hhardly a day Pass without any “falling horses” or corruption investigations by Chinese financial figures. State media warned on June 5 that the banking industry was infested with “moths” — middle managers slowly devouring lenders’ resources from the inside out. “Insiders,” executives who use their internal connections to steal billions from banks, often pose a greater danger. There are “nest cases”, in which fraud clusters of multiple banks are discovered at the same time, and “chain cases”, in which the arrest of one banker leads to the arrest of another banker, who then arrests another banker. One state-run newspaper has dubbed the small bank an “anti-corruption hard hit” after a string of recent scandals.
The claims imply widespread corruption in China’s sprawling financial system, which holds 400 yuan ($56 trillion) in assets. At least 60 financial institutions were hit with personnel investigations between January and May, according to official statements and news reports.researcher economist Over the past five years, 78 executives at eight of China’s largest banks have been investigated or charged for corruption, the report showed. Since 2018, authorities have also investigated 385,000 village bank shareholders who allegedly used lenders as personal piggy banks.
The crackdown shows no sign of abating as the Communist Party’s grip on law enforcement has tightened. In the biggest regulatory change in two decades, the central government announced earlier this year that it would create a super regulator to oversee all financial sectors except the securities industry. How China wields its superpower is bound to reshape an industry whose health and stability are critical not just to China but to the global economy.
The new system, modeled after the United States, seeks to avoid duplication of missions. State Administration of Financial Supervision (NAFR), as the new regulator calls it, has been granted status that brings it closer to the central government. That gives it stronger enforcement powers, similar to the U.S. Securities and Exchange Commission. It acquired investor protection responsibilities similar to the U.S. Financial Stability Oversight Board and took over financial oversight from the central bank (which, like the Fed, is now focused on macroprudential policy).
NAFR It is preparing to press ahead with what may be the broadest financial cleanup in history. Beginning in 2017, its predecessor worked to slow a dangerous rise in risky financial activity. It has tightened regulations on shadow banking, reducing the stock of shadow loans to 13.5 percent of banks’ total assets last year from 25.3 percent in 2017. It overpowers the huge financial corporations and powerful people who try to manipulate the system. These include insurance group Anbang and midsize bank Baoshang Bank. It destroyed the $1 trillion peer-to-peer lending industry, where people lend to each other through online platforms. The central government has also upended the fintech empire of Jack Ma, China’s most famous entrepreneur, after his company Ant Group built a sprawling lending business with little regulatory scrutiny.
The new team will have to account for ever-increasing cleanup costs. Many wealth management products went bust, sparking investor protests. The cost of cleaning up city banks and bailing out several large banks has reached RMB 10. Rescuing Anbang alone cost $10 billion. Tens of thousands of investors in peer-to-peer lending products lost their savings. Nearly 630 small banks completed restructuring.
Ma’s ouster has damaged China’s reputation as a safe place for entrepreneurial experimentation. The same goes for the recent detention of one of China’s most prominent investment bankers, Bao Fan. Senior regulators have bristled at such criticism, arguing that official action, at least in Ma’s case, is too timid for a risky business model.The new system will give NAFR Regulatory control over financial holding companies such as Ant Financial.
The vision for regulating the financial sector is becoming clear. Senior officials believe they have chosen the best features of the American system while rejecting the values of Wall Street, which they see as permeating China for 20 years. The message to bankers is grim. Entrepreneurs will be allowed to go on to reap great fortunes. But the government doesn’t want bankers to get very rich. No celebrity financier, no matter how high-profile, seems immune to corruption investigations.
NAFR Several urgent tasks lie ahead. First, it must replace local financial regulators with its own team and dismantle the link between banks and local governments. Since the 1990s, the creation of thousands of new banks and endless construction orders by politicians has fueled the cesspool of distressed assets. The small lenders that have sprung up across the country often have strong ties to local governments and the largest local companies (i.e. developers). In many cases, big Henrys who held shares in banks or had full control over them used them to finance their businesses. One result was a decade of high economic growth. Another is rampant corruption and misallocation of funds.
Sam Radwan of Enhance, a consultancy, says the crackdown on corruption – considered by many to be the biggest threat to China’s financial stability – has so far proved remarkably effective. The number of arrests is likely to drop. But cleaning the financial system of the bad assets exposed by the campaign will be a difficult task — and an urgent one. Close ties between banks, property developers and city governments have left the industry with a lot of risky lending. Developers and local government companies owe Bank of China 130 yuan, or about 42 percent of the bank’s total assets, ANZ Banka bank.
Most of these debts are considered healthy.Li Yunze, the new leader NAFR, said on June 8 that the risk is controllable. In its most recent review of the banking system, the central bank said only 1.6% of system assets were considered high risk.
That could change if things get worse for developers and local governments. Both are finding it increasingly difficult to repay their loans. A group of companies known as local government financing vehicles (Local government financing platforms) borrowing from banks, often on behalf of cities and provinces, has spooked markets in recent weeks as many showed signs of imminent failure. Such risks tend to emerge suddenly and have the potential to ripple through banks. Dalian Wanda, one of China’s largest developers, has reportedly negotiated a loan forgiveness program with banks. It has more than $90 billion in outstanding loans.one Local government financing platform A company in southwestern China is rumored to be using local social security funds to repay loans.
Failure to deal with this pile of debt can leave the system in bad credit. Many of these loans probably won’t turn into toxic assets overnight. Instead, some will be long-term drags on bank profits.other Local government financing platform South China recently reached an agreement with banks to restructure 15.6 billion yuan of loans by lowering interest rates and deferring loan maturities for 20 years. In this case, banks have no choice but to defer.
Regulators have been trying to consolidate bad banks for years. Twenty-three city banks have merged so far. But insiders say the process is cumbersome and could drag on for years, eventually leading to even bigger bad banks. The other option is to let the bank fail. This has only been tested a few times and risks causing a run on deposits – the opposite of the stability China’s leaders are trying to achieve.
Big banks are absorbing some of the bad debts of smaller banks. But their ability to do so is limited, and they are unlikely to take stakes in struggling banks. According to Chinese media reports, some local state-owned enterprises have started injecting liquidity and taking stakes in rural banks. This type of recapitalization is strengthening banks’ balance sheets and giving them more room to dispose of bad debts.
The only way to heal the industry is to identify and deal with bad loans. Efforts to do so are accidental. In 2019, regulators said they would require banks to report the true size of bad loans, rather than use fancy accounting to cover them up. But the pandemic then forced regulators to enforce the rules less strictly; they also told banks to roll over loans. This avoided large-scale corporate defaults, but also exacerbated the hidden accumulation of non-performing assets. Now, with the end of the pandemic, the long-delayed recognition of more bad debt begins, said Ben Fanger of distressed debt investor ShoreVest Partners. This means that a lot of toxic assets are flooding the market.
State-owned asset management companies will buy some of the debt at a discount. Unlike 20 years ago when mountains of bad assets failed to attract bargain hunters, there are now more local private investors willing to snap up bad loans from banks. Some corporate investors will also seek out distressed debt amid the rubble of the real estate industry so they can pick up projects on the cheap. With the economy slowing and the extent of financial corruption exposed, China’s new regulators can only hope they have enough of them. ■
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