The banking liquidity crisis in China seriously escalated, spreading from bank to bank and province to province. Now, not only in rural banks in Henan Province, but customers in many other provinces suddenly could not withdraw money from their accounts. The debt bomb has grown, smoldering for decades, seems to be nearing a critical level.

As reported, on July 10, about 3,000 customers in Henan Province were surrounded by police and “unknown” people (suspected to be underground police) while protesting to reclaim their money. They were brutally beaten shocking the world.

Some observers say such actions show that authorities seem powerless, like they have been cornered into dealing with the bank liquidity crisis. In other words, the banks no longer have enough money or financial tools to handle the spreading bank liquidity crisis.

The debt bomb spreads right across the country

Chinese media revealed that victims appeared in all provinces and cities across the country. Usually, deposits are raised through internet advertising, savings are deposited by bank transfers with great ease. When banks are insolvent, they cut off online services, and customers are forced to go all the way to Henan to withdraw money. The COVID-19 monitoring software system was programmed, automatically turning on the “dangerous,” “red warning” mode to force people not to leave their homes to withdraw money. At the same time, Henan Provincial Bank is also not open and does not offer direct cash withdrawal at the counter.

If this situation happened in another country, the bank would have gone bankrupt overnight. But in China, where there is no market economy, things are very different.

Sanlian Life Weekly quoted He Ping, a professor at Renmin University’s School of Finance, as saying that local banks have charged interest rates to the top of the floating range to attract deposits. But most of the businesses that this bank lends to, are not making money in the tight economy—the real estate market is collapsing, production is strictly blocked because of the zero COVID policy. So since the business are not repaying loans the bank does not have enough money to repay the debt to the depositors.

Sina Finance said that since April 18, five rural banks have not been able to allow withdrawals online. Hundreds of thousands of banking customers across the country have been affected, involving huge amounts of money. China Times, a Chinese media outlet, reported that some people who opened accounts at Hainan Industrial and Commercial Bank recently found their accounts frozen and were unable to withdraw, transfer, or make bill payments. Recently, Shanghai residents complained that ATMs at some Shanghai banks have limited deposit and withdrawal functions. Some managers of the banks said that the ATM function had been removed for pandemic prevention requirements, but customers doubted this statement.

Spreading from small to big banks

The Nikkei newspaper on July 17 quoted Pei Minxin, a professor at Claremont McKenna College, in the United States. He said that the incident in Henan showed that China’s debt bomb was about to explode. Investors should prepare for worse prospects in the Chinese banking industry.

Pei pointed out that China’s banking system has relied charging exorbitant interest rates on money lent since 2009 to stimulate economic growth. Currently, the debt-to-gross domestic product (GDP) ratio is as high as 264%. Rural banks in Henan lack supervision, have poor risk management and are plagued by corruption, while nearly 4,000 small and medium-sized Chinese banks with about $14 trillion in assets also face similar systemic risks.

The article warns that if a large number of small banks fail together, there could be a chain reaction that shakes the financial industry. This chain reaction will especially affect large banks as depositors’ confidence in the system has been severely reduced.

In addition, small banks often attract deposits through high interest rates. This negatively impacts the number and amounts of deposits at large commercial banks. The race in deposit interest rates could cause capital costs to skyrocket, choke economic growth, and increase bad debt and liquidity risks of the commercial banking system across China.

China’s large banks are also trapped in debt from the Belt and Road Initiative (BRI).

Large commercial banks provide loans in the tens of billions of dollars to poor countries under Beijing’s BRI framework; which is a debt trap that China has set up to annex developing economies. However, the global recession leaves borrowers unable to repay their loans, with much of their credit portfolios likely to turn into bad loans; a recent example is the collapse of Sri Lanka. The country went bankrupt under Chinese debt and is asking China to forgive most of its loans.

Large commercial banks in China are facing an intolerable collapse of the real estate market. According to Bloomberg, Chinese real estate businesses have defaulted on $1 trillion abroad. This data is also consistent with the statistics from Cbonds. Forty percent of China’s USD-denominated real estate bonds have defaulted (officially or technically), the total value of China’s foreign-issued corporate bond market is currently $3.12 billion.

In addition, the Fed is raising interest rates and the dollar is appreciating the most in several decades, causing money to flee Beijing. According to the Institute of International Finance, “money flows out of China were at record levels in the first quarter of 2022.”

Bankrupt at China’s banks is unstoppable. The extent of the breakdown and its harmful effects are extremely unpredictable.

Local government bond default: The detonator has been activated

Unlike other economies, local commercial banks in China are not independent of the government. In essence, local commercial banks are under the direction and are subordinates of the local government.

In order to have/acquire finance infrastructure investments to follow the economic growth target determined by the central government, local governments try to issue special local government bonds. This issue does not need to be included in government debt or national debt.

And then, it is the local government that asks the commercial banks to buy the debt for them. To pay off the debt, the government sells land to real estate developers. But when the real estate market collapsed, real estate developers became indebted around the world and were unable to sell properties and pay their debts, and local governments also lost revenue from land, lost the source of money to pay bond debt to local commercial banks.

As a result, depositors all over China lost their money. And those depositing money in Henan are only the first victims. This situation is continuing to spread to other areas, so chaos and violence will continue in China, and even escalate… That’s when the detonator of the Chinese debt bomb will be activated.

Now, the reality is that Chinese consumers and businesses are the most indebted in the world, and the growth rate is slowing rapidly. There is no simple way out of this situation. The era of using rapid growth to solve problems is over. The debt bomb, once activated, will quickly spread from small banks to large banks, possibly toppling the entire Chinese financial system.

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