Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

(Report produced by/by: Huachuang Securities, Du Jian, Zhou Guannan)

I. Banking industry risk and regulatory system

(i) Overview of banking sector risks

Banking risk refers to the possibility of banks suffering economic losses due to various uncertainties in the course of their operations, mainly including credit risk, market risk, liquidity risk and operational risk.

Credit risk is the most important type of risk faced by banks, caused by the default of bank customers, such as bad debts caused by the failure of loan customers to pay interest and repayments on time. Credit risk is mainly related to the bank's credit granting policy and customer credit qualifications.

Market risk refers to the possibility that changes in financial market conditions cause fluctuations in the prices of financial assets, resulting in damage to the bank's assets, including interest rate risk, exchange rate risk, etc. Generally, the larger the bank's exposure to interest rate risk and foreign exchange risk, the higher the market risk.

Liquidity risk refers to the risk that the bank is unable to obtain sufficient funds in a short period of time to make debt payments or expand its assets, such as the bank's short-term funds are insufficient to meet the cash withdrawal needs of its deposit customers or the reasonable credit needs of its loan customers. Liquidity risk is related to the bank's deposit to loan ratio and liquid assets ratio.

4. Operational risk is the possibility of direct or indirect losses suffered by the bank as a result of internal systems or personnel errors, and is related to the maturity of the bank's internal management system and the stability of its business operations.

(ii) Basel Accord regulatory system

The Basel Accord was born in the context of the breakdown of the Bretton Woods system, the disintegration of the global stable exchange rate regime, and the accumulation of risks in multinational banks, which greatly increased the systemic risk in global financial markets. The Basel Accord, which aims to maintain capital market stability, reduce unfair competition among international banks, and reduce credit and market risks in the banking system, is the main global standard for bank capital and risk regulation set by the Basel Committee.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

The Basel I Accord, enacted in July 1988, was a milestone in the history of international banking supervision, placing capital adequacy at the core of the supervisory framework to assess a bank's level of risk coverage and resilience. The Basel I Accord mainly provides for the classification of capital and the calculation of risk weights, requiring core capital to be at least 50% of a bank's capital, with a capital adequacy ratio of at least 8% and a core capital adequacy ratio of at least 4% by the end of 1992.

Basel II, enacted in 2004, introduced a comprehensive risk management system and for the first time established a three-pillar international banking regulatory framework. Basel II refined the content of minimum capital requirements and proposed that the weighted risks used in calculating capital adequacy include not only credit risk, but also market risk and operational risk. It also proposes that "minimum capital requirements", "supervision and inspection of capital adequacy by supervisory authorities" and "information disclosure" constitute the three pillars of risk-based capital measurement and supervision of banks. The minimum capital requirements, together with supervision and inspection by the supervisory authorities and information disclosure, constitute the three pillars of risk-based capital measurement and supervision.

Basel III, enacted in December 2010, is a further refinement of the international banking regulatory system, focusing on the first pillar of minimum capital requirements. Basel III requires the total capital adequacy ratio to remain unchanged at 8%, and the Tier 1 capital adequacy standard to be increased from 4% to 6% with a transition period of 2013-2019, rising to 4.5% in 2013, 5.5% in 2014 and 6% in 2015; the core Tier 1 capital adequacy ratio to be increased from 2% to 4.5% with a transition period of 2013, 3.5% in 2014 and 4.5% in 2015. The core Tier 1 capital adequacy ratio will be raised from 2% to 4.5%, with a transition period of 3.5% in 2013, 4% in 2014 and 4.5% in 2015; a capital retention buffer of 2.5% and a countercyclical capital buffer of 0-2.5% will also be established. A new minimum leverage ratio of 3% and a liquidity leverage ratio of 100% were also introduced.

In December 2017, Basel III (Final) was revised to standardize the measurement of risk-weighted assets and improve the comparability of capital adequacy ratios. Basel III (Final) continues to improve the measurement of risk-weighted assets by optimizing the standardized approach for credit risk, the internal rating approach for credit risk, and the standardized measurement approach for operational risk, while introducing additional minimum leverage ratio requirements for global systemically important banks, effectively increasing the minimum Pillar 1 capital requirements.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

(iii) Macroprudential Assessment System (MPA)

The Macro Prudential Assessment (MPA) system, which was issued by the central bank on December 29, 2015 and implemented in 2016, was upgraded from the Dynamic Adjustment Mechanism for Differential Reserves and the Consensual Loan Management Mechanism implemented since 2011. The differential reserve dynamic adjustment mechanism means that the deposit reserve ratio applied by financial institutions is linked to indicators such as capital adequacy ratio and asset quality status, and the lower the capital adequacy ratio and higher the non-performing loan ratio, the higher the deposit reserve ratio will be; conversely, the lower the deposit reserve ratio will be; the consensual loan management mechanism refers to the central bank's comprehensive measurement of lending targets with reference to data such as deposit-to-loan ratio, capital adequacy ratio and non-performing ratio. The MPA further improves the macroprudential policy framework, prevents systemic risks more effectively, plays a counter-cyclical role, and adapts to the trend of asset diversification by shifting the focus from narrow loans to broad credit, with the capital adequacy ratio as the core.

MPA assessment targets include commercial banks, finance companies, financial leasing companies, auto leasing companies, trust and investment companies and other banking financial institutions, mainly banks, which are divided into three categories: national systemically important institutions (N-SIFIs, generally large commercial banks), regional systemically important institutions (R-SIFIs, generally city commercial banks with the largest assets in each province) and ordinary institutions (CFIs, generally joint-stock banks and other institutions in each province that are not the largest in terms of assets).

The MPA assessment is conducted quarterly by the Central Bank's Department of Monetary Policy (responsible for the implementation of the assessment) and the Bureau of Macroprudential Management (responsible for the formulation of the policy framework), and includes seven major areas of capital and leverage, assets and liabilities, liquidity, pricing behavior, asset quality, cross-border financing risk, and credit policy implementation, with a total of 16 sub-indicators.

There are two valid indicators for assessing capital and leverage, with capital adequacy ratio accounting for 80 points and leverage ratio accounting for 20 points, and if this major indicator does not meet the standard, it will go directly to C grade. The capital adequacy ratio reflects the extent to which a commercial bank can absorb losses with its own capital before depositors' and creditors' assets are lost; the leverage ratio is an effective complement to the capital adequacy ratio, avoiding the complexity of the risk-weighted capital adequacy ratio and reducing the scope for capital arbitrage. The higher the indicator, the higher the capital and leverage score.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

There are three valid indicators for assessing assets and liabilities, with 60 points for broad-based credit, 15 points for entrusted loans and 25 points for interbank liabilities. The growth rate of broad credit covers most of the assets on the table of commercial banks, and the growth rate is basically close to the growth rate of asset scale, which has certain constraints on capital adequacy ratio. Interbank liabilities include interbank borrowing, interbank lending, interbank deposits, interbank payments by principals, etc. The lower the interbank liabilities/total liabilities indicator, the higher the score for this item.

Liquidity is assessed by three valid indicators, with a liquidity coverage ratio (LCR) of 40 points, a net stable funding ratio (NSFR) of 40 points, and compliance with the reserve system of 20 points. The liquidity coverage ratio is the reserve of high-quality liquid assets / net outflow of funds in the next 30 days, which is 40 points if it meets the regulatory target, otherwise it is 0 points; the net stable funding ratio = available stable funding / stable funding required for business, which is 40 points if it is not less than 100%, otherwise it is 0 points.

There is only one valid assessment indicator for pricing behavior, interest rate pricing, which accounts for all 100 points.

Asset quality is assessed by two valid indicators, of which the non-performing loan ratio and provision coverage ratio each account for 50 points. The NPL ratio is the NPL balance/loan balance, the higher the indicator, the higher the asset quality score, with an upper limit of 50 points; the provision coverage ratio is the allowance for loan losses/non-performing loan balance, the higher the indicator, the higher the asset quality score, with an upper limit of 50 points.

There is a valid assessment indicator for cross-border financing risk: the weighted balance of cross-border financing risk, which reflects the cross-border risk of commercial banks, with a score of 100 for compliance and 0 for exceeding the upper limit.

There are three effective indicators for assessing credit policy implementation: 40 points for credit policy assessment results, 30 points for credit policy implementation, and 30 points for the use of central bank funds. The credit policy assessment result is 40 points for excellent, 30 points for good, 20 points for fair, and barely 0 points. If all three items are not evaluated, the score is good; the credit policy implementation is selected from three credit priorities, and 10 points are awarded for meeting the three conditions at the same time, 7 points or 3 points for partially meeting them, with a total score of 30 points; the use of central bank funds guides banks to invest their funds in line with the current monetary policy objectives of the central bank, with a total score of 30 points.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

Based on the assessment results of each indicator, the MPA assessment system classifies the evaluated institutions into A, B, and C. A-ranked institutions are required to achieve excellence in all seven categories, and are subject to incentive reserve rates and some other incentives; C-ranked institutions fail to meet the standards in any one of the two categories of capital and leverage and pricing behavior, or fail to meet the standards in assets and liabilities, liquidity, asset quality, cross-border financing risk, and credit policy implementation. The MPA will be implemented for three months after the effective date of the current assessment result and will be readjusted after the next assessment result. The implementation period is 3 months after the current assessment result takes effect, and will be adjusted after the next assessment result takes effect. In addition, considering the lack of historical data required for the evaluation of new institutions and the rapid initial development, in principle, the MPA can be temporarily excluded within three years of opening (source: Future Think Tank).

II. Summary of important policies related to commercial banks in China

(i) Commercial Banking Law

The Law on Commercial Banks aims to protect the legitimate rights and interests of commercial banks, depositors and other customers, regulate the conduct of commercial banks, and improve the quality of credit assets. The Law came into force in 1995 and was amended twice in 2003 and 2015. The Draft Revision issued in October 2020 added two chapters on corporate governance and protection of customers' rights and interests to highlight their importance, and updated two chapters on capital and risk management, and risk disposal and market exit. The latest revised draft aims to supplement industry regulatory rules, improve risk management provisions, emphasize corporate governance and enhance the autonomy of banks.

(1) the establishment of commercial banks: 1) the registered capital has been increased compared with that of 2015, and the minimum registered capital of national commercial banks, city commercial banks and agricultural commercial banks is 10 billion RMB, 1 billion RMB and 100 million RMB respectively, which is 10 times, 10 times and 2 times of the minimum limit in 2015; 2) detailed regulations on the qualification of shareholders: major shareholders are those whose capital contribution or shareholding accounts for more than 5% or less than 50% of the total capital or share capital of a commercial bank, and those whose capital contribution or shareholding is less than 5% but has significant influence on the operation and management of a commercial bank; major shareholders, controlling shareholders and shareholders under effective control. (2) Detailed provisions on the qualifications of shareholders: major shareholders are those whose capital contribution or shareholding accounts for more than 5% but less than 50% of the total capital or share capital of a commercial bank, and those whose capital contribution or shareholding is less than 5% but has significant influence on the operation and management of a commercial bank; changes in major shareholders, controlling shareholders and de facto controllers need to be approved and registered; and any increase in shareholding or cumulative increase in voting shares up to 5% must be reported to the supervisory and regulatory authorities for approval and disclosure within three days. The requirements on shareholders and registered capital in the Revised Draft aim to improve corporate governance, strengthen the supervision of major shareholders of banks, and avoid the emergence of "tomorrow's system" of shareholders.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

2. Corporate governance: 1) strengthen the responsibility management of major shareholders and controlling shareholders of commercial banks, and the effective controller shall not abuse control to the detriment of the legitimate rights and interests of commercial banks, shareholders, creditors and other stakeholders; 2) clarify the supervisory and management responsibilities of the board of directors, set detailed requirements for its independence, and improve the risk prevention mechanism for related party transactions; 3) improve the internal control and internal audit system; and 4) improve the information disclosure system. 3) improve internal control and internal audit system and enhance information disclosure. We should learn from the past experience of similar risk events such as Hainan Development Bank and Baoshang Bank.

3. Capital and risk management: Banks are required to comply with the minimum capital adequacy requirements set by the regulatory authorities, establish capital replenishment mechanisms, and comply with macro-prudential management and risk management requirements, which are complementary to the requirements of Basel and MPA.

4. Business operation: Emphasis is placed on the specialization of bank operation, and city commercial banks, agricultural commercial banks and village banks are not allowed to operate across regions without approval. Banks can determine deposit and loan interest rates in accordance with the provisions of the central bank and the customer's independent negotiation.

5, the protection of customer rights and interests: highlight the customer-centric thinking, clear that banks should protect the legitimate rights and interests of customers. Detailed definitions are provided for marketing, bundled sales, personal information protection and data security, and fee management, reflecting the importance of protecting customers' rights and interests in various aspects.

6. Risk disposal and market exit: six conditions for receivership are clarified: 1) continuous deterioration of asset quality; 2) serious liquidity deficiency; 3) serious violations of laws and regulations; 4) major deficiencies in management; 5) serious capital deficiency that cannot be restored after corrective measures or restructuring; 6) other circumstances that may affect the continued operation of commercial banks. If the deposit insurance fund needs to be used, the deposit insurance fund management institution shall act as the receivership organization.

(ii) Deposit insurance regulations

The Regulations on Deposit Insurance were promulgated by the State Council on February 17, 2015, and came into effect on May 1, 2015, to establish and regulate the deposit insurance system, protect the legitimate rights and interests of depositors in accordance with the law, prevent and resolve financial risks in a timely manner, and maintain financial stability.

Deposit insurance means that the insured institution pays a premium to the deposit insurance fund management agency to form a deposit insurance fund. The deposit insurance fund management agency reimburses the depositors for the insured deposits in accordance with the regulations and takes necessary measures to maintain the safety of the deposits and the deposit insurance fund.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

Deposit insurance is mandatory, and all banks (including wholly foreign-owned banks, Chinese-foreign joint venture banks, rural cooperative banks, village banks, etc.) and rural credit cooperatives registered in China must participate in deposit insurance and enjoy the same protection for the deposits they take. To facilitate public recognition, the People's Bank of China has authorized banks participating in deposit insurance to use the deposit insurance logo and display it at the entrance of each participating bank's business branch.

Deposit insurance is subject to a limit of reimbursement, with a maximum reimbursement limit of RMB 500,000. If the combined principal and interest of all insured deposit accounts of the same depositor in the same insured institution is within the maximum payment limit, the full amount will be paid; if the amount exceeds the maximum payment limit, it will be paid from the liquidated assets of the insured institution according to law.

(C) commercial banks capital management approach (for trial implementation)

The Capital Management Measures of Commercial Banks (for Trial Implementation) aims to strengthen capital supervision of commercial banks, maintain the sound operation of the banking system and protect the interests of depositors. In June 2012, China's CBRC (formerly CBRC) issued the "Measures on Capital Management of Commercial Banks (for Trial Implementation)", which provides for the calculation of capital adequacy ratio and regulatory requirements, capital composition and deductions, measurement of risk-weighted assets, supervision and inspection, and information disclosure of commercial banks. The capital adequacy regulatory requirements for commercial banks include minimum capital requirements, reserve capital and countercyclical capital requirements, additional capital requirements for systemically important banks, and Pillar II capital requirements.

1. Minimum capital: Core Tier 1 capital adequacy ratio shall not be less than 5%, Tier 1 capital adequacy ratio shall not be less than 6%, and capital adequacy ratio shall not be less than 8%.

2. reserve capital: accrued on the basis of a minimum capital requirement of 2.5% of risk-weighted assets, to be met by core tier 1 capital.

3. Countercyclical capital: in certain circumstances, accrued over and above the minimum capital requirement and reserve capital requirement, which is 0-2.5% of risk-weighted assets and is met by core tier 1 capital.

4. Additional capital for systemically important banks: The additional capital requirement for domestic systemically important banks is 1% of risk-weighted assets, which is met by core tier 1 capital. If a bank is identified as both a domestic systemically important bank and a global systemically important bank, the additional capital requirement is not superimposed and is determined by the higher of the two.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

(D) Commercial banks liquidity risk management approach

The Measures on Liquidity Risk Management of Commercial Banks, which aim to strengthen the liquidity risk management of commercial banks and maintain the safe and sound operation of the banking system, came into effect on July 1, 2018. The Measures clearly stipulate liquidity risk management and liquidity risk supervision, and propose that liquidity risk supervision indicators include liquidity coverage ratio, net stable funding ratio, liquidity ratio, liquidity matching ratio and high-quality liquid assets adequacy ratio.

One of the most difficult indicators is the liquidity matching ratio, which is designed to address the maturity mismatch problem. The

III. Full review of credit events in the banking industry

(i) Banking sector bond valuation volatility combing

A comprehensive review of historical credit events in the banking industry helps us to capture the core of commercial bank credit analysis. Most of the commercial banks that have experienced credit events are weakly qualified agricultural and commercial banks with deteriorating asset quality, rising non-performing ratios and declining profits, except for Hengfeng Bank, a joint-stock bank, and city commercial banks such as Baoshang Bank and Bank of Gansu.

Since 2021, regulators have introduced policies to ease the pressure on the operations of small and micro enterprises, and the banking industry has stepped up efforts to write off and liquidate non-performing assets, resulting in a certain degree of risk relief for commercial banks' stock of assets. However, due to the impact of risk exposure in the real estate industry and the significant regional differentiation of commercial banks, bond valuation yields have become more volatile, the non-performing ratio in the banking industry in weak regions such as the northeast is high, the provision coverage ratio has reached or is close to the regulatory red line, and the asset quality is under pressure.

(ii) Overview of bank main rating downgrades

Since 2019, a total of 41 commercial banks have had their main ratings downgraded, mainly by regional agricultural and commercial banks. From the rating report concerns there are four main areas.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

1. On the asset side: downward pressure on credit asset quality, large scale of non-standard investment, high concern loans, rising non-performing rate and overdue loan rate, high percentage of real estate loans, high concentration of loan industry, and continuous exposure of guarantee chain risk.

2. Risk hedging: inadequate provisioning coverage, inadequate capital adequacy ratio, etc.

3. Profitability: Operating income and net profit declined and profitability weakened.

4. Management: Frequent changes in senior management, frequent adjustments in organizational structure, difficulty in management due to opening of new village banks, etc.

(3) The main body of bank's secondary capital debt extensions

In terms of the terms, the "declining" crediting capital gives banks a strong incentive to redeem. According to the "Rules Governing the Capital of Commercial Banks", the principal amount of Tier 2 capital debt will be reduced by 20% each year for the first five years of maturity, so issuers tend to exercise the redemption right at the end of the fifth year (5+5 years) and issue new Tier 2 capital debt for replacement.

The rollover risk of small and medium-sized banks is gradually emerging. According to the regulatory requirements, the capital adequacy level after redemption is still significantly higher than the regulatory requirements for exercising the redemption option. It is worth noting that among the Tier 2 capital bonds issued from 2013 to 2016, except for "14 CCB Tier 2 01" which has not yet matured (10+5), all other bonds have not been redeemed at maturity, and the subjects involved are all small and medium-sized banks. At that time, the interest rates of Tier 2 capital bonds issued by urban and agricultural banks were mostly around 5-6%, which was much higher than the current level, and therefore the cost of non-redeeming was higher. This phenomenon may reflect the pressure of capital adequacy assessment on small and medium-sized banks in recent years, which may have difficulties in rolling over the issuance and gradually releasing the rollover risk.

IV. Typical cases of credit risk in the banking industry

(i) Bao Bao Bank

1、Background history and disposal process of Baoshang Bank

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

Baoshang Bank is a large scale city commercial bank in Inner Mongolia, formerly known as Baotou City Commercial Bank, and the actual controlling shareholder is the "Mingtian System" (89.27% shareholding). Baoshang Bank is mainly engaged in agricultural and animal husbandry finance, small and micro enterprise financial services and financial market business, and has a certain degree of popularity in the market. After being jointly taken over by the Central Bank and the CBRC on May 24, 2019, Baoshang Bank has completed the disposal of all assets and liabilities and related businesses in less than two years, and was declared bankrupt by the court on February 7, 2021.

2、Baozhuang Bank disposal method

Baoshang Bank disposes of the risk by "acquisition and takeover + liquidation", which is divided into the following two parts.

First, the new Mongolian Commercial Bank acquired to take over the relevant business of the head office of Baoshang Bank and the branches in Inner Mongolia Autonomous Region. The Deposit Insurance Corporation, together with eight sponsors in Inner Mongolia Autonomous Region, including Construction Bank's wholly-owned subsidiary Jianxin Investment, Huishang Bank and the Department of Finance of Inner Mongolia Autonomous Region, will jointly establish a new bank in Inner Mongolia Autonomous Region, Meng Shang Bank, to take over the assets and liabilities and related business of Baoshang Bank in Inner Mongolia Autonomous Region and serve the economic and social development of Inner Mongolia Autonomous Region. It will take over the assets and liabilities and related business of Baoshang Bank in Inner Mongolia Autonomous Region and serve the economic and social development of Inner Mongolia Autonomous Region, and will not operate across regions.

Second, the assets and liabilities and related businesses of four branches of Baoshang Bank outside Inner Mongolia Autonomous Region were packaged and evaluated and sold to Huishang Bank. According to the announcement of Huishang Bank, the target businesses were divided into four categories of disposal: businesses and assets involved in the bookkeeping dimension of the four branches of Baoshang Bank, on- and off-balance sheet public credit businesses and retail loan businesses and assets of the four branches whose final customers are registered outside Inner Mongolia Autonomous Region, credit card businesses and assets in the locations of the four branches, and businesses and assets of off-balance sheet wealth management businesses whose customers are registered outside Inner Mongolia Autonomous Region. Prior to this disposal, 16 of the 17 branches established by Huishang Bank were located in Anhui Province, so the acquisition of the four off-site branches of Baoshang Bank could increase its own cross-provincial off-site branches and expand its business on the one hand, and help Baoshang Bank mitigate risks on the other.

The protection of the rights and interests of various types of debt (resident deposits, interbank certificates of deposit, Tier 2 capital bonds, etc.) and equity investors in the process of risk disposal varies for different types of investors. On the whole, the recovery rate of claims is relatively high, nearly 90% overall. The recovery rate is 100%. The interbank certificates of deposit can be converted into new certificates of deposit according to the prior protection ratio and are fully protected by PBoC, CBRC and deposit insurance fund. The recovery rate is 0%. The equity investors will be recovered according to the bankruptcy liquidation process, and no specific measures have been announced.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

3、Risk analysis of Baoshang Bank

Packer events are more difficult to identify in advance by analyzing financial indicators. Baoshang Bank's non-performing loan ratio, concern loan ratio, and overdue loan ratio are all within a reasonable range. The anomaly lies in the top ten borrowers of Baoshang Bank. Generally, companies in the wholesale and retail sector rarely appear in the top ten borrowers of city banks, but three of Baoshang Bank's top ten borrowers are in the wholesale and retail sector, and even one in the information transmission, software and information technology services sector. Many of these top ten borrowers are listed as defaulters and are clearly not normal businesses. In summary, there are anomalies in Baoshang Bank's financial data, but since most of the indicators are not obviously flawed, it is difficult to determine whether there is significant credit risk through financial data alone.

The root cause of Baoshang Bank's credit risk lies in corporate governance deficiencies, which are mainly manifested in three major problems: imbalance in shareholding structure, lack of control in internal management and failure in external monitoring.

First, the equity structure is imbalanced. The actual shareholder of Baoshang Bank, the "Tomorrow System", holds 89.27% of the bank's shares and has absolute control over the bank, and is invisible from public information in various ways. In fact, the regulatory authorities have regulations on the shareholder structure of small and medium-sized banks, but the "tomorrow system" has quietly bypassed the regulators by using a large number of shell companies to hold shares. For example, the top ten shareholders of Baoshang Bank are clearly unusual, with a complex shareholding structure and a small number of employees, suggesting that they are actually shell companies. As the de facto controllers of Baoshang Bank, the "Tomorrow System" extracted credit funds of 156 billion yuan through 209 shell companies, most of which became non-performing loans, ultimately causing credit risks and financial losses for Baoshang Bank.

Second, the internal management is out of control. Baoshang Bank has a board of directors, professional committees, and a supervisory board, which are supposed to serve as risk control structures. However, most of the directors did not participate in corporate decision-making at all, and the chairman of the board actually made all the decisions without playing a democratic role. In the absence of supervision, management was able to make a large number of non-compliant loans with impunity.

Third, external monitoring fails. Baoshang Bank bribed accounting firms, law firms, the press, and local supervisory officials to grant loans in violation of the law and for the personal benefit of its insiders. The failure of external monitoring was a major contributing factor to the accumulation of significant credit risk at Baoshang Bank, and among the loopholes in external monitoring, the corruption of supervisory officials was the most deadly.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

(ii) Hainan Development Bank

1、Background history and development history of Hainan Development Bank

From 1992 to 1993, the real estate prices in Hainan Province rose sharply, which led to the expansion of the trust-based financial sector, with 80% of the trust companies' funds invested in the real estate industry. In August 1995, the government came to the rescue and reorganized Hainan Development Bank on the basis of five trust investment companies, which was heavily indebted at the beginning of its establishment. 1997, Hainan Development Bank merged 28 urban credit cooperatives that were also affected by the burst of the real estate bubble, and at the same time adopted an interest-restricting policy. In 1997, Hainan Development Bank merged with 28 urban credit unions that were also affected by the burst of the real estate bubble, and at the same time adopted an interest rate limit policy, which led to some depositors seeking high interest rates withdrawing their funds, which, together with its plummeting credibility, caused panic among depositors and a bank run after the 1998 Spring Festival.

On June 21, 1998, Hainan Development Bank (hereinafter referred to as "HDB") was closed down and liquidated, and all of its debts were placed under the custody of the Industrial and Commercial Bank of China (ICBC). With the creditworthiness of ICBC, there was no massive run on HDB, and most depositors transferred their deposits to ICBC, and the bank registered the claims of both institutional and corporate depositors.

2、Risk analysis of Hainan Development Bank

The run on the bank caused by the interest rate limit policy and depositor panic was the direct reason for the collapse of Haihaisu, while the large proportion of non-performing assets, weak risk control and failure of internal control mechanism were the fundamental reasons for its collapse.

Administrative intervention in asset restructuring has led to a disproportionately large share of non-performing assets. The Sea Issuers, which was established on the basis of five trusts, was itself poorly run, illiquid, and had large amounts of nonperforming assets, and should have been the target of a merger, but instead it merged with the heavily loss-making City Credit Union. The government hoped that the government would improve its creditworthiness through economies of scale and institutionalized management to get it out of trouble, but instead of reducing the non-performing assets of any of them, this restructuring model accelerated the accumulation and exposure of risks after the restructuring, and the reorganized Sea Issuers relied on refinancing from the People's Bank to survive and lost their ability to pay as soon as the loans were stopped.

Banking 2022 Bond Investment Special Report: a full overview of banking regulatory rules and risk cases

Weak risk control and illegal operation. The company opened its doors on August 18, 1995, and from May to September, it issued 106 billion yuan in loans, of which 92 billion yuan were loans to shareholders, accounting for 86.71% of the total loans. The vast majority of these loans were made without legal guarantees, and their purpose was unclear. They were actually used to return temporary borrowing funds used by shareholders for equity participation, and became an important means of capital evasion by shareholders. At the same time, its loans were invested in a single direction, and after the burst of the real estate bubble, 80% of the loans were still invested in real estate and related industries, making it difficult to recover the funds.

Shareholders compete for control and internal control mechanisms fail. On the one hand, although the trust institution has been converted into a joint-stock commercial bank, there are sharp conflicts among shareholders in the board of directors, and the control issue has not been resolved, and the board of directors is inefficient. On the other hand, the bank did not have a complete internal control system, ignored the capital adequacy ratio, and expanded its business by raising deposit rates and other irregularities while the shareholders abstracted capital and were seriously undercapitalized.

The interest rate limit policy and depositor panic led to a run on the bank. Since the Sea Issuer was not a state-owned commercial bank and had no guarantee of state credit, rumors of its inability to pay during the Spring Festival in 1998 quickly caused panic among the public, which, together with the subsequent limit withdrawal operation, eventually led to a run on the bank. The central bank provided nearly 4 billion yuan in refinancing loans, and the Sea Issuers set up a branch in Shenzhen to draw deposits from outside the island, all to no avail, leading directly to the collapse of the Sea Issuers.

(This article is for information only and does not represent any investment advice from us. (For use of related information, please refer to the original report.)

Featured report source: [Futurewise]. Future Think Tank - Official Website