2017: The Moment of Truth for Chinese Banks

This is the first in a series of articles I will be publishing on this month with my views on some of the trends that will shape the course of the Chinese economy and business in 2017. Please follow me to be notified when I publish my next posts on this topic.

We are reaching a breaking point for many of China’s smaller banks. Simply put, there is no economic reason for them to continue to exist. While there may be political reasons, such as having a local bank willing to lend money to local struggling state-owned enterprises, the cost of doing so is about to become very high. 2017 will see the first of a growing number to go bankrupt – although that reality may be obscured by forcing the largest banks to take them over.

While these banks have had problems with the quality of their lending for many years, with bad debts being racked up and rolled over, that alone will not precipitate a crisis. What could trigger a crisis is the loss of deposits to fund these loans. 

Historically, Chinese citizens have been willing to deposit their savings with banks and receive very low interest rates; after all, they had few alternatives available. Interest rates were the same at every bank, regulated by the government and that was where you put your money. However, investors were certain that the government would stand behind the bank. Today they have many other options, in particular options enabled through the internet. 

By the end of 2015 more than 2 trillion RMB had moved into online accounts provided by Internet companies, not the traditional banks. Another trillion probably moved in 2016. Savers are attracted by the higher rates offered online, and assume that the government will guarantee these savings in the same way as they did with banks in the past. 

It is not just deposits that are disappearing: Revenue streams from payments, consumer loans, and credit cards are all shrinking in these smaller banks as online players such as Alibaba and Tencent and the giant nationwide banks invest billions in providing world-class, consumer friendly services. 

These larger institutions can also invest in the scale of big data analytics needed to be able to tailor individualized offers to consumers. They also invest at scale to provide high quality phone apps that allow customers to make wealth management decisions as easily as buying their evening meal online.

Smaller banks cannot hope to keep up. They would need the best talent in the banking and internet industries to even come close–and they don’t. They are stuck with lots of physical branches that fewer customers wish to use. They are caught at the wrong end of an industry facing enormous technological disruption, where competing requires large scale investments in unfamiliar areas, where the winners are almost always the scale players, where they have a high fixed cost base, and where government stakeholders tell them where to prioritize lending (and to not lay anyone off).

Smaller banks have been trying to respond to this challenge. They offer higher interest rate products, including off balance sheet wealth management products that the government continues to clamp down on. Some then turn to the wholesale market to borrow from other financial institutions, but this is even more expensive and short term funding, that can be withdrawn at short notice.

City banks based in cities where economic growth has fallen dramatically are probably most at risk. Steel and coal mining regions and parts of the northeast could see these issues surface first, but the challenge is not just limited to these banks. China has too many banks and the pressures just mentioned apply to all of them. 

Central and local government will want to ensure there are no social issues as a result of a bank failure. Investor confidence must be maintained. Most, if not all, jobs also need to be maintained. The easy option is to turn to the Big 4 Chinese banks. However, for a bold multinational bank operating in China, taking over 100% of a struggling bank and in return getting the license to operate wholly-owned in additional financial sectors in China might be an investment worth making, especially if they have familiarity with the geographic region the failed bank is from, and they could as a result of their global scale address some of the weaknesses that had caused the failing bank such stress. 

It just might be a win-win investment opportunity.

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标签：Chinese economy and business