SinoInsight 1
On June 9, the office of the Financial Stability and Development Committee under China’s State Council held a meeting to study the stability of interbank businesses. Present at the meeting were representatives from China Development Bank, Bank of Beijing, Bank of Shanghai, Bank of Jiangsu, as well as the six major state-owned commercial banks and 12 joint-stock banks.
Key takeaways from the meeting include:
- The People’s Bank of China, the China Banking and Insurance Regulatory Commission, and the China Securities Commission support small and medium-sized banks;
- The PBoC will continue to provide liquidity support to small and medium-sized lenders;
- The meeting confirmed the fluctuations in the interbank market over the past few days;
- The meeting stated that the risks in China’s small and medium-sized banks are under control.
On the same day, a CBIRC spokesperson said in response to a question about Baoshang Bank that “small and medium-sized banks are operating smoothly, liquidity is relatively ample, and overall risks are fully manageable.”
A Reuters analysis revealed that “at least 18 smaller institutions have not published up-to-date financial reports, and in some of those cases senior regulatory officials have been appointed for bank management oversight.”
OUR TAKE
1. The June 9 meeting held by the office of the Financial Stability and Development Committee affirms our analysis in the June 3 edition of this newsletter.
We wrote: “Medium- and small-sized Chinese banks rely on interbank borrowing for most of their funding … a banking crisis would ensue should more medium- and small-sized banks are found to be ‘severe credit risks’ … For instance, large banks will have to tighten their interbank lending to medium- and small-sized banks, either through lending less or charging high interest rates. This would in turn lead to tightening liquidity for medium- and small-sized banks and increased credit risks.”
We believe that serious problems in China’s financial system are surfacing as a result of the Sino-U.S. trade war. The fact that the central authorities have to step in to “stabilize” the fallout of the government takeover of Baoshang Bank (pressuring the big banks to provide liquidity to the smaller banks) hints at the severity and scale of the interbank situation on the mainland.
2. The official rhetoric about “manageable” and “controllable” risks are not reassuring in light of other information.
- The Reuters analysis mentioned above mentions that at least 18 smaller banks have not released updated financial reports. Baoshang Bank, which was recently subjected to a government takeover, had not published its annual reports for 2017 and 2018.
- On May 31, Ernst & Young LLP resigned as the auditor of the Bank of Jinzhou Co., a city bank with about $100 billion in assets. Ernst & Young claimed that they had requested information about certain loans by the Bank of Jinzhou but were unable to get enough documents to answer their questions and complete their audit.
3. The central authorities and Chinese officials are being disingenuous is claiming that risks in China’s small and medium-sized banks are “fully manageable.” Financial crises, however, usually start from the local before a chain reaction is triggered that affects the entire system. The collapse of Lehman Brothers in 2008 is an example of how the bankruptcy of a U.S. bank developed into a global financial crisis. The government takeover of Baoshang Bank, which some have described as a “mini-Lehman moment,” could yet spark a chain reaction given the current financial climate in China.
Some analysts may argue that the CCP’s authoritarian system is more resilient to financial shocks due to its iron grip on society and control of the military and propaganda/information channels. There are, however, limits to authoritarianism, and the CCP presently faces an avalanche of problems—low market confidence, increased capital outflows, rising unemployment, growing social unrest, food crisis, etc.—which makes it even harder for it to “fully control” the spread of a financial crisis.
SinoInsight 2
On June 9, hundreds of thousands of Hong Kong residents took to the streets to protest a proposed extradition law that would put people in Hong Kong at danger of being handed over to China to stand trial.
Protest march organizer Civil Human Rights Front estimated that 1.03 million people had participated in the day’s demonstration, according to a statement released at 9:30 p.m. Hong Kong time. This meant that the June 9 demonstration is more than double the size of a 2003 protest rally (500,000) against the enactment of a national security legislation (Article 23) which would target groups suppressed by the Chinese regime.
Many shops and businesses in Hong Kong took the day off to support the protesters, according to overseas Chinese language news reports. One local store even wrote in a social media post that, “one can start a new business after failure, but should Hong Kong fail, we can’t even start a business.”
The June 9 demonstration in Hong Kong inspired petitions against the Chinese authorities in at least 29 cities in 12 countries worldwide. Hong Kong residents living abroad held protests in front of Chinese diplomatic offices, the economic and trade offices of the Hong Kong government, or in public squares.
A day before the demonstration, a spokesperson for the U.S. Department of State said that the U.S. “is closely monitoring and concerned by the Hong Kong government’s proposed amendments to the law. Continued erosion of the ‘One country, Two systems’ framework puts at risk Hong Kong’s long-established special status in international affairs.” U.S. Secretary of State Mike Pompeo and the British and German foreign ministers have also spoken against the law. Further, 11 European Union envoys had met with Hong Kong leader Carrie Lam to protest the proposed extradition law.
OUR TAKE
1. We believe that the Hong Kong government is pushing ahead with the proposed changes to the city’s extradition law despite the amendments facing massive public opposition because the Hong Kong government is under the thumb of the Chinese communist regime. Chief Executive Carrie Lam is known to be in the pro-Beijing camp, while pro-Beijing lawmakers dominate the Hong Kong legislature.
There are two likely reasons why the CCP is strengthening its control over Hong Kong during this period. First, the Party’s survival instincts are kicking in as it struggles to maintain its political legitimacy. Second, there are complex CCP factional politics and interests in Hong Kong, and tensions tend to flare up in the city during critical moments in the factional struggle between the Jiang faction and the Xi camp (we will explore this further at a later date).
2. The proposed extradition law is set to undergo a second reading in Hong Kong’s Legislative Council on June 12. Barring last-minute changes or stronger U.S.-led international opposition, the law will likely be passed given the CCP factors mentioned in the previous point.
3. The passing of the extradition law may prove to be a double-edged sword for the CCP. On the one hand, the Chinese regime’s control over Hong Kong would grow tighter and it would likely seek out opportunities to suppress anti-CCP groups in the city. On the other hand, there is a real risk that Hong Kong’s status as a free port and international financial hub would take a hit, resulting in increased capital outflows and drops in the Hong Kong stock and property markets. Economic and financial downturn in Hong Kong would in turn affect China’s deteriorating economy and make a bad situation worse.
Hong Kong media reports note that the Hang Seng Index, which had a market capitalization of HK$33.81 trillion at the end of April, saw HK$2.87 trillion in market value evaporate by May 6. This was a sign that investors were voting with their feet and taking funds out of the city, according to Hong Kong media. Media reports also note that investor immigration seminars and divestment services offered by private banks have “exploded in popularity” in the past two months.
4. The U.S. State Department had expressed concern about the proposed extradition law at least three times before the June 9 parade. Also, the U.S.-China Economic and Security Review Commission released a report in May which noted that U.S. national security and economic interests in Hong Kong face serious risks if the law is passed. The report said that the law would “increase the territory’s susceptibility to Beijing’s political coercion and further erode Hong Kong’s autonomy.”
Meanwhile, the EU, Australia, Canada, Japan, and other countries have expressed concern about the proposed Hong Kong extradition law.
In our China 2019 outlook, we wrote that “the U.S. could reassess Hong Kong’s status as a free port, and even consider reclassifying Hong Kong as part of the same customs territory as mainland China.” Unless the Hong Kong government fails to pass the extradition law, current trends are moving in the direction of our forecast.
5. Whether or not Hong Kong passes the proposed extradition law would directly affect elite politics in the Chinese regime and China’s geopolitical situation. Thus, Hong Kong is a leading indicator to track when watching out for the arrival of political Black Swan events in China. For more analysis on this topic or Black Swan leading indicators, contact us.
