Tuesday, May 22, 2012

China's banking - the "people's way"

An interesting and sobering post by Patrick Chovanec covers some key issues faced by China's banking sector. Just as revealing however is a comment on the post that discusses the mentality of banking personnel in China and the cronyism that surrounds that business. Some of it by the way sounds a bit like banking in the developed world  (as those of us who've had the pleasure of working for a bank may recognize). Below is the the comment on full:

by Hua Qiao:
It’s important to understand the mentality of lenders, especially at the big state owned banks. First, to be successful and climb the corporate ladder, you generally do not do so by being a standout performer. Instead you do a satisfactory job while you spend time developing your relationships with superiors, schmoozing, essentially. While you could strive to be a standout performer, it is fraught with personal risks, especially in the financial industry where supernormal returns usually mean risk.

So what develops is a pattern of behavior where all employees seek to minimize personal risk within the job. Never sign anything if you can avoid it. Always make sure you have someone else to blame. And above all, characterize your behavior as falling within policy. Indeed, a kind of safe harbor for bankers is if you can show you acted within policy. Doesn’t matter how stupid the business decision is, if you complied with and supported policy, then you are less apt to be criticized.

So, everyone knows the guarantee companies are shams. But in most cases policy will require additonal collateral support for small, weak credits such as SMEs. By adding a guarantee from a guarantee company, the banker complies with policy. Most guarantee companies that I looked at would be laughed at by any good analyst…usually highly undiversified portfolios with poor liquidity.

A similar kind of behavior is seen in the coastal/eastern provinces like Zhejiang, Shandong and Jiangsu where small unrelated Industrial and commercial companies guarantee each other. Kind of a “you wash my back I wash yours” arrangement, these structures are absolutely air balls when it comes time to pay. Although there often is some kind of relationship, family, friends, buyer, supplier, the upshot is that none of these companies would allow a payment obligation under such a guarantee to bankrupt their own operations.

Inflated collateral is still another area where Chinese banks knowingly paper the file. I know a real estate lender that told me that the reason you see so many “see through” office and commercial buildings is the developers have an implied deal with bank lenders that if the market is soft during lease up, the borrower owner will not cut rents but instead leave the property unleased. This is because banks have latitude in massaging pro forma vacancy and leaseup times but they do not have the ability to fudge rents if the building begins to lease up for less than the proforma rents used in underwriting. That would cause a downward revaluation of the property and require a Loan to Value adjustment and therefore a loan pay down; kind of like a margin call. I don’t know how rampant this game is but it sure explains a lot.


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