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China's takeover of local lender hints at wider trouble ahead

First government-led seizure in 18 years seen as beginning of industry reshuffle

Chinese authorities last took over a bank in 2001, with the seizure of Shantou Commercial Bank.   © Reuters

BAOTOU, China -- China's first government takeover of a bank in 18 years sent shudders through the financial sector, suggesting growing concern among the authorities that ailing smaller lenders serving struggling local economies could at some point spark a broader financial crisis.

Baoshang Bank, a private lender based in this Inner Mongolian city 600 km west of Beijing, found itself under state control overnight May 24, indicating that the institution is essentially bankrupt. A taxi driver named Zhang recalled the chaos from that evening.

"Many people came to take out cash," Zhang said. "I also had tens of thousands of yuan in savings, so I had to stand in line for 30 minutes." A friend who is a Baotou native took a flight from the southern city of Guangzhou to withdraw money.

The People's Bank of China, the central bank, took over Baoshang's management in tandem with the China Banking and Insurance Regulatory Commission. The PBOC installed officials in executive posts and contracted out daily functions to China Construction Bank, one of the country's four big state commercial banks. It is expected that Baoshang Bank will be swallowed up by the major lender.

The rare government-led seizure drove account holders into a panic. "There were so many people on May 24," said a Baoshang teller. "Since then, I've been working without taking a day off."

The bank stayed open during that weekend to calm nerves. On May 27, interest rates on three-year fixed savings accounts were raised 8.9 basis points to 4.386%. The yield is more generous by as much as 40 basis points than rates offered by the Big Four banks.

"Right now, there's backing by the nation's faith and credit, so there's more security than before," a bank employee said.

Baoshang Bank, a local lender serving an outlying region, has won praise for its service and substantial interest rates. In 2016, the bank earned net profit of 4.2 billion yuan ($608 million at current rates), and the capital adequacy ratio stood at 11.69%. Baoshang has not disclosed its financial statements since 2017.

The bank's collapse has roots in decisions made by Tomorrow Group, the investment conglomerate run by Chinese billionaire Xiao Jianhua, who vanished from Hong Kong over two years ago -- reportedly abducted to the mainland. While lenders of Baoshang's stripe are usually owned by regional government authorities, Tomorrow Group held an 89% stake in the bank.

The PBOC alleges that Tomorrow Group illegally to control of funds, leaving Baoshang Bank unable to repay liabilities for long periods of time and jeopardizing the bank's credit. Tomorrow Group is accused of forcing companies in its orbit to embark on inappropriate investment and lending, which resulted in a pile of nonperforming assets.

But Baoshang Bank's fate was sealed by the weak local economy surrounding Baotou, which depends on coal and rare-earth mining. In 2017, the region's gross domestic product figures were found to be padded. The following year, retail sales climbed only 2% . A study by an agency under the State Council agency shows that Inner Mongolia had the highest ratio of bad debt among China's 31 provinces for three straight years through 2016.

Baoshang Bank attempted to calm account holders by raising rates on fixed savings accounts to 4.386% following a takeover by the state. (Photo by Issaku Harada)

During a Politburo study session in February, President Xi Jinping said he would deepen the supply-side structural reforms in the financial sector, suggesting that small and midsize banks would be reorganized. The takeover of Baoshang is potentially the first of such administrative actions.

Tomorrow Group was a major shareholder in over 10 banks. Anbang Insurance Group, HNA Group and other conglomerates have bought stakes in lenders as well.

"There are more than a few banks that do the bidding of specific shareholders," a state economist said.

The stagnation of local economies has grown into more of a nationwide phenomenon, with multiple Chinese banks believed to be on the verge of bankruptcy.

Hengfeng Bank, a lender with branches across the country, is undergoing a restructuring led by its home province of Shandong, the Banking and Insurance Regulatory Commission said on June 9. Authorities previously opened an investigation of Hengfeng executives on suspicions of disciplinary violations.

Though the PBOC has quelled fears over the supply of funds, the market continues to exhibit concerns about the banking system. New issues of negotiable certificates of deposits plummeted 80% in the last week of May from the previous week. NCD yields for banks with high credit ratings took a dive while yields at lower-rated banks remained elevated.

Chinese commercial banks shouldered 2.16 trillion yuan worth of bad debt at the end of March, and lent another 3.6 trillion yuan to questionable borrowers. The total amount of distressed debt is rising by the day, and the consensus opinion is that marginal borrowers have deteriorating finances. Critics say these weaker banks could become the Achilles Heel of the sector.

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