Cleaner books in China's rustbelt

The bratwurst and sauerkraut selections on the menus at Changchun’s smartest hotel, the Shangri-La, are the giveaway as to how this heavily industrialized and heavily polluted city in China’s grim northeast earns its living. And how things have changed in this tough, regional rustbelt.

Changchun is the headquarters of the massive First Automotive Works, one of China’s biggest state-owned enterprises. Best known for building the clunky Hongqi – or Red Flag sedan – favoured by Mao Zedong, FAW was set up in the early 1950s as the prestige project of communist China’s first five-year plan. The idea was to create an industrialized socialist paradise with help from the Soviet Union, which was China’s ideological fellow traveller and “elder brother”, as Beijing’s propaganda had it at the time.

Moscow’s Stalinist brothers moved on from Changchun long ago, replaced by the sausage-fancying executives of Germany’s Volkswagen, which set up a joint venture with FAW. The giant state-owned enterprise sprawls over vast tracts of southwest Changchun, a city of 7.6 million people that still only ranks as China’s 30th most-populous. But these days, 25 years after VW first placed its marque on Changchun, free-spending China is in the midst of its 13th five-year plan while its economic regulators obsess about the by-products of rampant capitalism, such as the need to disarm the massive debt bombs in the financial system and how to bring shadow banking out of the murk and into full daylight.

But what hasn’t changed in this rustbelt of China is the fealty to China’s omnipotent Communist Party across the economy, as revealed by Asiamoney’s discussions with executives of big regional banks – Bank of Jilin and Jilin JiuTai Rural Commercial Bank, which dominate banking in Changchun and the surrounding Jilin province.

In both cases, the chairmen – 52-year-old Zhang Baoxiang of Bank of Jilin, and his 49-year-old counterpart, Gao Bing at Jilin JiuTai Bank – also hold the position of secretary of the Communist Party chapters at their respective banks. 

At state-connected Chinese banks, the two positions tend to be indivisible. In China, you can’t be one without being the other.

“It is common in Chinese corporations, particularly those with state ownership, for the most senior party official at the corporation to be running the corporation,” says Bank of Jilin’s Zhang. At Jilin JiuTai Bank, chairman Gao agrees. “The main leaders in China’s banks must be Communist Party members. I have been chairman for nine years. I have been in the party for more than 20 years.”

Asked which institution, the bank or the party, takes precedence in prestige and managerial attention, Jilin JiuTai’s Gao is in no doubt. “Without the Communist Party in power, such a big country as China would be in chaos.”

Changchun’s auto industry might be famous for producing the Hongqi sedan but it’s a different type of red flag that worries foreign investors in China’s regional banks. 

A report last year by the Hong Kong-based banking research department of UBS analyzed more than 700 Chinese banks and estimated that a staggering Rmb4.5 trillion ($660 billion) in bad loans may need to be refinanced or cancelled “to bring asset quality down to a manageable level”.

That might explain why more and more regional banks controlled by provincial or city authorities such as Bank of Jilin and Jilin JiuTai Bank, are exploring public listings in Hong Kong or on China’s stock exchanges to raise much-needed capital and help get balance sheets in order.

But getting them to market is quite another thing, thanks in part to concerns in markets like Hong Kong about the quality of the prospective listings.

Created from a collection of city cooperatives, Bank of Jilin is the bigger of the two Changchun-based banks, with its 11 subsidiary banks; one in each of Jilin province’s nine municipalities and two in the province’s neighbouring cities of Dalian and Shenyang. Some 486 branches span 60 counties across the northeast, with 10,000 employees, making it one of Changchun’s bigger employers – though a far cry from the 150,000 who toil at FAW-VW. Zhang says the bank has assets of Rmb425 billion ($62.6 billion), with calendar net profit coming in just shy of Rmb3 billion.

Seoul-based Hana Financial Group, one of South Korea’s biggest banking and finance houses, bought an 18% stake in Bank of Jilin in 2010, earning it two seats on the board and a deputy general manager, who answers to chairman Zhang. Hana might be Bank of Jilin’s biggest single shareholder, Zhang says, but as he also points out, Bank of Jilin remains very much a Chinese official entity. He says 46% of its shares are in the hands of various arms of Jilin’s provincial and Changchun city administrations.

As its name suggests, Jilin JiuTai Rural Commercial Bank is agriculture-based, a collection of rural cooperatives and credit unions that served the region’s farmers and cropholders growing mostly corn and sorghum. China’s agricultural sector is going through structural change and land reform as old communist collectives are transformed into corporations designed to compete in global markets.

“Our customers are changing from individual farmers and smallholders to small and medium-sized enterprises and corporations,” says chairman Gao. “Now, our customers are enterprises.”

Unlike his counterpart Zhang at Bank of Jilin, who boasts degrees in economics, philosophy and law, Jilin JiuTai’s chairman Gao rose through the ranks of one of the rural cooperatives. “I don’t have a degree but I do have the practical experience,” he says.

Today, he bestrides a bank that’s listed on the Hong Kong stock exchange, which he says has assets of Rmb191.4 billion and 2016 profits of Rmb1.89 billion. Jilin JiuTai Bank has 335 branches of its own across Jilin and Heilongjiang provinces, with varying degrees of control over 32 subsidiaries elsewhere in China.

Though dominating the local banking scene, and with their tentacles reaching deep into government, Bank of Jilin and Jilin JiuTai Bank are about to get some private-sector competition in Changchun.

In May, a new outfit called Yillion Bank opened to service the SME sector. It follows an initiative by the China Banking Regulatory Commission, or CBRC, to widen the number of privately owned banks in China, now tallied at 17, according to the official People’s Daily, but with only nine in actual operation.

Still, it’s the state that matters in this part of China. And the managers of the state-owned companies that dominate China’s northeastern economy, like FAW and the banks that service it, place great store on yiqi, which broadly translates as ‘together’. In practice, it describes a fraternity of common experience: in such a tough place as the northeast, people share the same lot. But it also describes a mutual backscratching bond between state officials and industry leaders, whose jobs are often interchangeable.

The notion of yiqi links flows to higher centres of power. As many locals of China’s three main northeastern provinces bordering Russia and volatile North Korea – Jilin, Heilongjiang and Liaoning – are quick to point out, current Chinese premier Li Keqiang, an economist, was party secretary for Liaoning during the mid-2000s.

The marriage of politicians and financiers has repeatedly proved disastrous in banking systems elsewhere – the recent travails of Spain, Indonesia and Italy spring immediately to mind. But in a China trying to stabilize its chaotic financial sector, such bureaucratic shortcuts from the ruling Beijing centre direct to provincial party hacks who actually run the banks may help in fixing the system. And all the more so as China’s anti-corruption officials steadily pick off officials who have got a little too rich a little too quickly.

It is evident, at least in their rhetoric, at both Jilin banks. Both chairmen say they are busy enacting directives handed down from Beijing’s banking regulators, notably from the central People’s Bank of China and the CBRC, run since January by ex-PBoC high-flyer Guo Shuqing, who also hails from China’s tough north.

At the Bank of Jilin, chairman Zhang admits the bank is undergoing what might be described as an internal stress test. “We are now subject to stricter regulatory controls from the CBRC,” he says. Jilin JiuTai Bank’s chairman Gao has also got the same memos from Beijing. “With General Secretary Xi Jinping, our trends are clear,” he says. “We know what is going to happen.”

Says Bank of Jilin’s Zhang: “We know the banking system is undergoing a process of standardization, and we are no exception. We are restructuring and re-adjusting to address and rectify the non-compliances.” Zhang admits that in the past, “we did what we called off-the-book business. But now, according to CRBC requirements, we have had to shift all this off-book business onto the books. This has put pressure on us in terms of capital.”

Zhang says adjustments from these “self-checks” and “self-audits” will affect about 30% of Bank of Jilin’s assets. “We are also required to make bigger provisions,” he says. “We are making sure our procedures and books are in line with the more rigorous signals coming from the CBRC.”

It’s a similar message from chairman Gao at Jilin JiuTai Bank, whose prospectus filed in Hong Kong last year revealed it too had kept at least 20% of its business off balance sheet. “With MPAs (macro prudential assessment), everything should be regarded as on the books,” Gao says, describing the CBRC directives as like a “medical check-up to check your diseases.”

As Gao puts it: “If you have a disease, you have to go to a hospital to get cured. If you suffer from a cold, you need to get some medicine. Or maybe you just need to exercise more, to get in good shape.”

Jilin JiuTai listed in Hong Kong in January, becoming only the second mainland provincial lender to do so, seven years after Chongqing Rural Commercial Bank went public in Hong Kong. The Chongqing bank IPO was then expected to prompt a rush of China’s promising regional banks into the market, except that didn’t happen. Chongqing Rural Commercial Bank shares were priced at HK$5.25 ($0.67) in its IPO in December 2010. Almost seven years on, the stock was trading at around HK$5.20 in early June, having peaked at around HK$7 in early 2015.

Similarly, the Jilin JiuTai listing seven years later doesn’t auger well for the reception of any Chinese provincial banks aiming to list in Hong Kong.

JiuTai’s arrival on the market last January has also been unremarkable, at best. The issue was oversubscribed by just 9%, and raised $335 million, or well under the $500 million that JiuTai had hoped for when it first sounded out the listing last year. JiuTai tried to sweeten the lukewarm investor response to its IPO by promising to distribute at least 40% of its profits as dividends in 2017/18.

Analysts fretted about Jilin JiuTai’s possible exposure to shadow banking and rising bad loans. The investor mood wasn’t helped by Jilin JiuTai’s prospectus admission that though it boasted a widespread network of associated banks across Jilin province, “the bank cannot assure you that the subsidiary banks will always operate their businesses in the way expected.” The shares were priced at HK$4.56 in the IPO, at the lower end of its expected range. In the six months of trading since, the stock has risen from HK$4.56 to a becalmed HK$4.89 in early June.

It also hasn’t helped matters that analysts’ fears about Jilin JiuTai’s questionable relationships and exposures have come to pass. In March, it was revealed that Jilin JiuTai had a Rmb1.35 billion loan to China Huishan Dairy Holdings, a debt-troubled dairy products group also based in China’s northeast that has experienced one of the more spectacular implosions of a Hong Kong-listed Chinese company.

When news broke in March that Huishan was struggling to renegotiate debts of much as $6 billion and had defaulted on a $200 million loan, its Hong Kong-listed shares collapsed by 85%, one of the biggest single-day falls in the Hong Kong stock exchange’s history.

It also emerged that Huishan’s embattled chairman Yang Kai, once regarded as the richest man in China’s northeast with a fortune calculated at $3.7 billion, had been progressively offloading his 16% holding in JiuTai Bank through March, while at the time his various creditors, who were collectively owed $6 billion, moved to freeze Huishan assets. 

Both Yang and Huishan have denied any wrongdoing, according to media reports. However, the crisis has hurt Jilin JiuTai: on March 27, the bank’s shares sank 9%.

Despite fraud allegations swirling around Huishan’s senior management, Jilin JiuTai’s chairman Gao outwardly seems untroubled by the drama. He confirms to Asiamoney Huishan has outstanding loans with his bank, which he describes as normal business practices.

“I don’t call it trouble. He (Yang Kai) has very little shares now. They are our customer. I don’t believe the Huishan loan will have any risk,” Gao says.

He acknowledges that some of the Huishan stock that Yang had deployed as loan collateral had been “confiscated” by his creditors. But the Huishan matter has been exaggerated, hyped up by the media, Gao insists. “For us it is normal business, so we are a little bit uncomfortable with this scrutiny by the media.”

Gao says Jilin JiuTai Bank listed in Hong Kong to help improve management and to bring the bank into line with international governance and disclosure standards. But going public in Hong Kong has been a double-edged sword, he says. He laments that the extra bureaucracy and paperwork have “slowed down our development.”

With China’s provincial banks in need of capital while under the regulatory hammer from Beijing, would Gao recommend a public listing to his fellow rural bankers? “I would say: ‘Don’t go public unless you are fully prepared for it’,” he says.

The tepid reception given to Jilin JiuTai Bank in Hong Kong may have also affected Bank of Jilin. Chairman Zhang tells Asiamoney that the bank had made preparations to go public in Hong Kong last year, as Jilin JiuTai Bank was also scoping out the market.

“But the prospective valuation was not encouraging or attractive,” Zhang says. Now, Bank of Jilin is contemplating a listing on the Shenzhen stock exchange instead, which Zhang hopes will happen by 2018. “It doesn’t really make any difference to our bank where our shares are traded,” he says.

As for shadow banking, the practice of lending by unregulated institutions or under unregulated conditions, Jilin JiuTai’s Gao says his bank is innocent. Asked what he understands the term to mean, he sees a foreign bogey. “I understand it to be activities beyond the banking system. I believe it is a European term,” he says.

“We’ve learned a lot from Wall Street, from the American sub-prime crisis; we’ve learned about the technologies and the methodologies to develop business beyond our banking system. This is called liberalization.”

Bank of Jilin’s Zhang also says foreigners are responsible for shadow banking. He blames “overseas non-financial institutions dealing with Chinese institutions under the table. To me, it means under-the-table transactions, illegal transactions between foreign capital, non-financial institutions and unregistered organizations in China. It’s illegal banking.

“I don’t think we have such a thing. In banks like ours it does not exist.”

Jilin JiuTai’s Gao says that the shadow-banking crisis could be solved, or at least “corrected,” if state restrictions on venture capital were lifted.

“In China, the venture capital market is not very developed,” he says, pointing out that Jack Ma of Alibaba fame, one of China’s richest men, would not have been able to get a start-up credit line from a Chinese bank because he lacked collateral when starting his business.

“He would not be able to get a loan from a Chinese bank. He would not get any loan from any bank in China.”

Chairman Gao says shadow banking flourishes in China “because some of the small and medium-sized companies are not up to the standards that official banks require to provide loans.”

China is trying to rectify this problem, he says. “I think the space for the shadow banks to manoeuvre will become smaller and smaller in the future.”

Bank of Jilin’s Zhang doesn’t see any scope for consolidation among China’s myriad regional and provincial banks. Though it is legally possible for Chinese banks to buy each other, Zhang says none of the big state-owned national banks are interested in acquiring provincial and regional banks. Nor is he a buyer of banks elsewhere. 

“In the future, we will be going back to where we were, focusing on our main services,” he says. “Because of the CBRC, we have to be conservative right now.”