The Chinese Banking Crisis Explained

have you ever been hungry and gone shopping what do you buy pretty much everything in the shop and that's exactly what's happened to China Post global financial crisis except for you are the Chinese industry and the bank is a shot so let's figure out what happened here thanks to Michael for posting this question of my wall he's linked to an article from the ABC and he's asked the question if I'm reading this right china is lending itself a large amount of money that it doesn't have and more importantly that its banks don't have is this fry yep that's pretty much exactly what's happening but it's a little bit more complex than that you see at the moment China's banks are facing about 8 trillion renminbi in losses that's about 1.7 trillion dollars Australian which to put this in perspective that's the entire GDP of Australia imagine if every single person in Australia went to work for an entire year we took all that money and poured it down a big hole that's exactly the size of the losses that China is facing at the moment China's non-financial debt grew by more than 15 percent last year to a total of 250 percent of their GDP more than one quarter of Chinese state-owned firms are lost making about 40 percent of new credit goes towards financing interest on old loans this essentially means that the stockpile of debt is growing exponentially they're running but not fast enough to keep up China could lose as much as half of its banking capital if a crisis ensues so China has a big banking problem and while every banking and financial crisis has debt involved the causes are always slightly different so let's go back to 2008 during the global financial crisis which is the origin of this story China's government decided to spend up beat the boss of the economy the real problem here is that they haven't actually stopped the spending the Chinese government poured four trillion remember into GFC stimulus and this went to things such as building roads or building new steel factories building new capacity this inherently makes sense while the demand for exports is suppressed you pump up investment and that pumps up the economy for now that gives you demand for industrial goods now it also gives you capacity into the future but herein lies the problem today they have excess industrial capacity they're now suffering deflation and the worst part about it is that some of these loans are starting to go very very bad in the rush to spend managers did not always invest in the best projects to make matters worse here the Chinese state-owned enterprises they are not really separate of the government per se you see this is theory of corporate governance that maintains that there are some countries that are insider systems or outsider systems english-speaking countries tend to be outsider systems or shareholder based systems you see if you run a big business and you need the money you're going to have to go to someone outside someone who's going to give you the capital to run your business in the first place but there are other countries that are stakeholder or insider systems China being one these stakeholder systems rely on three sources of capital banks the government and family bank driven systems include countries such as Germany government sources of finance include countries such as Malaysia Norway and China and family driven systems are also seen in countries such as Italy and India so it's common knowledge that state-owned enterprises are a really big deal in China in 2014 Forbes magazine reported that of the ten largest companies in the world five of those were Chinese state-owned enterprises including the world's largest Bank Industrial and Commercial Bank of China you see when the government is the primary stakeholder they don't need general-purpose financial reports because as the sole or primary shareholder they have access to all the internal management accounting data and even on many publicly listed joint stock companies party members are present on the board so while in some countries there is a big gap between the literature and big business in China this is pretty tenuous there are overlapping areas of responsibility so during the GFC stimulus not only did the government actually go ahead and spend its own money but it also lent on the banks to provide credit to the state-owned entities remember many of these banks are state-owned entities in themselves the banks would lend the money to major industrial giants such as China steel those industrial giants would then take the money and invest in more factories and more infrastructure this is incredibly efficient because it means that when the government is conducting stimulus it doesn't have to necessarily spend all of its own money by being able to coordinate the economy you can actually get private business to chip in and actually get the economy back on track faster indeed part of the problem here is that the state-owned enterprises with their public charter are better to toe the line and carry out public social policy in line with the government's ideas but herein lies the problem not only has this over capacity started to push out other people out of business overseas but it's now a case of Chinese businesses pushing out Chinese businesses there is just simply too much supply out there this means that a lot of these businesses are bankrupt or going close to being bankrupt and if you can't make any money then you can't repay the interest let alone paying taxes to the government and this over capacity is a really big deal particularly in steel power and automotive it's not just a case of being patient and waiting to get paid you see if you miss an interest repayment you're in default and if you default on a debt that means that the bank has to go and take the money back somehow and necessarily that's going to involve bankruptcies bankruptcies are going to lead to unemployment unemployment is going to lead to unhappiness and that unhappiness is going to lead to problems for the Communist Party and that is going to lead to suffering so in the short term while this might mean a bunch of pain it might also mean that China will miss its growth targets and if you start missing growth targets and there are officials out there that might miss their promotions there's a lot riding on this in the longer term it means that you clean up the bad debts it means that the credit that's available isn't going to feed the existing interest repayments and it can actually go to more innovative industries as well but at the moment everybody's scared of the short-term pain so they're keeping this cart going let's see how long it can last there's a particular Chinese way of managing the economy here and that's one of maintaining control you see a big part of maintaining the legitimacy of the Communist Party is making sure that the people always feel like they're better off under the party that they would be under any other leadership back in the dark days of Mao's Great Leap Forward private property was completely abolished but then the great opening happened and everything started to become a little bit more privatized more recently president Jiang Zemin was particularly aware that during the downfall of the USSR that it was this rush towards a market-based system that completely changed the political landscape demand for blue jeans coca-cola and change led to a hell of a lot of instability at the time so the Chinese government has been incredibly deft at managing this change slowly slowly but also doing so in a very controlled way and for a little while the growth was pretty easy you needed some technology transfer you needed to build some roads you need to build infrastructure and you needed to export export export and conveniently enough the Chinese savings rate of their people is insanely high for this entire time it's floated between 40 and 50 percent can you imagine taking half of your pay packet pre taxes and sticking it in the piggy bank well that's exactly what the Chinese people are doing and have been doing for decades and indeed for a long time Chinese consumers didn't really have much of a choice there was only one place to put your money and that was the state-owned banks interest returns were often regulated and indeed often times they were lower than the rate of inflation at the same time to the stock market in China is at the moment still fairly underdeveloped but it's crazy big it's this world's second-largest stock market and it is growing in complexity as well but for the longest time Chinese consumers really couldn't trust the numbers so if you can't trust the stock market because you can't trust the numbers where you going to put your money it's either going to end up in banks or property and indeed both of those are huge now this control actually has a major upside and that is stability you see in the West when there there's a banking and financial crisis the regulator is trying their level best to quell that fear but in China because party members sit on the board the party can simply instruct all the bank's to act in unison and this quickly quells the fear so what can China do and unfortunately the government's facing some pretty unpalatable options option number one is just ignore it and hope the problem goes away and indeed this work in the 1990s where they avoided a lot of the instructional reform essentially they are able just to grow their problems away that won't work anymore because of course we've already reached our limits here we've already over invested we already have glutes so you can't simply grow further to grow away those glutes so you really only left with the option of reform now if you pick the option to reform there are two ways you can go about it you can reform quickly or you can do it live by little if you pick the slow option it means extending additional credit to cover the interest repayments that should have been made on the old loan it also means that you slowly have to shut down those loss-making industries now this slow by slow by slow approach is a very Chinese way of operating the economy and let's face it so far it's sort of them pretty well and the risk here is that reforms will stall and you'll end up doing nothing and that's not really an option because you will definitely end up with an economic crash the other option is this like a band-aid rip it off fast and there are two sides of this reform number one is banking number two is industrial from banking perspective they're gonna have to write off their bad loans that invariably means eating into the banking assets and essentially reducing net assets bank capital is going to get thinner on the industrial side you're going to have to close down bad businesses and kill off bad projects it means unemployment and it means people are going to be unhappy it might even lead to civil unrest this is pretty darn scary stuff now unlike the Asian financial crisis in the late 1990s or indeed the global financial crisis more recently China's banking system does not have huge interconnections with the global financial system so this is unlikely to end up with a global banking crisis based on a Chinese banking crisis but here's the kicker where are all vast rallyin exports going without Chinese demand we're in a lot of hot water so in these circumstances it wouldn't take much a few SOS go down a few banks lose their capital this becomes a banking crisis this becomes an economic crisis for all of China which becomes a global economic problem this is potentially a huge problem it's quite complex and we won't get anywhere with oversimplifications let's keep an eye on China and let's hope that their leaders can do their very best to keep things afloat thanks very much Michael for asking this question if you have any other questions please post them on Facebook wall you can tweet me or you can leave them in the comments below if you found this video pretty helpful and you think of it when you give me a like and subscribe my name is philip wang and thanks for watching happy studies you

Channel: Tetracarbon (Phillip Wong)

Views: 179,841

Rating: 4.7795372 out of 5

Keywords: Accounting, Business education, banking, Banks, China, Economics, Chinese Banks, Chinese Banking, Chinese Economics, GDP Growth, GFC, Global Financial Crisis, Asian Financial Crisis, Chinese Finance, Finance, Debt, Shadow Banks, Banking crisis, Financial crisis, Phillip Wong, tetracarbon, SOE, State owned Enterprises

Id: gCzZEth8uNA

Length: 10min 59sec (659 seconds)

Published: Wed Jun 29 2016

Reddit Comments

[u/kulio_forever]

"Let's hope their leaders to do their level best to keep things afloat"

Oh, hope away. Pls, do go ahead.

[u/kulio_forever]

Well, its fairly good. I mean he is pretty much spot on if not providing deep insight or whatever.

I think you guys are saying its just a bit basic for your level, which is probably true for you.

However we have a lot of people out there with totally wrong analyses, so its nice to see some decent, proper analysis.

DISCLAIMER I am not Phillip Wong's sockpuppet. Really!

[u/ting_bu_dong]

If I understand it correctly...

They spent their way through the 2008 recession. Just typical Keynesian stuff. And it worked! They were insulated from the global crisis.

Which was good for the world! The global crisis would have been worse had they also crashed. Also, good for them. An economic downturn in China leads to a legitimation crisis, since they really have no other basis for legitimacy.

But, well, they've never actually come out of the recession. So, they're just spending and spending, with no end in sight.

Well, there's one end. The "hard landing."

^{Is... Is that about right?}