Baoshang Bank a Symptom of Widespread Corporate Looting

Update: English version here

Many observers see the Baoshang Bank takeover as a banking story, but in good news for the banking sector and bad news for China's financial markets, it might be a sign of corporate looting instead. The Baoshang Bank incident came only a month after the Market Rattled by Kangmei's $4.4 Billion Accounting Error for example. At heart, China lacks property rights. Major shareholders can extract wealth and leave a hollowed-out shell of company in the hands of equity and debt holders. A major area of disagreement between China bulls and bears rests on this issue. Is the Baoshang Bank incident isolated or does it signal this problem is finally too big to handle?

Translation note: in a couple of places I changed the Google translation to "looting" and "hollowing out" as I think those are more accurate than the machine translation. Looting is a more accurate term for what is taking place, but the editorial itself did not use such a loaded word.

Caixin: Editorial | Baoshang Bank’s warning
Baoshang Bank was taken over and the action has just begun, but its impact on the market has gradually subsided. The bank has a large amount of funds to be controlled by the major shareholders tomorrow. occupied illegal , and it was difficult to return for a long time, which led to a serious credit crisis, which triggered the legal conditions to be taken over according to law for the first time in 20 years. This move is undoubtedly an important step in the "anti-risk" battle. This incident may have lost the sensation of news, but the reflection it brings should be long-lasting and profound. We should study how to prevent major shareholders from “looting” and explore how the regulatory authorities should deal with risk institutions in a timely manner to avoid problems.

At the beginning of the acceptance of Baoshang Bank, some market participants expressed doubts about whether this would impact the financial market when the downward pressure on the Chinese economy increased. There were also views on the trade friction between China and the United States, and questioned the timing of takeover. improper. Now it seems that these ideas are too much to worry about. The interest rate price signal in the interbank market indicates that the market has basically returned to calm. This is due to the thorough deployment and decisive efforts of the regulators. Several consecutive "answer reporters", explaining the reasons for taking over, the follow-up treatment plan and the liquidity of small and medium-sized banks, provided sufficient expectations to the market, eased market anxiety, and at the same time, the takeover action was proceeding in an orderly manner. However, this incident reflects the common problems of financial institutions represented by small and medium-sized banks and must be given sufficient attention. The takeover may be able to cope with the moment and solve the problem. However, the supervision should be institutional and normal, in order to cope with the endless financial risks. The Baoshang Bank incident is a lesson and a warning.

The crisis of the Baoshang Bank stems from the hollowing-out by major shareholders. This is not a new phenomenon. Similar incidents have long been commonplace and are not limited to the financial sector. However, due to the uncertainty, high leverage and contagiousness of financial risks, such hollowing-out behaviors are more harmful, spread more widely and more destructive. "Tomorrow Department" and "Ampang Department" have been wiped out one after another. Their methods have long been known. They are nothing more than resorting to capital evasion, capital injection, false capital injection, and mass transfer through improper affiliate transactions, depending on the financial institution as a "cash machine". Since the majority shareholder has mastered the absolute right to speak, the internal control mechanism of financial institutions is ineffective, and financial risks are finally detonated, which has severely hit financial credit. In China, there is still a long way to go to improve corporate governance in financial institutions.
Although it isn't directly applicable in this case, my mind goes back to cartoon I saw in the late 1990s of a man in a restaurant, paying for a fake bottle of XO with counterfeit renminbi. Both are happy. As long as you take Chinese financial statements at face value, you can invest with confidence!
The "financial crocodile" smashed not only the internal control of this layer of window paper. The "Tomorrow Department" incident has been more than two years, but the large amount of capital exchanges between the Baoshang Bank has not been significantly affected. Data show that as of the end of September 2018, the total debt of Baoshang Bank was 503.4 billion yuan, of which 212.9 billion yuan was absorbed by various deposits, and the inter-bank liabilities (including interbank deposit certificates) were 221.1 billion yuan. In 2018, the rating of the interbank deposit receipts of the contractor bank has been negative. Is the counterparty collectively neglecting risk management or completely disregarding the potential risks? It is difficult to draw conclusions. However, the "comprehensive beliefs" firmly believed by all parties that "there will always be people who have the bottom" have undoubtedly played a role in fueling the situation. As long as the return is high, the risk can be put aside. A mature financial market can never be so strange. Breaking the industry's belief in the business, it has tried in the process of taking over the Baoshang Bank, but it may not be thorough enough for various practical reasons. The next step needs to consider the regulatory system and process, how to prevent the emergence of the Nth Baoshang Bank.
If you want to promote an air of calm, do not use the term "Nth."
The Baoshang Bank incident reflects the bad ecology of financial institutions such as small and medium-sized banks. They have weak storage capacity, low internal control levels, bad growth, a large number of peers, and high costs. On the other hand, in recent years, China's financial industry has shown unprecedented prosperity. The added value of the financial services industry has been rising in proportion to the GDP, even surpassing the developed countries such as the United States and Britain. However, behind this surface prosperity is the constant pressure on the real economy. Finance is the blood of the modern economy and relies on the real economy. The development of the financial industry is inseparable from the soil of the real economy. If a large amount of money is only vacated in the financial sector, or even become a "blood machine" of the real economy, the existence of relevant financial institutions will have a big question mark. The reform of the financial supply side is to solve this structural problem. To build a multi-level, wide-coverage financial system, we must be able to effectively serve the real economy and meet social needs. At the same time, we must try our best to break down the institutional and institutional obstacles that restrict financial services. In this regard, we must make greater determination and courage.
This paragraph is the essence of many China bear theses. The U.S. economy is over-financialized, debt and interest costs are choking the real economy. China has by some measures surpassed the United States in its financialization and in the velocity of its debt creation.
As mentioned earlier, there have been some doubts about the timing of taking over the contractor's bank. Regardless of the endorsement of interest, it is necessary to distinguish the deviation of knowledge. Strengthening financial supervision should not set too many preconditions, and find that violations of laws and regulations should be promptly issued, otherwise it is tantamount to connivance or even collusion. The position of supervision cannot be loosened, and there should be no extraneous factors, otherwise it will become an opportunist. Over the years, the shareholding ratio and the number of homes held by the “Tomorrow Department” have long violated relevant regulatory requirements, but they have not been corrected for a long time. It can be a unique exception, which has transmitted very harmful to the financial market. signal. It is very necessary for the central bank and the regulatory authorities to face this "historical issue" and take it out. It should become a new starting point for strengthening supervision and reshaping China's financial ecology.

The storm of the Baoshang Bank incident has largely subsided. The person in charge of the central bank said that there is no plan to take over other institutions. We are also looking forward to this. However, the warnings issued in this case are not lost in general terms and should not be ignored. Established in 1999, Tomorrow Holdings constitutes the "wonderful situation of the 20 years in China's financial industry." Only by thoroughly disposing of the "Tomorrow Department" and its kind, and preventing the "Tomorrow System" from the system and supervision, the Chinese financial market is only Have a beautiful tomorrow.
Calm was restored to parts of the financial market after Bear Stearns went bankrupt. It didn't last. The biggest question around the Baoshang Bank takeover was why now, why this bank? Financial problems are normally swept under the rug. Was it a warning short to others, is it really a unique case as the regulators argue, or is it a sign that accumulated losses and fraud are becoming to large to handle?

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