China’s Ponzi banks are teetering

What began as a run on a handful of provincial banks is rapidly morphing into one of China’s worst financial scandals, threatening the stability of the country’s heavily indebted financial system. It poses a serious challenge to a Communist party obsessed with social order, which has thuggishly cracked down on desperate depositors demanding their money back.

At the weekend, protesters in Henan’s capital Zhengzhou were charged, beaten and dragged away by unidentified security officials dressed in white shirts and dark trousers, who appeared to be working in concert with uniformed police. An estimated 1,000 angry depositors had gathered in front of a branch of the People’s Bank of China, carrying banners that read ‘We are against Henan government’s corruption and violence’ and ‘No deposits, no human rights’. They chanted, ‘Henan banks, give me my money back’ and one protester reportedly pasted pictures of Mao Zedong on pillars in front of the bank.

Some of the protesters suffered broken bones and eye injuries. The ugly scenes rapidly circulated on Chinese social media but were quickly deleted by CCP’s censors. The first scandal emerged in April when four provincial banks suddenly suspended online cash withdrawals, freezing the deposits of thousands of people. The local authorities claimed ‘criminal gangs’ had taken control of the banks and siphoned off the funds through illegal transfers and fictitious loans worth as much as 40 billion yuan (£5 billion).

The case attracted widespread attention in China after the local authorities in June manipulated the personal health codes of depositors to prevent them from getting to Zhengzhou to protest. Covid apps are mandatory in China, crunching vast amount of data about health, contacts and location to determine Covid risk. Those who receive a red rating are grounded and usually quarantined. They certainly can’t travel, as the depositors discovered.

At the time, the authorities were roundly condemned for undermining trust in the country’s anti-Covid strategy. The manipulation was reportedly repeated against some would-be protesters at the weekend, but this time it did not prevent others from getting to Zhengzhou.

The Henan depositors do seem to be the victims of fraud, but the headache for Xi Jinping is that they blame the government and are unlikely to be the only ones whose savings are at risk. Opaque provincial banks in particular are heavily indebted, weighed down with bad loans, and for years have colluded with powerful local businesses and the local authorities. Loans have typically been made to well-connected firms or individuals with little or no due diligence. It was a recipe for corruption. At the same time, small investors were offered ‘wealth management products’ that typically offered high-interest rates, which were necessary to attract the funds to pay off earlier investors – a classic Ponzi scheme.

Zombie banks could stagger on as long as the Chinese government continued to pump money into the economy, but the economic backdrop has now changed radically. Economic growth is stagnating and the Covid-19 pandemic and the CCP’s ceaseless lockdowns are taking their toll. Bad loans are soaring.

At the same time, after years of soaring real estate prices, China’s property bubble is bursting, with a growing number of developers unable to repay their loans. It now threatens to spill over into the local banking crisis. In 2020, lending to developers accounted for an astonishing 39 per cent of bank loans. Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission has described the property market as a ‘grey rhino’ – a very obvious but ignored threat.

Property is the main driver of China’s domestic economy, accounting for almost a third of GDP. A large proportion of local government income comes from selling land to the property developers, an income flow that is now drying up. There is concern about hidden local government debts because of the widespread use of opaque financing vehicles, often in collusion with local banks. By one estimate, outstanding local government debt is worth 44 per cent of GDP, but nobody knows for sure, since the financial system is so lacking in transparency.

The events in Henan are the tip of a potentially very large iceberg. In the short term, opaque and badly regulated regional lenders and their local government patrons are the most vulnerable, but China’s national financial system is shaky too. The party secretary in Henan, Lou Yangsheng, is an ally of Xi, which makes it more difficult for Beijing to pass it off as just local ill-discipline.

After the ugly scenes of the weekend, the local regulator promised that depositors in the Henan banks will be repaid. But the promises were vague about how this will happen and who will pay. Many in China remain were sceptical. ‘The statement gives no clear clue. They just don't want to return our money,’ said one depositer. There was scepticism too about local government claims that the problems are all down to ‘criminal gangs’. The anger is unlikely to subside – there is very little trust in the authorities and with life savings at risk, some have little to lose.