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RR RUEHWEB

DE RUEHGZ #0685/01 3260931
ZNR UUUUU ZZH
R 210931Z NOV 08
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC 0013
INFO RUEHGZ/CHINA POSTS COLLECTIVE 0005
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC 0003
RUEATRS/DEPT OF TREASURY WASHINGTON DC 0003
RUEAIIA/CIA WASHDC 0005
RUEKJCS/DIA WASHDC 0005

UNCLAS GUANGZHOU 000685 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR CHINA OFFICE 
 
 
E.O. 12958: N/A 
TAGS: EFIN SENV ECON PGOV CH
SUBJECT: South China Financiers Prepare for China's First Real 
Financial Crisis in Thirty Years 
 
REF: A) GUANGZHOU 214, B) GUANGZHOU 398 
 
(U) This document is sensitive but unclassified.  Please protect 
accordingly. Not for release outside U.S. government channels. Not 
for internet publication. 
 
¶1. (SBU) Summary:  The withdrawal of inter-bank credit lines to 
foreign banks following Lehman's collapse was largely due to 
bankers' concerns about increased counter party risks, according to 
south China bankers.  They told Financial Minister Counselor 
Loevinger that regulators did not explicitly instruct Chinese banks 
to reduce exposure, but implicitly signaled concern by asking for 
daily reports of exposure.  Financiers are preparing for an extended 
economic downturn, described by one contact as the first "real 
financial crisis" since China adopted its reform and opening policy 
30 years ago.  Given excess production capacity among many borrowers 
and the worsening outlook for borrowers' sales and profitability, 
bankers expect lenders to be increasingly reluctant to lend and 
borrowers to be increasingly reluctant to incur additional debt. 
The recent lifting of credit controls and reduction in reserve 
requirements and interest rates won't be effective in overcoming 
this reluctance.   They expect non-performing assets to rise 
(particularly to small and medium-sized private exporters) and bank 
profits to fall next year.  While they expect local officials to 
pressure banks to support enterprises in isolated cases, they do not 
anticipate systemic moral suasion to prop up unviable enterprises. 
End summary. 
 
Stability is Key 
---------------- 
 
¶2. (SBU) In a recent meeting with Financial Minister Counselor David 
Loevinger, China Merchant's Bank (CMB) Executive Vice President 
Zhang Guanghua said inter-bank lending in recent weeks had "mostly" 
returned to normal for the first time since they were suspended 
immediately after Lehman's collapse.  (Comment:  Some foreign banks 
report that they still have difficult getting RMB credit from 
Chinese banks.)  He said that the withdrawal of inter-bank credit 
lines to foreign banks had been largely due to bankers' concerns 
about increased counter party risks. Regulators did not instruct 
Chinese banks to reduce exposure, but instead signaled concern by 
asking for daily reports on such exposure, according to Zhang. 
 
¶3. (SBU) Zhang said his bank had suffered direct Lehman bond losses 
of approximately USD 70 million and losses of 20 percent on its 
approximately USD 1 billion in holdings of fixed income and equity 
of U.S. financial institutions.  However, he emphasized that CMB was 
less exposed to U.S. assets than China's biggest banks.  He praised 
U.S. government efforts to stabilize financial markets. 
 
¶4. (SBU) Before Lehman's collapse, Zhang had expected the financial 
crisis to be over in one to two years, but he now expects a longer 
period of weak growth.  He said the "panic" in financial markets 
appeared less threatening now, however, his bank was preparing for 
difficult conditions in the near and medium term, citing the 
slowdown in China's export growth and real economy.  China's top 
banks (China Merchant's is the sixth largest) have set aside a total 
of RMB 15 billion (approximately USD 2.2 billion) for possible 
write-downs, according to Zhang. 
 
¶5. (SBU) Guangdong Development Bank (GDB) President Michael Zink 
described a recent meeting he had with local officials in 
Guangdong's coastal city of Zhanjiang where Communist Party leaders, 
sugar factory owners and representatives of local sugar cane farmers 
pressed GDB to provide interim financing to pay for harvesting and 
processing of the current crop.  They pressed him arguing that such 
financing would prevent disgruntled sugar cane farmers from "burning 
down government offices."  Zink speculated that few such meetings 
end as this one did because, in this case, the bank was represented 
by a non-Party member.  GDB agreed to provide financing only after 
the government identified buyers for this year's crop, but without 
committing to incur losses to support the area's largest sugar 
company or sacrificing the bank's fiduciary duty to shareholders. 
 
Predictions of an Extended Economic Downturn 
-------------------------------------------- 
 
¶6. (SBU) Vice CEO of Shenzhen Stock Exchange (SSE) Dai Wenhua 
predicted an extended downturn, amplified by slowing export growth 
and declining real estate values in south China.  Dai said this was 
the first "real financial crisis" to seriously impact China since 
the country adopted its reform and opening policies 30 years ago. 
New initial public offerings ceased in October as central government 
regulators stopped authorizing new listings, and the 
 
long-anticipated launch of a new SSE board for small companies now 
appears indefinitely postponed until market conditions improve (ref 
A).  In addition, Dai said Chinese qualified domestic institutional 
investors (QDII - those who bought foreign securities via licensed 
mainland dealers) had seen their investments drop by an average of 
40 percent, spurring many calls from upset investors, and a possible 
area of concern for government authorities concerned about broader 
social stability.  Dai also expects a slowdown in the development of 
Chinese derivative markets. 
 
Inherent Contradictions in PRC Responses 
---------------------------------------- 
 
¶7. (SBU) Shenzhen Development Bank (SDB) President Frank Newman said 
south China's current economic difficulties, and the options 
available to prevent greater damage, were hampered by structural 
weaknesses in the domestic financial system.  Weak and 
over-regulated equity markets, as well as under-developed bond 
markets, mean that bank loans are the only real source of financing 
for struggling companies, especially small and medium sized 
enterprises (SMEs) (ref B).  Although the government has eliminated 
lending caps and encouraged banks to step up lending, neither the 
government nor banks are willing to accept additional risk given 
concerns about excess production capacity among many borrowers and a 
deteriorating outlook for demand for manufacturers' products.  As a 
result, China's recent interest rate cuts are unlikely to spur 
lending, according to Newman.  He also expressed concern that the 
government had cut lending rates more than deposit rates, thus 
squeezing banks' intermediation margins at a time when 
non-performing assets were expected to rise and put downward 
pressure on profitability. 
 
Continuing Risks for Banks 
-------------------------- 
 
¶8. (SBU) Each of the three bankers expects a rise in non-performing 
loan ratios as growth slows, particularly among private SME 
exporters.  The biggest banks will also face lower fee-based 
earnings as local investors trade fewer mutual funds and other 
equity-related financial products due to the weak stock market. 
Less systemic threats include property-related lending schemes that 
some property developers and wealth management firms used to 
circumvent lending quotas.  In one scheme, property developers would 
threaten their banks with default unless the bank agreed to extend 
favorable mortgage terms to home buyers.  In other cases, funds of 
banks' wealth management clients were channeled to trust companies 
who then made an "equity investment" in property developers with "a 
guaranteed return" (thus allowing banks to circumvent loan limits). 
Even though these assets and liabilities are off balance sheet, 
reputational risks could force banks to make their best customers 
whole in case of losses.  Thus, as a result of these and other 
possible schemes, banks' actual exposure to the property sector was 
higher than senior management had thought. 
 
Unrealized Opportunities? 
------------------------- 
 
¶9. (SBU) SDB's Newman suggested that the lack of exotic and 
sophisticated financial products insulated many of China's banks 
from the worst problems seen in U.S. and E.U. institutions.  At the 
same time, the role of these products in the crisis may make it more 
difficult to convince China's regulators that continued innovation 
in financial products like derivatives is in the country's best 
interests. 
 
¶10. (SBU) One banker told us that the lack of merger and acquisition 
activity between medium and small Chinese banks is an unrealized 
opportunity.  He said several of the strongest city banks would be 
excellent takeover candidates for strong regional banks like SDB and 
GDB.  He theorized that the absence of these transactions might 
indicate a prevailing aversion to such deals by local officials, 
especially when viewed in comparison to the recent pace of PRC banks 
taking over competitors in Hong Kong and Macau. 
 
Comment: Hard Times, But Not Impossible 
--------------------------------------- 
 
¶11. (SBU) With high exposure to the export sector, bankers in south 
China are generally more concerned than their colleagues in other 
regions about the short and medium-term outlook.  This exposure 
primarily takes the form of loans to small and medium-sized private 
exporters, which are less likely to gain direct government support 
than home mortgages or loans to real estate developers.  However, 
each contact expressed optimism that his institution would weather 
 
the downturn and continue to remain profitable, albeit with greatly 
reduced profits.  Interlocutors were cautiously optimistic that 
although local government officials would press banks to help 
struggling businesses to maintain employment and ensure social 
stability in isolated cases (particularly as these local governments 
have been forced to compensate workers of bankrupt firms for unpaid 
wages), regulators would not force banks to prop up unviable 
enterprises to a systemic extent, as during previous severe cyclical 
downturns.  Such an approach would undermine the longstanding 
efforts of both senior bank management and regulators to turn 
China's banks into more commercially oriented enterprises. 
 
JACOBSEN