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Although the People’s Bank of China has said it was not planning any more seizures after taking over Baoshang Bank on May 24, analysts see the move as a precursor to sector consolidation. Photo: Reuters

Could seizure of Baoshang Bank lead to consolidation among China’s smaller banks with assets worth US$9.9 trillion?

  • Beijing is under pressure to boost bank lending to help cushion impact from higher US tariffs on Chinese imports
  • At least 18 smaller institutions have not published up-to-date financial reports

China is set to see consolidation among its smaller banks after a rare government seizure of a troubled Inner Mongolia lender in May, as Beijing looks to avert any systemic risk amid a slowing economy and an escalating trade war with the United States.

Mergers of weaker small banks with stronger peers is seen by analysts as the best option for a sector reeling from rising bad loans and funding costs, and which Beijing is wary of due to probable knock-on effects should some lenders start to fail.

Although the central bank said on Sunday it was not planning any more seizures for the moment after taking over Baoshang Bank on May 24, citing serious credit risks, analysts see the move as a precursor to sector consolidation.

“This is China’s mini-Lehman moment,” said Natixis’ chief economist, Alicia Garcia Herrero. “The regulators would start looking at consolidation as a real option … this is just a trigger for that,” she said referring to Baoshang’s takeover.

The People’s Bank of China, the central bank, and the China Banking and Insurance Regulatory Commission did not respond to a request for comment.

Bank of Jinzhou auditors resign citing loan inconsistencies

China’s move to head off any instability among its 4,000-plus banks comes as Beijing faces pressure to boost bank lending to help cushion the economic impact from the higher tariffs on Chinese imports imposed by the US.

While the country’s five biggest banks, including the Industrial and Commercial Bank of China and Bank of China, dominate the sector, smaller banks still account for a quarter of assets, according to regulatory data, and have complex ties to the broader financial system.

Total assets of mid and small-sized banks reached 68.6 trillion yuan (US$9.9 trillion) by end 2018, accounting for 26 per cent of the total market share of financial institutions, up from 18 per cent in 2008, according to Chinese brokerage CICC.

China’s regulators in first state takeover of a private bank since 1998

Although small banks are not by themselves seen as a systemic risk, the concern is that enough of them have largely funded themselves via short-term money market borrowing, posing a collective danger if one or two fail.

Many smaller banks have also invested heavily in shadow banking products. Often classified as receivables on balance sheets, these tend to actually involve loans and grew at a much faster pace than other assets and deposits.

Moreover, at least 18 smaller institutions have not published up-to-date financial reports, and in some of those cases senior regulatory officials have been appointed for bank management oversight.

China’s bank regulators take over Baoshang Bank

Last week one lender, Bank of Jinzhou, said its auditor EY had quit before signing off on its 2018 accounts, after being unable to agree with the bank on how it could check out loans where the actual usage did not match the purpose stated in the original documents.

“With the amount of loan defaults surging, one or two (client) defaults will be big enough to drag some of the medium and small-sized banks, usually the main creditors, into a similar situation to Baoshang,” said a Shanghai-based lawyer.

The problem for investors is identifying which of the weaker banks could be next to go, as well as how any seizure or forced consolidation might happen.

In Baoshang’s case, state-backed China Construction Bank has been tasked with taking over the operations for a year.

But there were still some expectations about CCB being asked to consolidate Baoshang, JPMorgan said in a research note.

UBS analyst Jason Bedford said consolidation would accelerate but it would mainly be restricted to intra-province because of the bureaucratic hurdles involved in crossing provincial borders.

“There are other banks in trouble, and some banks are just in trouble not because they built up a large shadow loan book, but because they are in a difficult regional economy,” he said.

Harry Hu, senior director at S&P Global Ratings, said smaller banks with more concentrated exposure to sectors affected by the trade war would be under pressure to consolidate.

“In our view, consolidations within the banking sector will continue … and financial stability as well as commercial interests are both important considerations to the authorities.”

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