How China dealt with SVB-style crisis

Banking with China’s Characteristics - China’s dynamic banking regulation in 30 years

Editor's Note: The review below was prompted by the recent SVB and subsequent banking industry crisis in the US, as well as China's recent reform of its financial regulatory framework. China's evolving banking regulatory framework and its response to bank crises are the subjects of review by our guest writer, Sophia Sun, a seasoned financial industry lawyer from one of China's oldest law firms. The review offers both practical and theoretical analysis and challenges the notion that China's system can be understood using international frameworks. Sophia presented evidence that China has learned from best practices while also localizing its system based on its own experience, creating differences at the underlying level that can be confusing to outsiders. In a short 25 years, China’s bankruptcy handling of banks has evolved from ad hoc administrative directive driven to a law-based, multi-apparatus coordinated, market-oriented system. At the end of the review, Sophia gave a detailed look at the recent Baosheng Bank crisis, which we mentioned in a previous post. This review's unbiased, contextualized and native analysis is exactly what we hope to provide, and it echoes BAiGUAN's mission to faithfully help our readers to put China’s many issues in context.

Reflecting on China's bankruptcy system through the SVB bankruptcy incident

By Sophia Sun

It has been a month since Silicon Valley Bank ("SVB") was closed and taken over by the Federal Deposit Insurance Corporation ("FDIC") on March 10, 2023. According to a statement released by the FDIC on March 26, the latest development is that First Citizens Bank has purchased the remaining assets, deposits, and loans of SVB. It is a relatively "happy ending” for the market, investors, and SVB to see that SVB has finally found a "good home" rather than going bankrupt and liquidating.

It is intriguing, when one reflects about bankruptcy system of Chinese banks in light of the SVB case. This article examines the progression of China's banking bankruptcy system from the bankruptcy of Hainan Development Bank ("HDB") in 1997, to the current response and reaction of the Chinese government to Baoshang Bank Co., Ltd in 2022. It offers valuable insights into the growth and distinct attributes of China's bankruptcy system over the last 20 years.

History in Perspective - Hainan Development Bank in 1997

Established on August 18, 1995, HDB had a registered capital of 1.677 billion yuan. According to its page on China’s company registration information site, Qichacha, "During the initial phase, the bank operated well, so creditors poured in a huge amount of funds into real estate and raised funds at high interest rates. However, due to the collapse of the real estate bubble, the high-interest savings could not be recovered, and a large number of depositors demanded repayment, leading the bank into a credit crisis with debts that could not be repaid." [1]

The specific story is even more complex. In 1997, a payment crisis occurred in the Hainan Province Urban Credit Cooperative. The People's Bank of China decided to treat 22 of the 34 urban credit cooperatives[1] in Hainan Province differently, merging them into HDB and transferring the debts of the 5 closed urban credit cooperatives to HDB. To some extent, the "Response on Implementing the Plan for Dealing with the Payment Crisis of Hainan Province Urban Credit Cooperatives" from the People's Bank of China predicted the subsequent consequences: "...due to the huge amount of overdue debts of the original urban credit cooperatives and the concentrated payment of customers at the end of the year and during the Spring Festival, there will be a payment peak in the early stages of closing and merging. HDB needs sufficient cash positions to pay off debts in large amounts. If the funds cannot keep up with the payment speed, coupled with the possible lack of confidence in HDB by the public, it will lead to the expansion of the payment crisis of urban credit cooperatives to HDB, causing a liquidity crisis and even loss of solvency.” This statement became a prophecy—in spite of the measures taken by the People's Bank of China (”PBOC”), including allowing large savings deposit limits, deferred payment, and conversion, and providing funding support (it is reported that the People's Bank of China made an emergency allocation of 3.4 billion yuan), these measures were still of little help under the pressure of public panic.

According to the "Chronicle of the People's Bank of China in 1998" published on the official website of PBOC, PBOC decided to close HDB from June 21, 1998 onwards and suspend all its business operations, with a liquidation team organized by the PBOC to carry out the closing liquidation. At the same time, the Industrial and Commercial Bank of China (”ICBC”) was designated to act as a trustee for the debt of HDB, guaranteeing the payment of the principal and legal interest of overseas debt and domestic resident savings deposits, and the remaining debts would be paid after the liquidation. In the end, due to the endorsement of ICBC, most depositors only transferred their original deposits in HDB to the ICBC and did not engage in further bank runs.

The bankruptcy and closure of HDB occurred during China’s special period of economic transformation. After a series of financial institution bankruptcies, China gradually established a special bankruptcy system applicable to banks and other financial institutions. The establishment of the system roughly followed this process:

Gradual Establishment of Bankruptcy System for Banks

• Architected design of the upper law: Enterprise Bankruptcy Law, Commercial Bank Law