It’s been a tumultuous year for mainland China’s economy .

A debt crisis of seismic proportions has brought some of the country’s biggest property developers to their knees, while a spate of Covid-19 lockdowns spanning manufacturing hubs and commercial centres in the summer has hobbled output.

No one in the financial sector is feeling the pinch more than the small lenders, which account for about a quarter of the country’s total banking assets. This could spell trouble for millions of individual savers, analysts warned.

Some 20 per cent of the 45 regional and rural banks listed on stock exchanges suffered a plunge in profits in the first half of 2022, while some saw their non-performing loan ratios deteriorate. It was the poorest half-year performance in years.

The wounds of non-listed small lenders – 128 city commercial banks, 1,596 rural commercial banks and 1,651 village and township banks, to be precise – could be even deeper, a worrying prospect that prompted the banking regulator to promise speedy action.

Two rural banks, Liaoyang Rural Commercial Bank and Liaoning Taizihe Village Bank, in the northern province of Liaoning, entered bankruptcy proceedings, in a rare move announced by the China Banking and Insurance Regulatory Commission last Friday.

Bank liquidations are not common in mainland China. The most recent case came in 2020, when Baoshang Bank, based in Inner Mongolia, was declared insolvent.

While big banks in China appear to be largely unscathed, some of the 4,000 small lenders are walking a tightrope, say analysts.

“Small banks are in a perfect storm this year. Each incident just makes their life tougher,” said Gary Ng, senior economist at Natixis Corporate and Investment Bank.

“But it is just the start. Small banks as compared to their bigger peers are weaker even during good times. They are struggling to attract stronger capital and healthier borrowers.

“When the macro environment turns sour, bad loans at these small banks will rise first, and inevitably we will see more small banks run into trouble in the coming years.

“The worst part is that this could deal a huge blow to individual savers and market confidence over the country’s economic recovery.”

China’s banks have been rocked by a harrowing succession of incidents so far this year.

April saw a series of angry protests triggered by small, village-level banks in Henan province that refused to allow ordinary depositors to withdraw their own cash.

Then, in July fears erupted over the quality of assets of Chinese lenders when a mortgage boycott over unfinished units quickly spread to hundreds of housing projects across the country.

Some commentators were worried that it heralded China’s “Lehman Brothers moment”.

The mortgage revolt puts about 1 trillion yuan in bank loans at risk, according to ratings agency S&P.

In some of the worst cases, small banks are vulnerable not only because they have unpaid mortgages on their hands, but also because they have a large and concentrated exposure to distressed developers.

Property loans accounted for just over a quarter of banking credit in China as of the end of June, central bank data showed.

“Mortgages are still a good-quality asset on the balance sheet of a bank when compared to corporate loans exposed to those bruised industries, such as real estate,” said Harry Hu, a senior director at S&P Global Ratings.

Two thirds of the 35 listed regional banks that disclosed the information saw their non-performing loans (NPLs) to property developers increase in the first six months.

Bank of Jinzhou, in the northern province of Liaoning, for example, saw the highest ratio of NPLs to developers, reaching 10.37 per cent by the end of June, up from 9.77 at the end of last year and nearly double the level in 2020.

Its NPL ratio exposed to the construction sector – mainly subcontractors on building sites – hit 9.39 per cent, up from 7.78 per cent at the end of 2021.

Jinshang Bank in Taiyuan, the capital of Shanxi province in the north of China, was also hit badly by headwinds in the homebuilding sector. Its NPL ratio to developers climbed to 10.29 per cent, up 10.01 percentage points from 2020. The non-listed bank did not report its half-year results.

In comparison, the average NPL ratio among all commercial banks stands at 1.67 per cent.

It is more than likely the bad loans owed by home builders will continue to grow as the Chinese real estate sector veers from crisis to crisis.

Some 21 major developers have defaulted on their unmanageable debts in the last year, most notably China Evergrande Group.

Hu estimates Chinese banks’ average NPL ratio in the property development sector will rise to 5.5 per cent by year-end, up from a 2.6 per cent sector-wide ratio at the start of the year.

“The potential of rising NPLs will remain a threat to banks’ asset quality,” he said.

Players in the property sector are not the only borrowers contributing to the mounting pile of defaulted loans at regional and village banks.

On-off lockdowns across the country as local governments wrestled to quash fresh outbreaks of Covid-19, and the recent power crisis have hurt a wide range of sectors, including manufacturing, retail and agriculture, leaving companies and individuals unable to pay their loans back to the banks.

Hong Kong-listed Bank of Harbin said defaulted loans that it had lent to the manufacturing sector reached 15.47 per cent while Bank of Jinzhou booked an incredible 50.4 per cent NPL ratio for money it lent to personal businesses at the end of June.

The real picture could be bleaker than that suggested by official figures.

“Bad loans are only one facet of credit stress, when taking into account factors such as loan forbearance policies,” said Hu.

“Loan quality among small and regional banks is under greater pressure, and the associated risks have yet to be fully exposed, including those from non-standard credit investments in local developers and government financing vehicles with low cash flow cover.”

Land sales contributed 8.7 trillion yuan to the coffers of local authorities across China last year, making up 42 per cent of their revenue, excluding funding from the central government in Beijing.

Plunging land sales and the need to splash out billions on Covid-19 controls have left some local governments out of pocket.

“If any of these small banks stumble into financial difficulties, it may not become a systemic threat for the Chinese economy, as the banking sector remains well capitalised,” said Carlos Casanova, senior economist for Asia at UBP.

“However, it may lead to rising social instability in cases where depositors are unable to temporarily withdraw their savings.”
Some savers, after witnessing the desperation of those who found themselves unable to access their money in Henan province, have started to shun small banks that have performed poorly.

Li Min, a teacher in Anhui Province, recently opted to withdraw her three-year fixed term deposit of 200,000 yuan due in 2025 early from Bank of Liaoshen, forfeiting some 20,000 yuan in interest.

Having only opened the account in February, she decided to sacrifice the interest after reading about the public outcry in Henan and the news that Bank of Liaoshen had lost 1.2 billion yuan last year.

“Compared to losing all of my savings, not receiving the 20,000 yuan in interest is just a small piece of cake,” said Li, who has now transferred all her savings to the Bank of China, one of the country’s “big four” lenders.

Bank of Liaoshen, which absorbed Bank of Liaoyang and Yingkou Coastal Bank to launch in June 2021, also has a rather thin asset portfolio. More than three quarters of its assets are concentrated in two 15-year private placement notes issued by local governments in the northeastern province of Liaoning.

The bank can only start to collect the two 176.74 billion-yuan notes in 2027.

The assets of many small banks are highly concentrated in local government-controlled units and local business partners, a trend viewed as risky and unsustainable. The structural weakness of these institutions had worsened amid the economic slowdown.

“Who knows whether I can get my money back,” said Li. “I do not want to bet my savings. I do not want to be like those miserable protesters in Henan province.”

Indeed, the scenes in Henan have left savers across the whole of China worried.

Protests, some of which turned violent, broke out when deposits estimated at 39 billion yuan at four banks were frozen in mid-April.

Authorities blamed fraudulent management practices for the crisis in one of China’s most populous provinces.

For years, many of the country’s small lenders offered eye-watering interest rates to attract depositors, as a way to finance more profitable loans.

Some 60 per cent of 128 regional banks booked a net interest margin at the end of last year, below the average 2.08 per cent among Chinese commercial banks. Bank of Liaoshen, the worst performer, booked a negative 1.23 per cent net interest margin, according to calculations by the Post based on data released by the banks.

That means the interest the bank is paying on deposits is too high to be covered by the loan interest it receives, leaving no possibility of making a profit.

“Such a funding structure is no different from drinking from the poisoned chalice,” said Lee Kaichung, financial institution analyst with Pengyuan Credit Rating International, a Hong Kong-based rating agency.

“The potential risk contagion is less about system-wide failure and more about the social instability concerns stemming from it. And that could be the biggest, most worrying issue for the authorities in the coming years.”

China’s factory activity shrank for a second consecutive month in August. The Purchasing Managers’ Index (PMI), a key gauge of manufacturing, came in at 49.4, below the 50-point watershed that separates growth from contraction.

The weak economic indicator has sent economists scurrying to slash their growth forecasts for the world’s second-largest economy. Output is now projected to expand by just 3.5 per cent this year, down from a previous forecast of 3.9 per cent, according to Bloomberg’s latest quarterly survey of economists.

The Chinese government originally set a growth target of around 5.5 per cent for 2022, but with growth slowing sharply and coronavirus outbreaks continuing to spread, officials have downplayed the goal.

Beijing has not missed its GDP target by such a large magnitude before.

“We are facing much slower economic growth than we have not seen in the past decade,” said Lee. “The era where a bank can have three branches on the same street is gone.

“Either through bankruptcy, like the recent two village banks in northern Liaoning Province or being taken over by big banks, many of these small banks with weaker profitability and thinner capital buffers will be eliminated.”

by Pearl Liu in SCMP, 3 Sep, 2022

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