Bank Run in Rural China Tests Faith in Thousands of Lenders

(Bloomberg) -- It started with an unverified rumor from an obscure social media account: Yichuan Rural Commercial Bank was insolvent.

Within hours of the post on Tuesday, more than 1,000 worried customers had lined up to withdraw their money. By Wednesday, a run on the bank had prompted local authorities to arrange more than 30 billion yuan ($4.3 billion) of liquidity injections. As branch staff sought to restore confidence, they displayed stacks of cash to convince depositors that there was enough to go around.

While the panic appeared to subside on Friday, the episode marked the latest test of faith in more than 2,000 rural Chinese lenders that collectively control $5 trillion of assets. Confidence in their financial strength has dwindled since May, when the government seized a bank for the first time since 1998 and imposed losses on some of its creditors. At least two more small Chinese lenders have subsequently required bailouts.

Even though no retail depositors have lost money, some worry that they could get burned if China starts paring back the implicit government backstop for banks that has underpinned the nation’s financial system for decades. Smaller banks, faced with rising nonperforming loans after years of explosive growth, are seen as particularly vulnerable.

While the run on Yichuan Rural Bank was likely an over-reaction, it reflects the Chinese public’s uncertainty over the health of small lenders, said Xiaoxi Zhang, a Beijing-based analyst at Gavekal Dragonomics.

Reducing state guarantees -- and the moral hazard that comes with them -- is seen as crucial to the long-term stability of China’s financial system. But the country faces a difficult balancing act: If the public loses confidence in banks’ ability to survive on their own, it could precipitate exactly the type of crisis authorities are trying to prevent.

Yichuan Rural Bank, based in Luoyang, an industrial town better known as the cradle of Chinese civilization, saw its NPL ratio climb to 2.95% in 2018 from 0.54% two years earlier, according to China Chengxin International Credit Rating Co. Chengxin International cut the bank’s rating to A+ from AA- in July.

The rumor about Yichuan Rural Bank’s solvency may have stemmed from an investigation into the lender’s former chairman. Authorities confirmed the probe on Wednesday, saying the executive was being investigated on suspicion of “severely violating discipline and law.” They also said one person was taken into custody for allegedly fabricating information and spreading rumors on WeChat, China’s wildly popular messaging platform.

Calls to Yichuan Rural Bank weren’t immediately returned. A local representative from China’s banking regulator told reporters after a press conference on Thursday that the local government has set up a working group and reiterated the bank has abundant liquidity.

Yichuan Rural Bank aside, many of China’s smaller lenders face real challenges because they’ve been pumping money into risky loans and investments that have soured amid a slowing economy, according to Michael Pettis, professor of finance at the Guanghua School of Management at Peking University in Beijing.

A UBS Group AG analysis of more than 250 Chinese banks in July showed that they face a potential capital shortfall of 2.4 trillion yuan. UBS’s estimate for a broader universe of Chinese lenders in “distress” was 9.2 trillion yuan, or about 4% of the commercial banking system and nearly 10% of gross domestic product.

To contact Bloomberg News staff for this story: Lucille Liu in Beijing at xliu621@bloomberg.net;Jun Luo in Shanghai at jluo6@bloomberg.net

To contact the editors responsible for this story: Candice Zachariahs at czachariahs2@bloomberg.net, Michael Patterson, David Scheer

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With assistance from Bloomberg