Could Northeast China be the next banking disaster?


“CABAGE HOUSES “ have made Hegang well known in recent years. Apartments in the small town in far northeastern China sell at outrageously low prices – some for as little as $ 3,500 apiece – and deserve a comparison with the cheapest items in the vegetable markets. The region’s economic prospects have long been so bad that it cannot keep residents. The city in Heilongjiang Province has lost about 16% of its population in a decade. The cabbage houses were built by the government to alleviate poverty, but they have found few buyers. The local government is now struggling to pay off its debts and is restructuring its finances. In late December, officials said they had stopped hiring new government employees to save money.

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Hegang is one of many dark stories from China’s rust belt provinces of Heilongjiang, Jilin and Liaoning. The region bordering Russia, known for its long, bitterly cold winters, has suffered years of poor economic conditions, as state-owned industries shut down and young people migrated south. Due to the poor energy infrastructure, companies in the region were disproportionately affected by an acute power shortage in 2021. In a desperate attempt to prevent family exodus and stimulate population growth, Jilin has announced that it will “provide consumer loans for marriage and childbirth” of up to 200,000 yuan (US $ 31,500) to couples.

The plight is also of concern to the region’s banks, whose total assets stood at 15.8 trillion yuan in September. Bad debt losses are already higher in the northeast than in any other area in China; The loan loss provisions are the lowest. But recognizing a crisis as it arises is a difficult task. Hiding bad debts is an easy trick for smaller banks. The local supervisory authorities are understaffed. And domestic rating agencies cannot be relied on to identify problematic lenders. In the first seven months of 2021, rating agencies only downgraded six banks. Often times, they only take action when a lender is on the brink. For example, shortly after being downgraded, Jilin-based Huancheng Rural Commercial Bank suddenly announced that its net profit had fallen 42%.

For an inside look at China’s troubled banks, check out how much investment managers are asking for smaller loans from the country’s largest lenders. Most banks across China pay similar returns on tradable certificates of deposit (NCDs), securities that are similar to short-term bank-to-bank loans and that are traded on the interbank market. Returns paid out NCDThe s issued by most banks across the country fell over the course of 2021, suggesting a decline in perceived risk. However, the payments from the underwriters in the three northeastern provinces differed from the rest over the course of 2021 (see chart).

The average premium paid for one year NCDs issued by banks in Liaoning rose from about 0.24 percentage points in February to 0.65 towards the end of the year, compared with those in healthier provinces, according to research firm Enodo Economics. Banks in Heilongjiang and Jilin have paid similar premiums. The higher yields suggest that big banks believe local northeastern governments could struggle to bail out their financial institutions in the event of a crisis, analysts at Enodo said. (The surveyed NCDs were all still rated as AAA, but safest from rating agencies.)

The northeast is a prime contender for China’s next banking disaster. Of the four major rescue operations by the city’s commercial banks since 2019, two are located in the region. Failures in regulation and corporate governance have left some institutions under the influence of private companies or individuals who have skewed their lending. Shengjing Bank, a large Liaoning-based bank with assets of 1 trillion yuan, has high exposure to Evergrande, a failing real estate developer. Some lenders in the region lost billions of dollars when financial products went sour. Liaoning regulators recently planned to merge 12 troubled banks to prevent a crisis. That plan was later watered down to just two. How the problems will be dealt with with the remaining ten lenders is unclear.

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This article appeared in the Finance & Economics section of the print edition under the heading “Northeast Exposure”

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