China Has A Little Bank Run

Is China starting to implode financially as well? If so, what will this mean for the U.S.?

From the FT:

Hundreds of depositors have raced to pull their cash from a small rural bank in eastern China, forcing local officials to take emergency measures to calm the panic after the bank run began to spread.

…But it has also been a localised event, contained to one farming county where lightly regulated credit co-operatives and loan guarantee companies failed this year after mismanaging funds.

…With the panic reaching other branches of the bank, the government intervened on Wednesday. In a video posted on the local government’s website, the governor of Sheyang county promised depositors that their money was safe. Tian Weiyou, the governor, said that People’s Bank of China, the central bank, would protect depositors.

At least Rmb80m was wiped out in Sheyang county this year when credit co-operatives and loan guarantee companies closed suddenly.

Zang Zhengzhi, chairman of Jiangsu Sheyang Rural Commercial Bank, blamed the bank run on worries sparked by these earlier collapses. “Because ordinary people here have been scammed by the credit guarantee companies, when they hear that the banks might also have problems, they come right away to pull their cash out,” he told state radio.

Here’s how it started, from Reuters:

The rumour spread quickly. A small rural lender in eastern China had turned down a customer’s request to withdraw 200,000 yuan ($32,200). Bankers and local officials say it never happened, but true or not the rumour was all it took to spark a run on a bank as the story passed quickly from person to person, among depositors, bystanders and even bank employees.

Savers feared the bank in Yancheng, a city in Sheyang county, had run out of money and soon hundreds of customers had rushed to its doors demanding the withdrawal of their money despite assurances from regulators and the central bank that their money was safe.

The panic in a corner of the coastal Jiangsu province north of Shanghai, while isolated, struck a raw nerve and won national airplay, possibly reflecting public anxiety over China’s financial system after the country’s first domestic bond default this month shattered assumptions the government would always step in to prevent institutions from collapsing.

Rumours also find especially fertile ground here after the failure last January of some less-regulated rural credit co-operatives.

From FTAlphaville, Deutsche is recommending deposit insurance:

We think deposit insurance is the most important step in the process of educating or reforming depositors. A deposit insurance regime that protects only bank deposits – i.e., probably not trust company accounts, wealth management products or liabilities of other non-bank financial institutions – will for the first time inform depositors of the relative risks involved in different types of financial products. It should be expected that some deposits now held in un-insured accounts will flow back to deposits in insured institutions.

Deposit rate liberalization will likely follow and is expected to lead to an increase in interest rates. But by clarifying what is guaranteed and what is not, deposit insurance will likely help to limit the rise in bank deposit rates relative to interest rates on other retail products. Deposit insurance is the next step in the process of educating depositors about risk.

Interestingly, while deposit insurance is generally viewed as having contributed to moral hazard in banking in the US – by providing a guarantee where none existed before – the opposite is likely to be true in China. By removing guarantees where they are believed to exist, deposit insurance in China should enhance market discipline. This is the conclusion, for example, of Gropp and Vesala (2001), who find that the establishment of explicit deposit insurance systems in Europe significantly reduced risk-taking by banks because it implied a de facto reduction in the scope of the safety net for banks.

The argument is that when interest rates are floated, deposit insurance will prevent a flood of savings out of small banks and towards big. Sounds familiar. Deposit insurance is a sensible enough precaution.

 

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