We might never know the context in which the Chinese government took over the Baoshang Bank given the opaque nature of China’s financial system and the controversial nature of some of the story’s elements. But it is worth considering the case to try to get a sense of whether it is an exception or a reflection of an endemic problem within the system.

On May 24th, China’s top financial regulators, the People’s Bank of China (PBoC) and the China Banking and Insurance Regulatory Commission, jointly announced that they would take over the management of Baoshang Bank for a period of one year because of its serious “credit risk.” The news sent frantic waves through global financial circles over what the implications were for China’s banking system.

It was the first such case in China since 1998 and it took place against the backdrop of rising defaults, growing debt burdens and a slowing economy. The privately-owned bank had RMB 576 billion ($83 billion) in assets at the time of the takeover, said financial market data provider Refinitiv. Baoshang Bank had not filed on its assets and liabilities since 2016 and the last report showed the bank had a total of RMB 156.5 billion in outstanding loans, a 65% jump from the end of 2014.

The main concern of the markets was whether or not Baoshang’s problems were reflective of wider problems among smaller regional banks across the country.

The theories

Media and analysts discussed whether or not the case of Baoshang Bank was a one-off instance. But a more pessimistic view of the crisis would be suggested by what Barclays has called the RMB 4.47 trillion “blind spot” in the country’s financial reporting by smaller city and rural commercial banks. There are 19 banks yet to publish 2018 financial results, including Baoshang Bank, a delay which could signal a potential build-up of non-performing loans. The delay has at the least left investors in the dark about the levels of bad debt these banks now hold.

The Baoshang Bank case is muddied further by the fact that the bank is partly owned by Tomorrow Holdings whose founder is Xiao Jianhua, the Chinese billionaire who vanished from a luxury Hong Kong hotel in early 2017. Xia was reportedly placed under graft investigation by Chinese authorities and his current situation is unknown. His involvement in the bank inevitably raised the question of whether or not that was factor in the takeover by the central bank and if it was meant to send a message of some sort.

Around the time of the takeover, Bank of Jinzhou, a small bank based in China’s northeastern Liaoning Province and another of the institutions yet to release 2018 results, fell into trouble when its auditor Ernst & Young resigned because they said they were unhappy with how the bank’s loans were being handled.

Fast forward

In response, the PBoC has assured the markets that it does not have plans to take over other institutions and that it is confident in maintaining financial stability. The central bank has also announced plans to resolve the Baoshang and Jinzhou problems. In mid-June, the China Bond Insurance Co., a state-owned credit insurance provider backed by the central bank, announced it would make up the balance of any certified deposits from the Jinzhou bank.

The central bank also transferred  98% of Baoshang’s corporate clients to an insurance fund management company, completing the first phase of the takeover in less than a month.

The markets have reacted positively to the steps taken by the PBoC and Interbank market interest rates have also indicated that the hype around the takeover has died down.

The current picture seems to align more with the theory of Baoshang Bank a one-off situation. But the markets are still going to be watching closely for further similar cases.

By Max Kaernfelt

President Xi Jinping announced in November 2018 that the Shanghai Stock Exchange will establish an innovation and technology equity board. No exact launch date appears to have been provided to the public. The new board represents a renewed attempt to turn stock markets into a catalyst for technological innovation. By improving smaller companies’ access to capital, the new board is intended to help put capital into the hands of companies who have promising new business models or technology.

Whether the tech board can help to effectively accomplish this goal is far from certain. Other tech boards previously launched have been underperforming the market for years. Characteristics of the market are unfavorable for the shares of smaller idiosyncratic firms, but recent developments address some of these problems. There is reason to be optimistic about the new board.

The new board could address several government goals at once

Recent documents related to the Made in China 2025 industrial upgrading plan highlight innovative businesses’ role in the future of the Chinese economy. Providing these companies with enough financial support and sharing their profits with the domestic market is becoming a policy priority. According to some reports China now has more unicorns than the US. But more favorable conditions outside the country often lead to these companies choosing to list abroad or in Hong Kong where most Chinese cannot benefit from their success.

The Chinese government likely hopes the board will also attract existing tech giants to list their shares there. Attempts to bring the shares of Chinese tech companies listed abroad such as Alibaba and Xiaomi home to the domestic market have been unsuccessful. A report co-authored by CICC states that the board is expected to attract a larger number of overseas stocks. As CICC is majority government owned the report’s predictions might give a window to the government’s hopes for the board.

Beijing has drafted special rules designed to make the board an attractive place for companies to list. The rules clearly favour start-ups. It allows companies which have not yet become profitable to list; the listing process will be faster; companies with weighted voting rights will be accepted (this corporate structure typically puts more power in the hands of founders); and more price movements are to be tolerated. Additionally, the launch of the board will likely be covered closely and favourably by the state media. This should lead to large amounts of capital being raised in the first round of IPOs.

Past attempts to use equity markets to spur innovation might give an idea of the life cycle of the new board

Shenzhen’s ChiNext tech board which was launched in 2010 had similar goals as the new tech board. Initially, ChiNext performed extremely well, between 2010 and 2015 the value of the index quadrupled. It then crashed and stabilized at a lower level. In recent years it has underperformed the market. The amount of capital raised has been declining, and the number of IPOs has likewise fallen.

ChiNext’s initial performance looked very much like a bubble, a common phenomenon in China’s financial markets (see a MERICS blog on the topic here). Once stock prices left bubble territory performance deteriorated. ChiNext has underperformed the Shanghai Stock Exchange since 2017. There is more than one likely reason why this is the case.

One problem faced by the kind of smaller firms which might list on a tech board is poor access to credit as state banks generally prefer lending to SOEs. This problem has been covered extensively (for example by me here). 

A lesser known problem is Stock Price Synchronicity, when stock prices move together. This phenomenon, caused primarily by a lack of reliable firm-specific information, is common in emerging markets. The most cited scientific study on the topic found that 80 percent of Chinese stocks move together in a given week (compared to 56 percent in the US).

This following example illustrates how this phenomenon can distort the market, and hurt the performance of companies with unique business models:

Imagine a skilled investor who is considering buying shares in a company which is developing industrial robots. Despite being very different from most listed companies the share price of this company will, because of stock price synchronicity, often move in a similar way. The investor would, however, still bear the risk of losing his entire investment. This could happen if, for example, it was discovered that company’s robots did not work, causing it to go out of business. While the returns are distorted, the risk of losing everything is the same. Under these circumstances the investor might decide to buy into a fund which tracks the market instead. The returns on his investment would often be similar, but without the risk of losing the whole investment.

Scale this example up to the whole market, and it becomes clear how stock price synchronicity can cause investors to systematically avoid risky stocks, contributing to them underperforming the market.

Reasons for optimism

Several developments make it likely the new board will perform better than ChiNext:

Firstly, as mentioned in the first part of this piece, new rules will improve the listing progress.

Secondly, increasing foreign investment can help address stock price synchronicity. Research shows that the stock price of companies with large degrees of foreign ownership is more closely related to fundamentals and less driven by the market.  This is likely because foreign ownership leads to a greater number of independent analysts covering the stock. China’s inclusion into the MSCI index and the establishment of the stock connect programs are examples of recent changes which will attract more foreign investment.

Finally, the government is pressuring banks to lend more to the private sector, this should also help the performance of stocks on the new board.

It would be surprising if Shanghai’s New Tech Board did not at least have a good start. Chinese investors have limited investment options, so the new board will be welcomed. Additionally, the government is guaranteed to lend a hand with promotion. At the very least a few impressive companies should make the board their home. However, there is a large risk that an initial stampede of investors could cause stock price overvaluations and subsequent crashes.

Max Karnfelt is an economic analyst at the Mercator Institute for China Studies (MERICS). Follow him on Twitter at @max_karnfelt.

By Maximilian Kärnfelt and Kristin Shi-Kupfer

Online finance platforms in China have come under pressure after a series of scandals ranging from defaults to frauds. In August 2018, police broke up a demonstration in Beijing organized by investors who had lost money invested in high-risk, high-return online finance platforms such as P2P lending and various wealth management products. It was not the first outbreak of social unrest in reaction to the lending practices of these providers.

Chinese policymakers are slowly waking up to the threat that the country’s widely unregulated online finance sector poses to the financial system – and to social stability. The scandals involving China’s risky online funds illustrate the difficulty of allowing market elements free reign in an otherwise highly regulated environment.

Valued at RMB 1.3 trillion (some 163 billion euros), China’s online finance sector has grown to become the world’s largest. China is also the home to the world’s largest money market fund, Alibaba’s Yu’e Bao. Between 2014 and 2018, the number of online financing platforms in the market grew from 651 to 1594, according to Online Lending House, a research group that tracks the industry.

The rapid growth of the sector has many causes. Online financial products often guarantee higher returns than the products offered by banks (see MERICS blog “A Financial Pressure Cooker”). They are also quickly gaining popularity in rural areas with limited access to banking services. The lack of alternatives led many in the middle class to invest enormous sums – only to find out later that the owners of these platforms embezzled or lost their money.

Government support helped spur the growth of the online finance sector

The Chinese government has supported fintech and online finance as future growth engines. The state banking system has been bad at financing smaller enterprises, something government officials often complained about publicly. The hope was that online financing vehicles would help improve the allocation of capital and generate funding for small and innovative businesses.

A famous example of implicit government support was the online fund Ezubao, which advertised on CCTV before the evening news and even held its annual meeting in the Great Hall of the People. The fund was eventually revealed to be a Ponzi scheme, which led to protests in 34 cities.

Further support has come through positive statements from government agencies. Both the State Council and what was then known as the Banking Regulatory Commission have, in the past, released statements supportive of online finance.

The case of the Ezubao fund was far from unique. According to the Financial Times, problems with 150 online lending platforms were reported this year in June alone, ranging from refusing withdrawals to police investigations of embezzlement. In some cases, the owners even disappeared. Throughout all of 2017 there had only been 217 similar cases.

Investors did not accurately assess risks

Many of the investors who lost their money in the online funds had not understood the risks they were taking. There are several likely reasons why Chinese investors misread risks in the online finance sector:

1. The Chinese growth miracle has lasted so long that many people have seen nothing but increasing economic prosperity for their entire lives. In that context, it is not difficult to see why many would believe claims of amazing investment opportunities.

2. The government’s active role in the economy leads to the expectation that financial products that are publicly sold (and in this case, officially endorsed) would be regulated. Victims of online finance fraud in China have expressed dismay over the fact that the government allowed these risky businesses practices.

3. Herd behavior is common in Chinese markets, partly because the rates offered by banks are so low that promising investment opportunities are in high demand. One example of such behavior was in 2015 when Chinese stock markets climbed quickly as investors rushed to buy stocks (this time also endorsed by the government), and the market subsequently crashed. A more bizarre example is from 2009, when the misconception that garlic could protect against infection with the swine flu spread quickly, resulting in large price increases as people rushed to buy garlic.

4. Online finance removes many middlemen, decreasing the distance between the buyer of financial products and the investments. This innovation means the typical investor takes a step towards the role of banker, requiring him to more actively assess risk.

Regulation will dry out funding for small businesses

In short, many investors lack the experience to assess the risks of online financial products, resulting in many losing their money, which in turn caused them to protest. The sector will now be strictly regulated. In a recent speech, an official from the Banking and Regulatory Commission, Fan Wenzhong, said that fintech had entered a high-risk era. Moreover, at the recent Financial Development and Stability Committee meeting, online finance was identified as one of four focal areas for risk prevention in the financial system.

Once online finance becomes more strictly regulated, many of the financial flows will dry out, depriving small businesses of the funding that the functioning parts of the sector would have generated. The problem of underfinanced smaller enterprises will likely persist until the next time innovation opens a new unregulated market, which the government may or may not initially support. If individuals were granted more opportunities to take on risk (including investments) outside the online sector perhaps that would train them to better assess risk – otherwise the events surrounding China’s online finance platforms are likely to repeat themselves.

Maximilian Kärnfelt is Economic Analyst and Kristin Shi-Kupfer is Director of the Research Area on Public Policy and Society at the Mercator Institute for China Studies (MERICS).

Murmurs of a property tax are once again rolling around Beijing, after local media reported that a comprehensive first draft of the plan will be up for national legislative review by the end of the year, citing official sources.

This latest report echoes comments made by policymakers earlier in the year. In March, the finance ministry also gave the year end as a preliminary deadline for a first draft of the law, and in July the National Bureau of Statistics said that it would “accelerate the property tax programme” to meet this deadline.  The property tax is also listed among the 69 top-priority items on the Politburo Standing Committee’s current five-year agenda.

Although each of these titbits of information has yet to deliver much detail, the tone seems to be clear: words will soon become action.

“Legislation first, full authorization, move forward step by step,” asserted finance minister Xiao Jie during the National People’s Congress.

The apparent momentum to sign in a property tax is the culmination of a campaign launched two years ago to get a hold of China’s swelling real estate market. In 2016, house prices in Shanghai and Beijing rose more than 25% year-on-year, and in some smaller cities the growth rate was even higher, raising fears of a crash.

Since then, Beijing has introduced a string of measures designed to curb prices in the big cities, and President Xi Jinping’s line that “houses are for living in, not for speculation” has become something of a mantra.

But rumours of a property tax have been bubbling since the start of the decade, and sceptics will rightly ask: what makes this time any different?

One sign that things are changing is that the government is making concrete preparations to bring in such a tax, like the creation of a national land-ownership database last year, and pilot programmes in major cities such as Shanghai.

“ If this time around stands out from previous property tax discussions, it’s because the government has put in place the necessary infrastructure,” James Macdonald, Head of China Research at Savills, told CER. “One of the key obstacles that the government had was that they simply didn’t know who owned what – the centralised database lets them clear this hurdle.”

On the flipside, however, a recent wave of domestic economic headaches could force officials to push back any legislation with the goal of tempering demand.

Riding the wave

Since market liberalisation in the early 1990s allowed local authorities to sell land to private citizens, property has become a cornerstone of China’s high-growth economy.

But with this growth has come persistent fears of speculation and asset bubbles. Cornered by a lack of viable investment outlets in China due to capital controls and a volatile stock market, many Chinese value property as a safe bet for their savings. Real estate makes up nearly three-quarters of the assets of Chinese households, according to the Survey and Research Centre for China Household Finance in Chengdu.

The result has been unsustainably high prices in Beijing and Shanghai, where property prices are now more than 40 times higher than the average annual income of local residents, the highest level in the world. There are also worrying numbers of homes lying idle: up to 50 million empty homes across the country, the Southwestern University of Finance and Economics estimates.

Beijing’s sustained efforts to stamp out speculation have only been partially successful. Price rises in the big cities cooled last year as heavy restrictions were imposed on buying multiple homes, but the market is now picking up again.

On the national level, growth in new home prices accelerated for the fifth consecutive month in August to hit a two-year high. Dozens of smaller cities posted double-digit increases, and even the big cities are now growing again. In a recent Reuters poll, analysts revised up their forecasts to predict home prices to rise 5% across the board in 2018.

Ironically, previous government action may have even stoked the appetite for speculation. Xinling Wang, a policy researcher at the German Chamber of Commerce in Shanghai, believes Beijing’s habit of swinging from intense tightening to extreme easing has been absorbed by those with an eye on the market.

“It has become household knowledge in China that restrictions imposed during boom times would be relaxed in lean times, resulting in ever bigger price hikes,”  . “This becomes a self-fulfilling prophecy, with public expectation luring speculators to enter the market at any cost, driving up prices.”

One primary role of the property tax will be to stabilise market expectations, replacing this system of frequent price swings with a more stable, long-term market outlook.

“Every time Beijing tries to cap the property price, it comes up against a number of factors that are not entirely within its control, such as local governments’ dependency on land prices,” said Serena Zhou, Chief China Researcher at Mizuho Securities. “This has caused a lot of mini-cycles to come out every three to five years, which is not preferable for Beijing.”

Public comments so far have yet to take on how the tax will be implemented. Given China’s vast diversity in terms of standards of living, many anticipate that local governments will oversee details of the tax in their regions, guided by broader policy goals from Beijing.

A progressive scale could be used based on property size, as per the Shanghai pilot programme. Calculations by SWS Research estimate that a standard three-person household in a third-tier city apartment could expect to pay around 8% of its annual income on the tax. For the same family in Shanghai, however, this could rise to 20%.

There is also the option to target the multiple-property-owning investors with plenty of exemptions for primary residences of below-average-income households. “This is the message that the government wants to send out,” said Zhou.

The balancing act

The government, however, faces a colossal dilemma with any property tax it hopes to roll out. The sheer size of China’s property sector means moderating measures must be just that – moderate. Any sudden movements, or spooks in market confidence, could reverberate around an economy already laden with worries.

Roughly one-fifth of China’s GDP is tied into its housing market, a proportion comparable to that seen in Spain and Ireland before their property sector crashes in 2008, and triple the US before the subprime crisis. Housing construction provides jobs to a staggering 16% of the urban population, and, as Dinny McMahon describes in his book China’s Great Wall of Debt, has been a welcome driver of demand for commodities from dozens of over-producing Chinese industries, such as steel, cement, and glass. Moreover, property benefits from almost one-third of bank-issued loans, a business kept afloat by robust property prices.

Local governments are also likely to be apprehensive. Many authorities have grown accustomed to using land sales as a reliable supplement for their budgets. Any squeeze on demand from fresh taxes could cut off an immediate income generator, at a time when financing channels have already been tightened from deleveraging.

However, as James MacDonald notes, local governments need not necessarily fear a property tax. On the contrary, if implemented correctly, it could set up a “virtuous cycle” of revenue and investment.

However, as James Macdonald notes, local governments need not necessarily fear a property tax. On the contrary, if implemented correctly, it could set up a ‘virtuous cycle’ of revenue and investment.

“We are seeing a slowdown in land sales anyway, especially in the most-developed parts of the country such as Shanghai,” says Macdonald. “Governments will have to face the fact sooner or later that land is a finite resource, but a property tax could provide a recurring form of income. If reinvested in the local community, house prices will increase as the area becomes more attractive to live in, which in turn creates more tax revenue which can again be reinvested.”

Nevertheless, China’s deep reliance on its the property sector sits poorly with its current weakening economic outlook and an intensifying trade dispute with Washington. Decision makers may well be nervy about taking the wind out of such a large demand driver, and targets to finalise legislation by the end of this year or next could once again be pushed back.

“I do believe that there may be some delay in the rolling out of China’s property tax,” says Zhou of Mizuho. “Due to concerns about the economy slowing down from credit tightening and the impact of tariffs, I expect a property tax actually comes pretty far down on the list of worries for the government.”

Indeed, the China Real Estate Association said in a post on its website that legislation may take over five years to push through given current circumstances, citing a former director of state-backed Chinese Academy of Fiscal Sciences.

There is also precedent for postponement. Preparations were under way as part of a five-year strategy starting in 2011, but the stock market crash in 2015 and subsequent slowdown fears forced Beijing to shelve its plans. Steps taken in recent months to bolster growth and revive borrowing in certain areas of the economy hint that the situation could repeat itself.

If the can does get kicked down the road once more, noises from the government within the past six months suggest that the tax that will inevitably resurface. Beijing may wait for the domestic headwinds to blow over, but afterwards there will still be a bubble to deflate.

This article was kindly contributed by Technode. For the original article, click here.

Reports of trade tensions between China and the US in the past few months have been hard to ignore. In early July, the US imposed $34 billion on Chinese goods, prompting the Shenzhen Component Index, dominated by technology and consumer product stocks, to fall to its lowest point since 2014, igniting fears among investors.

“The US tariffs, coupled with a falling yuan, will significantly increase the cost for many Chinese technology companies that rely on imported raw materials, such as semiconductors, integrated circuits, and electric components,” Zhang Xia, an analyst for China Merchants Bank Securities, told the South China Morning Post.

Additionally, the US’s commerce department announced yesterday it will place an embargo on 44 Chinese companies—including the world’s largest surveillance equipment manufacturer Hikvision—for “acting contrary to the national interests or foreign policy of the United States.” The move caused the companies’ share prices to fall by up to nearly 6%.

However, the focus has shifted to more than just the trade war. And a number of big Chinese tech companies have seen their share prices plummet for other reasons.

Pinduoduo, China’s latest e-commerce giant to list on the Nasdaq, found that an initial public offering (IPO) is not a panacea. Conversely, its listing has drawn attention to the company’s counterfeit products. And investors are not happy.

Tencent’s shares have nosedived by over 25% since its peak in January, erasing $143 billion in market value over the past seven months.

Search giant Baidu also hasn’t been immune. The company’s stock price dropped by nearly 8% this week (August 2) following news that Google plans to re-enter the Chinese market.

Government crackdowns

While IPOs are usually a cause for celebration, Pinduoduo has proven this past week they can also be bad for business. The company—which has integrated e-commerce and social media—caters to low-income consumers living outside first and second-tier cities. It has been plagued by accusations of facilitating the sale of counterfeit low-quality goods.

Just days after going public, the company’s share price tumbled by 16%, falling below its offer price of $19. The drop was, in part, initiated by requests made by television maker Skyworth to remove counterfeit listings of its products from the e-commerce firm’s marketplace.

The company announced this week that it had removed 10.7 million listings of problematic goods (in Chinese). However, this did little to assuage concerns from investors and regulators after the latter launched an inquiry into Pinduoduo’s product listings. It’s stock price dropped to 30% below its closing price on its first day of trading, wiping out over $9 billion in value.

This is unlikely to be helped by the fact that seven US law firms have launched investigations into the company on behalf of its investors. The statement issued by the firms shows that investors suffered financial losses after Chinese regulators began looking into the company’s dealings. The company met today (August 3) with regulators and agreed to improve its products’ vettingprocedures.

However, it’s not only e-commerce platforms that have been affected. Video streaming service Bilibili has seen its stock price drop by almost 21% since July 20. The decline comes amid renewed efforts led by the Cyberspace Administration of China (CAC) to crack down on what it deems to be “vulgar” or “inappropriate” content.

The company has subsequently had its app removed from app stores in the country for one month. Nasdaq-listed Bilibili responded by saying it is “in deep self-review and reflection.”

Rumored competition

Baidu, which runs China’s biggest search engine, found that even unconfirmed competition can cause stocks to tumble. In a move which could mark its re-entry into the Chinese market, news broke this week that Google has plans to launch an Android app that could provide filtered results to users in China.

Baidu currently commands nearly 70% of China’s search market, while Google shut down its search engine in China in 2010 over censorship concerns, giving up access to a vast market. China’s online population now exceeds 770 million, double the entire populace of the US and more than that of Europe. An attractive prospect for the US-based tech company.

Baidu’s revenue is still highly dependant on ad revenue, which increased by 25% in the second quarter. Google’s return is clearly seen as a threat, causing Baidu’s stock price to fall from $247.18 on July 31 to $226.83 on August 2. This marks the most significant fall since the company announced the departure of its chief operating officer Lu Qi.

Steady decline

Nonetheless, all losses seem insignificant in comparison to Tencent’s. The company saw its stock price increase by 114% in 2017, reaching a record high in January 2018. However, since then, the price has dropped by nearly $130 per share, eviscerating a considerable portion of its market value. In July alone, its stock price fell by 9.9%. The company’s devaluation tops Facebook’s $130 billion rout following its earnings call last month.

In April, the company lost over $20 billion in value after South African investment and media firm Naspers announced it was trimming its stake by 2%. Additionally, Martin Lau, the company’s president, sold one million of his shares in the company. This, added to the Naspers sale and warnings of margin pressure, led to a loss of $51 billion in market value.

“Investors are increasingly pricing in lower expectations for Tencent’s interim results,” Linus Yip, a strategist at First Shanghai Securities in Hong Kong, told Bloomberg.

Yip expects the downward trend to continue, and not just for Tencent. “Overall, tech companies are facing a similar problem. They have been enjoying fast profit growth in the past few years, so it will be difficult for them to maintain similar growth in the future as the competition grows and some segments are saturated,” he said.