Two weeks after veteran regulator Liu Rong arrived in central Henan province, plainclothes security officials clashed with hundreds of protesters outside a local branch of the People’s Bank of China.
Protesters were desperate to recover about 40 billion Rmb ($5.9 billion) in frozen deposits from four rural banks. Beijing’s deployment of Liu, a veteran of Chinese banking regulation, suggested the central government wanted a quick resolution to the dispute.
A day after the rare outbreak of public dissent on July 10, Liu’s team doused the flames of the unrest by promising to refund the funds protesters had lost to fraud, but wider damage had already been done .
The protests in Henan drew national attention, in part because local officials tampered with the personal health applications of more than 1,000 depositors to suggest they were at high risk for Covid-19 and prevent them from protesting. Five officials linked to the case have been fired or demoted.
While bank deposits should be the safest assets in any financial system, the Henan case, which also involves a bank in Anhui province, has raised concerns about lax regulation of the country’s huge rural banking sector. China and has exposed the loopholes in the country’s deposit insurance system.
The problems at rural banks, while not considered a systemic financial risk in themselves, have added pressure on an economy reeling from Covid-19, a years-long housing slump and a broader slowdown in growth.
“We are not concerned about Henan’s rural banks per se,” Citigroup analysts said. “However, the situation could worsen if the public started to worry about other banks, particularly some larger financial institutions.”
A run on the banks began in April after local police opened an investigation into privately owned Henan New Fortune, the largest shareholder of the four institutions. They accused a criminal gang led by Lu Yi, owner of Henan New Fortune, of defrauding banks by forging loans and illegally transferring funds.
On July 11, the China Banking and Insurance Regulatory Commission pledged to start paying individual investors with savings of up to Rmb500,000 ($74,000). This will cost about Rmb20 billion, according to S&P Global Ratings.
The bank operates in Henan province
Plainclothes security officials clash with protesters outside a People’s Bank of China branch in Zhengzhou, Henan province © Reuters
April 18
Yuzhou Xinminsheng Village Bank, Shangcai Huimin County Bank, Zhecheng Huanghuai Community Bank and New Oriental Country Bank of Kaifeng Discontinue Online Cash Withdrawals
April 19
Local police open a case against Henan New Fortune Group, the largest shareholder of the four banks, for fraudulent management practices
June 13
Depositors find their Henan health code turned red, making them unable to protest
June 30
Liu Rong, a former top banking watchdog, is taking charge of Henan’s financial regulation work
July 10
A protest by depositors in front of the local central bank turns into violent clashes
July 11
Henan authorities release initial repayment plan for depositors
July 20
The bank watchdog has pledged to start a second round of refunds next week
Regulators hope their approach will appease the vast majority of smaller depositors. The initial payments will come from recovered criminal funds, regulators said, but it is not yet clear how the larger accounts will be paid or who will collect the final check.
Harry Hu, senior director at S&P Global Ratings, said how regulators resolve the case will have a “profound impact” as an example for other local governments and struggling borrowers.
Many people had deposited less than Rmb500,000 in each bank to ensure their savings were protected by the country’s deposit insurance scheme. However, this scheme has limited reserves compared to other countries, and the Chinese authorities have so far been unclear about the classification of the lost money; if they feel they were stolen by fraud, the insurance may not apply.
“Since the nature of the missing funds is still unclear at this stage, it is not certain that the deposit protection scheme will be triggered,” Hu said.
In the wake of the Henan protests, China’s central banks have downplayed the idea of a wider threat to the financial system. “Financial risks are largely under control and 99 percent of our bank assets are within a safe range,” said Sun Tianqi, head of the PBoC’s financial stability office.
Still, PBoC officials have also said rural banks remain the most stressed in the country, accounting for a third of the 316 institutions deemed “high risk” to their financial health.
For the past three years, they have been scrutinizing small banks and their shareholders, focusing on the banks’ lending to their own investors, a practice reminiscent of the U.S. savings and loan crisis of the 1980s.
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Since 2019, the CBIRC has been “naming and shaming” unscrupulous bank owners, leading to a series of mergers in weak regions such as Shanxi and Liaoning, as part of its bid to improve regional bank governance.
However, the resurgence of fraud in rural banking has left a question mark over the complicity of local regulators and whether the CBIRC has done enough to insulate the system from widespread moral hazard during an economic downturn.
Instead, Beijing is accelerating the issuance of special local government bonds to inject capital into smaller banks. A Rmb103 billion share of these bonds was issued in Liaoning, Gansu and Henan provinces, as well as Dalian city, in the first half of 2022. The banking watchdog has said that they will issue more bonds in August.
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