China’s first bank seizure since 1998 shows hidden loan risk

Bloomberg

China’s first government takeover of a bank in more than two decades has underscored the potential for increased stress at regional le- nders that piled into off-book financing in recent years.
Regulators said that they would assume control of Ba-oshang Bank Co. for one year because of “serious” credit risks. The Inner Mongolia-based lender, once seen as a model for funding regional economies, is one of many smaller Chinese lenders that used shadow-financing techniques to obscure their exposure to risky borrowers, according to analysts.
While China has been cracking down on such techniques, UBS Group AG analyst Jason Bedford said the country is rife with regional banks that used special-purpose vehicles to circumvent lending restrictions and hide the true state of their bad loans. Shares of big Chinese lenders may be vulnerable to the fallout on concern they’ll be asked to help resolve problems at smaller peers, according to Sanford C. Bernstein. Regulators face a difficult balancing act as they try to clean up risky lending practices without sinking the world’s second-largest economy amid a trade war with the US.
The troubles at Baoshang stemmed in part from its heavy exposure to a small number of borrowers, said Bedford, executive director of Asian financials research at UBS in Hong Kong. He added that there are other banks in similar situations.
Baoshang was part of the investment conglomerate led by financier Xiao Jianhua, known as the Tomorrow Group, which is being probed by Chinese officials, according to two people familiar with the investigation.
Officials arranged for a Shenzhen state-owned investment company to buy a significant stake in Bao-shang last year, then realised that the lender’s financial situation was more precarious than previously thought, the people said, asking not to be named as they’re not authorised to talk to media.
The deal didn’t go through and regulators were forced to take over the bank instead, according to the people.
Xiao, who disappeared in early 2017, could soon face trial, the people said. The People’s Bank of China and China Banking and Insurance Regulatory Commission didn’t immediately respond to requests for comment.
Regional banks in China’s rust-belt provinces drove the rapid expansion of non-traditional lending that peaked in early 2018. Smaller firms, who used shadow-loan instruments to diversify from their struggling home provinces, exposed themselves to a much wider spectrum of Chinese corporate risk, according to a 2017 UBS report by Bedford and his colleagues. Some banks are now getting squeezed as Chinese companies default at a record pace and financing costs for shadow-lending activities increase.
As part of the government clampdown, banks have been forced to reclassify loans overdue for more than 90 days as non-performing, a move that led to a record surge in soured debt and wiped out capital at some small lenders.
China Construction Bank Corp., the nation’s second-largest lender, will be responsible for managing Baoshang’s business while it’s under government control, regulators said.