Could China's Banks Take Down the Global Economy?

Chinese yuan notes. Pixabay/public domain.

The Party has struggled to keep its banks in check.

In terms of possible external shocks coming from the failure of a Chinese bank, the first thing for western observers to appreciate is that China’s financial system remains largely insulated from Western capital markets. Movements in currencies and equity market valuations are certainly a concern in terms of Western perceptions, but less so for the reality on the ground. Market moves have internal significance more for the financial position of the Chinese state and how that influences public perception of the CCP than for the solvency of a specific Chinese bank or company. If movements in the currency markets, for example, were to cause a large loss to a Chinese bank, the decision to support the institution with new government “loans” would be a political rather than financial consideration.

The more interesting question regarding risk to foreign markets from China’s economy comes from efforts by the government of paramount leader Xi Jinping to inject “risk” into the system, this in an effort to weed out the most troublesome money-losing state companies and banks. As we noted in the previous article for TNI, part of the political campaign against “corruption” in China—what Xi refers to as “tigers and flies”—is about preparing to restructure inefficient parts of the economy. When Chinese officials discuss “inefficient” state companies, however, they are really referring to instances of ostentatious and excessive corruption by CCP officials, behavior that can lead to popular discontent and social turmoil.

Western financial institutions such as Lehman Brothers and Citigroup in 2008, or even large Western banks today, were and are vulnerable to changes in market perception, which in turn can translate into a loss of liquidity. In China, by comparison, the leaders of state-controlled banks and state companies are the ones at risk. If the Beijing government makes the political decision to allow a state-run bank or company to fail, this judgement will reflect a deliberate choice to cut off official support.

Foreign investors and media will naturally react to such developments with alarm and surprise, but the fact remains that, for now, the Chinese state led by the CCP remains entirely in charge. On the day that the Party loses the ability to maintain political control in China, then the systemic-risk implications of financially troublesome Chinese banks will be the least of our problems. For Xi and other officials, the common fear that haunts their dreams is political instability.

Christopher Whalen is senior managing director and head of research at Kroll Bond Rating Agency. He is the author of Inflated: How Money and Debt Built the American Dream (Wiley, 2010) and the coauthor, with Frederick Feldkamp, of Financial Stability: Fraud, Confidence, and the Wealth of Nations (Wiley, 2014). His website is www.rcwhalen.com.

Image: Chinese yuan notes. Pixabay/public domain.

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