China’s rural bank scandal has $300 bln tail risk

Demonstrators hold up signs during a protest over the freezing of deposits by some rural-based banks, outside a People's Bank of China building in Zhengzhou, Henan province, China July 10, 2022, in this screengrab from video obtained by Reuters. Text in foreground reads, "Henan Bank, return to us our legal deposits! The people's life-saving deposits!" Reuters TV via REUTERS

HONG KONG, July 12 (Reuters Breakingviews) - China’s small-bank crisis is far from over. On Monday authorities in Henan finally agreed to cover customer deposits that were frozen in April after getting caught in a possible fraud. It’s a cautionary tale for the country’s 1,600-odd village banks that lend to small businesses, are most exposed if national GDP tanks, and receive insufficient regulatory oversight.

Last year, the People’s Bank of China identified a group of high-risk lenders that are dominated by this tier of lenders, with some $300 billion of assets between them per the China Banking Association, as well as another 1,500 larger so-called rural commercial banks. All told, about 3,800 rural lenders account for 12% of the industry’s assets.

They are significant lenders to small and medium-size businesses, extending some $740 billion accumulatively as of 2020 as part of a push by Beijing to stabilise jobs. But their average return on assets is just 0.39%, per ANZ analysts, leaving little wiggle room if the economy shrinks.

The central bank, though, excluded them from its contagion risk stress test, and estimated that only 1.4% of total banking system assets might pose a problem.

That may downplay their role. The four village banks in Henan, for example, enticed depositors, many of them out-of-towners, by using flexible terms and high interest rates brokered by third-party apps and internet platforms. That was a widespread practice until regulators banned it last year; some 550 billion yuan ($82 billion) of such products were outstanding by end-2020, per the PBOC.

In April, deposits worth up to $1.5 billion were frozen, per Chinese media, and regulators then accused private shareholders in these banks of siphoning off funds by falsifying loans and data reporting, with the mastermind appearing to have fled abroad. In past bank crises, like the 2019 Baoshang bank saga, the PBOC made sure depositors got their cash back, using the industry’s mandatory insurance scheme.

Henan’s foot-dragging ignited fears that wouldn’t happen this time; only after more than 1,000 customers took their frustration to the streets last weekend did provincial authorities promise to help, albeit in batches and with conditions attached. It’s not an isolated case: within hours, officials for a small city in nearby Anhui province announced they would do the same for a local village bank.

China’s rural lenders might not be big enough to pose a systemic risk, but their ability to cause regional pain is already being felt.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

CONTEXT NEWS

The banking and insurance regulator in Henan province said in a statement late on July 11 that it will start reimbursing some banking clients whose deposits had been frozen in April, Reuters reported. It took the step after more than 1,000 customers protested over the weekend. Payments will be made in batches, with the first one starting on July 15.

Henan police said in a statement on July 10 that further investigations showed that, since 2011, a criminal group led by a suspect named Lu Yi had gradually taken control of several rural banks, through companies including the Henan New Wealth Group, to illegally transfer out funds. The police said they had arrested more suspects and seized more assets involved in the case.

Editing by Antony Currie and Thomas Shum

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Beijing, crunching economic data, interviewing high-level officials, and travelling to far-flung provinces to visit factory floors and talk to local shopkeepers. Before that, she spent nearly three years in Santiago, Chile, where she built a trade news website reporting on the produce industry – and developed Spanish as a third language alongside Mandarin Chinese and English.