“The Bank of China industry can easily fall into an obsession with growth. However, an excessive pursuit of scale often leads to very serious consequences, such as massive losses, and even teetering on the brink of bankruptcy.” A vice president in charge of risk control at a major bank commented on the current banking industry, where the risks of local financing platforms and real estate loans are gradually surfacing, while smaller banks with high exposure and very tight liquidity are under the most pressure.
“Weak liquidity is an inherent flaw of banks because the mismatch of terms between short-term deposits and long-term loans means that depositors can withdraw at any time, but loan recoveries have a certain timeframe. An excessively high loan-to-deposit ratio can easily lead to a liquidity collapse.” he said. The daily average loan-to-deposit ratio assessment implemented since June has become the biggest challenge for some small banks, and the various deposit wars that have erupted to increase deposits and lower the excessively high loan-to-deposit ratio have become a continuous topic of discussion in the industry.
Before the worst happens, what should regulatory authorities do? Caixin's 《New Century》 learned that the drafting work for the “Banking Financial Institutions Bankruptcy Regulations” (hereinafter referred to as the “Regulations”) has recently been restarted, led by the China Banking Regulatory Commission, with the central bank participating in the drafting.
Relevant officials from the China Banking Regulatory Commission revealed that they are currently conducting preliminary feasibility studies by referencing the bankruptcy situations of banks in other countries and related advanced legal systems, including some framework principles and provisions, and it is still early to widely solicit opinions from various departments, “it is still in the preliminary stage.”
The previous round of drafting for the “Regulations” stalled in 2009, “the reason was the outbreak of the international financial crisis. The “Regulations” were included in the “State Council's 2011 Legislative Work Plan” at the beginning of this year, but when they will be released, and whether they will be launched simultaneously with the deposit insurance regulations, there is still no timetable, it depends on the arrangements of the State Council.” the aforementioned official stated.
“During the changes in the economic cycle, commercial banks often become the concentrated absorbers of various losses.” the aforementioned bank executive believes.
Data from the U.S. FDIC indicates that in 2010, a total of 157 banks in the U.S. went bankrupt, up from 140 in 2009, setting a record high since 1992. The root cause is that during the rapid economic development, too much risk was taken on and problems accumulated. While reflecting on this, the Chinese banking industry also needs to learn from its effective market exit mechanisms and establish a bankruptcy legal system for financial institutions.
Ambiguous System
China has yet to legislate specifically for bank bankruptcy. Although the “Enterprise Bankruptcy Law” revised in 2007 has provided a legal framework for the elimination of enterprises in market competition, financial institutions are not included. The State Council has clarified that separate regulations will be made for the bankruptcy of financial institutions, but the formulation of the “Banking Financial Institutions Bankruptcy Regulations” is still very slow.
A person involved in the drafting of the “Enterprise Bankruptcy Law” revealed to Caixin's 《New Century》 that the bankruptcy of financial institutions still needs to follow the “Enterprise Bankruptcy Law,” with only some differences in certain aspects.
He emphasized that this “Regulations” is indeed very difficult to formulate, as it involves a wide range of issues. If not handled properly, it may cause a chain reaction and even systemic risks. For example, banking financial institutions cannot easily apply for bankruptcy due to inability to repay debts, “the bankruptcy process must be approached with caution; sometimes even a slight disturbance or market rumor can trigger risks such as bank runs.”
The aforementioned CBRC official introduced that there are still differences among parties on some important issues involved in the “Regulations,” such as who will serve as the bankruptcy administrator and who will take over after the bankruptcy of financial institutions. It is usually supposed to be taken over by the competent authority, but there are also suggestions that it could be handled by the Central Huijin Investment Ltd. and others.
Since joining the WTO and the establishment of the CBRC, China's legislative bodies and government departments have increasingly emphasized the market access and ongoing supervision of banks. However, there have been few substantial changes in the legal aspects of market exit. In reality, some local banks, especially rural credit cooperatives, are on the verge of bankruptcy due to poor management. Currently, there are nearly 3,000 rural credit cooperatives, with only a few hundred in relatively good operating conditions, less than one-tenth of the total.
At present, China has established a relatively mature banking regulatory standard that is applicable to international rules, but how to establish a long-term mechanism for the market exit of financial institutions suitable for China's national conditions is very urgent.
“If the market cannot even be found, how can we talk about a market exit mechanism?” said a senior researcher in the banking industry.
In practice, the Chinese government always handles the issue of bank delisting on a case-by-case basis, discussing each matter individually. Many insolvent banks are often rescued through administrative means, lacking corresponding legal guidance. Typically, in addition to regulatory agencies, local governments also participate in the rescue of troubled banks. Due to concerns about social stability, governments at all levels have been reluctant to allow failing banks to exit the market through bankruptcy procedures.
How to Exit
Due to the lack of a legal framework and judicial system, as well as a supporting regulatory framework, the liquidation and restructuring process of troubled banks is very lengthy and extremely inefficient. The first commercial bank in China's financial history to be administratively closed, Hainan Development Bank, has been in the liquidation process for 13 years and has yet to implement bankruptcy procedures.
“Once the ‘Regulations’ are issued, Hainan Development Bank should be able to enter the liquidation process.” said the aforementioned CBRC personnel.
At the end of 2010, CBRC Vice Chairman Wang Zhaoxing wrote that it is currently necessary for the regulatory authorities to establish mechanisms to control the occurrence of moral hazards in banks, allowing small banks to close and go bankrupt, while large banks can exit the market smoothly. Wang Zhaoxing has publicly expressed similar views twice, and the industry believes this indicates that the regulatory authorities are considering no longer “protecting the weak.”
A lawyer in the industry pointed out that whether in the “Commercial Bank Law” or the “Regulations on the Management of Capital Adequacy of Commercial Banks,” the wording used when taking measures against banks in crisis is “may” rather than “should,” “regulators have a large degree of discretion.”
The regulations regarding bank bankruptcy are scattered across different laws and regulations. The relevant bankruptcy provisions of the “Company Law” and “Civil Procedure Law” also apply to banks. The “Commercial Bank Law,” “Banking Supervision and Administration Law,” and “People's Bank Law” all contain provisions regarding bank delisting. In addition, relevant regulations and departmental rules, such as the “Regulations on the Revocation of Financial Institutions” and the “Regulations on the Management of Capital Adequacy of Commercial Banks,” also constrain the issue of banks exiting the market due to bankruptcy. However, in the aforementioned regulations, the triggering standards for regulatory agencies to take action are not clear.
For example, according to the provisions of the “Commercial Bank Law”: when a commercial bank has or may have a credit crisis that severely affects the interests of depositors, the State Council's banking regulatory authority may take over the bank. However, the law does not define the term “credit crisis,” and the specific standards under which regulators will take action are not clear. Article 5 of the “Regulations on the Revocation of Financial Institutions” states: If a financial institution engages in illegal or irregular operations, or poor management, and not revoking it will seriously harm financial order and damage the public interest, it should be revoked in accordance with the law. Both of these provisions do not clearly distinguish the conditions for closing a bank from those for taking over a bank.
The “Regulations on the Management of Capital Adequacy of Commercial Banks” formulated in 2004 drew on the “Prompt Corrective Actions” in the U.S. “Federal Deposit Insurance Corporation Improvement Act,” using capital adequacy as a measure of regulatory insolvency. For banks with a capital adequacy ratio below 4% or a core capital adequacy ratio below 2%, the CBRC can require the bank to adjust its senior management; or take over the bank according to the law or facilitate institutional restructuring, up to revocation.
In China's financial industry, so far, only two securities companies (Dapeng Securities and Southern Securities) and one trust investment company (Guangdong International Investment Trust Company) have been resolved through judicial bankruptcy procedures. There has yet to be a precedent for bank bankruptcy.
Regarding why the market exit efficiency for dealing with troubled banks is so low, Wang Jun, chief financial expert of the World Bank's East Asia and Pacific Financial Development Bureau, pointed out that currently, the regulatory authorities follow a “whoever's child, whoever holds” approach to dealing with troubled banks, “this can only be a stopgap measure, making it difficult to achieve efficient and low-cost restructuring of troubled banks.”
It is worth noting that, as an industry expert pointed out, the closure of Hainan Development Bank was due to previous unsuccessful financial institution rescues, which were of a “forced match” nature. Typically, the government encourages and assists healthy banks in acquiring poorly managed financial institutions, but even so, relevant mergers should comply with market rules, “however, the case of Hainan Development Bank was not like that.”
At the end of 1997, under the directives of local governments and banking regulatory agencies, the Hainan Development Bank, which was itself not healthy, acquired 28 local rural credit cooperatives, most of which were insolvent and poorly managed, thus falling into a predicament and ultimately triggering a payment crisis.
This expert pointed out that on one hand, this is a legacy issue of the state-owned bank system, and on the other hand, it reflects the inadequacies of the existing bank market exit system.
Zeng Gang, director of the Banking Research Office of the Financial Research Institute of the Chinese Academy of Social Sciences, stated that China has not yet had a single explicit bankruptcy event, but over the past decade, more than 80% of banks in China have undergone thorough financial restructuring, with the scale of restructuring exceeding that of any other country in the world.
“Before the financial restructuring and reform listing of the four major state-owned banks, it could technically be said that they should have gone bankrupt, but they did not operate under the name of bankruptcy; instead, they underwent financial restructuring. Now we should summarize and standardize the previous practices to establish a long-term mechanism.” Zeng Gang told Caixin's 《New Century》 reporter.
Controversies Remain
The aforementioned official introduced that as early as 2007, the CBRC had initiated the drafting of the “Regulations,” but the financial crisis that broke out in 2009 had a significant impact on the initial draft of the “Regulations,” especially the negative effects brought about by the bankruptcy of Lehman Brothers, which forced the drafters to change their original intentions, aiming to avoid the bankruptcy of commercial banks as much as possible, primarily through administrative-led takeovers to guide bank restructuring, “the work is still at the preliminary stage of demonstrating feasibility and coordinating with the corresponding judicial bankruptcy restructuring.”
Wang Jun believes that the goal of establishing a bankruptcy system is to minimize bankruptcies as much as possible, but when it becomes absolutely necessary, there should be no hesitation. “If bankruptcy cannot occur, the moral hazard of banks will be too severe, and the number of banks that truly need to go bankrupt (dead bank working) will increase.”
Informed sources who participated in the drafting discussions revealed that there were significant disputes among the parties on three important issues: first, the establishment of a deposit insurance system is considered a parallel condition for the “Regulations.” Caixin's 《New Century》 reporter learned that the central bank has begun to cooperate with the CBRC to formulate regulations regarding the deposit insurance system, and the weakest rural credit cooperatives in the financial industry will all be included in the deposit insurance system. In 2010, the central bank submitted the plan for the deposit insurance mechanism to the State Council, but there is still no timetable for when it will be launched.
Second, there is the issue of the interrelation between regulatory actions and the final bankruptcy legal procedures, specifically, who will assume the role of bankruptcy administrator? In most cases, the bankruptcy procedures of banks are initiated and managed by banking regulators, and one of the main measures in the pre-liquidation phase is to replace the existing management. Bank bankruptcies can often be divided into pre-liquidation and liquidation phases, and as a regulatory authority, it is argued that regulatory actions should be placed within this framework—during the pre-liquidation phase, regulatory agencies will rescue banks through various measures. Only when rescue is hopeless will the bankrupt bank enter liquidation. At this stage, the law should clearly specify the standards for regulatory agencies to take action and the rescue measures that can be taken, limiting their discretion to avoid regulatory leniency; while in the liquidation phase, the powers of regulatory agencies should be clearly defined. However, there are also viewpoints arguing that regulatory intervention is not needed in the bankruptcy process, as regulation itself has been stipulated in the “Commercial Bank Law.”
Furthermore, the bankruptcy standards are very difficult to define. In 2010, CBRC Vice Chairman Cai Esheng publicly stated that there was significant controversy over the bankruptcy standards during the formulation of the bank bankruptcy regulations. He believes that typically, when a bank's liquidity issues arise, making it unable to pay due debts and affecting society, measures need to be taken immediately. However, quantifying these conditions in the regulations and expressing them in written form, especially as statutory standards, remains quite challenging.
Countries like the UK, which have experienced the international financial crisis, mainly adopt separate legislation and formulate corresponding regulations specifically for bank bankruptcy. Financial experts point out that the bankruptcy systems of various countries have some basic characteristics, one of which is that as financial enterprises, they try to follow creditor procedures when undergoing bankruptcy restructuring or integration, rather than re-integrating under the guise of bankruptcy restructuring.
Cai Esheng believes that the formulation of China's bank bankruptcy procedures faces several important issues: first, how regulatory authorities can prevent systemic risks across the entire system and reasonably intervene in the legal procedures for the bankruptcy of enterprises or institutions, especially in handling the bankruptcy of large enterprises or institutions. Second, the issue of intervention by the takeover layer. There is significant debate over whether the takeover actions should be related to the bankruptcy procedures of enterprises or institutions in the law. Third, due to the involvement of many departments in the bankruptcy restructuring of banks and financial institutions, there remains the issue of who will lead and coordinate the cooperation among these departments. He believes that currently, it is uncertain who will lead, and it requires cooperation among multiple departments, but the order of cooperation also needs to be resolved.
Wang Jun pointed out that the technical difficulties can all be resolved; the key is how to clarify the responsibilities for bank bankruptcy, namely, who will bear the losses and how to achieve credible implementation. “This involves the governance structure of the government, namely, the government's positioning in this bankruptcy mechanism. In the past, without a bank bankruptcy mechanism, the government ultimately bore the costs.”