedford of ubs assessed capital levels, bad

loans and loss provisions at a large sample

of banks. He estimated that banks with to-

tal assets of 9.2trn yuan ($1.3trn) are in dan-

ger, amounting to about 4% of the com-

mercial banking system, or nearly a tenth

of gdp. That is a big problem, but not an in-

superable one.

The banks rescued in recent months

were atypical in various ways. Baoshang

was the piggy bank of a disgraced tycoon;

Bank of Jinzhou’s auditors resigned amid

signs of loan fraud; multiple executives at

Hengfeng were felled by corruption char-

ges. “There doesn’t appear to be other

banks left with the same scale and toxicity

as these three,” says Mr Bedford.

Yet much about them was also normal.

China’s smaller banks have been especially

aggressive, increasing their assets by 144%

over the past five years, compared with 53%

for large banks. They have also relied more

on interbank borrowing. The implication

is that as the economy slows, and as big

banks grow wary of counterparty risk,

more small banks will be exposed.

Charlene Chu of Autonomous Research

has long estimated that bad loans in China

are much higher than reported: more like

20% of bank assets rather than the official

2%. She thinks this year’s turbulence is a

preview of what lies ahead. But she also

says that China has ways to delay the reck-

oning, potentially for a long time. When

defaults spread to brokerages in June, regu-

lators brought them and their creditors,

mostly banks, together in emergency

meetings. “It is a rare tool that Chinese au-

thorities have,” says Ms Chu. “They called

in all parties, and said no one is defaulting

any more.”

Even if China can prevent widespread

defaults, its banks’ newfound risk aversion

poses dangers itself. Small banks had been

big lenders to small companies, which in

turn are big drivers of growth. Now, the

outlook for all is more subdued.

At Hengfeng it is no coincidence that,

when not engaged in self-criticism, bank-

ers are talking up their role in helping

small firms. In a recent news broadcast,

Hengfeng’s chairwoman was shown visit-

ing a local food company. She gazed over a

rice field, trimmed to look like Tiananmen,

complete with a portrait of Mao. A slogan

was cut into the field: “I love my mother-

land”. In banking as in farming, it is good to

know which way the wind is blowing. 7

SHANGHAI

After three banks are rescued, how many more are at risk?

China’s financial system

Expelling the poison

Struggle session

Source: Wind Info *Urban commercial banks

China, issue interest rate of three-month

negotiable certificate of deposit (NCD), %

2017 18 19

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Large banks

Smaller banks*

Emmanuel Alvarez Agis, another adviser

who served under Néstor Kirchner, Ms Fer-

nández’s late husband and predecessor as

president. “The future depends on build-

ing coalitions, for change, not governing

just from one side or the other,” he has said.

Mr Nielsen says the next government

will negotiate with the imf, rather than

walk away from it. Having already bor-

rowed almost 80% of the $57bn on offer,

Argentina will need new loans from the

fund to help it repay the old ones. Mr Niel-

sen has also described China as a potential

“financial life jacket”. Ms Fernández, who

has remained remarkably quiet during the

campaign, is known to covet Chinese in-

vestment, which might be attracted to Ar-

gentina’s infrastructure, 5gnetworks and

renewable-energy projects.

If that is the extent of Ms Fernández’s

influence on the next government, foreign

investors will be relieved. And so will some

Argentines. “Many of us could never vote

for Cristina and Alberto Fernández,” says a

retired woman, waiting at her bank this

week to change pesos into dollars. “But

who can trust any of our politicians after all

this?...I trust only my purse.” 7