Automatic bailouts no longer an option in China

PUBLISHED : Friday, 28 March, 2014, 3:54am
UPDATED : Friday, 28 March, 2014, 3:54am

It was to be expected that debt defaults on the mainland would fuel rumours about bank solvency sooner or later. The result has been a run on a rural commercial lender in Jiangsu province as hordes of depositors laid siege to branches in a rush to withdraw their money. That should serve as a warning, even if the rumours were unwarranted. It may be only a small lender, but the run not only reflects the perception of fragility of a wider financial system awash with debt but also, more worryingly, a growing lack of confidence amid concerns about asset quality. These can be early signs of systemic stress.

Much of the lending spree after the global financial crisis went into dubious projects and overcapacity that failed to generate enough cash for repayments, leading to defaults since 2012 involving wealth management and trust products and bonds. Predictions of more this year have been borne out by the bond default of Shanghai Chaori Solar Energy Science & Technology and the collapse of a real estate company with 3.5 billion yuan of debt and 15 bank creditors. The collapse of the illegal underground banking system has exacerbated the bad-loan problem, with the besieged Jiangsu lender blaming damaging rumours on the failed businesses of loan guarantors.

Failures should not come as a surprise after Premier Li Keqiang's warning to the National People's Congress that despite tightened scrutiny of government debt and the shadow banking system, it would be difficult to avoid a few defaults; nor after the recent comment by a central bank official that the healthy development of the wealth management market would benefit from "allowing some default cases to happen naturally in compliance with market forces".

Beijing has apparently begun to accept that a shakeout of weak institutions could be healthy up to a point. It is no longer a question of when, but whether, they should be bailed out by the government. Previously bailouts were knee-jerk reactions, for the sake of stability. We trust the government will now be prepared to resist the urge except, heaven forbid, in the case of major banks that are of critical systemic importance.

Allowing more badly run institutions to fail will send the right message to the financial community. Reports like that on the run on the Jiangsu rural lender raise understandable concerns, but they present opportunities for Chinese leaders to show they have the stomach to allow failures that ultimately make the whole financial system stronger.