Fallout from the Chinese Housing and Banking Crises
Fallout from the Chinese Housing and Banking Crises
By: Peter Frerichs
August 20, 2024
All is not rosy in the Middle Kingdom. For years, Chinese growth leaned heavily on its real estate sector, averaging an impressive 13.4% of GDP since 2013. Like many developed countries, the Chinese coveted property ownership, which was a sign of upward progression. Presently, some estimates suggest up to 96 percent of urban households own at least an apartment or home.
In parallel, Chinese urbanization has been nothing short of impressive. The demand for homes in cities across China boomed over the past decades, but early signs of a housing bubble began to percolate before the pandemic. A big reason why owning a home is so popular in China is the country’s thin social safety net and a dearth of investment alternatives for people in a socialist market economy. Taking note, developers took out eye-popping amounts of debt to keep pace, eventually catching President Xi Jinping's attention.
The Three Red Lines
President Xi implemented regulations colloquially known as the “three red lines” to deleverage the real estate industry to ward off a housing crisis. The lines that developers were urged not to cross were:
- Maintaining company liabilities (debt) at less than 70% of their assets;
- Carrying a debt-to-equity ratio of less than 100%;
- Maintaining a ratio of cash to short-term debt of 100% or more.
In addition to the regulations, banks were also constrained from making further loans to developers. President Xi assumed these short-term band-aids could stave off a pending disaster, but in August 2021, the country’s second-largest property developer, the Evergrande Group, promptly halted construction. Overdue payments were at the core of the stoppage, and the following month, Evergrande missed two offshore bond coupon payments for a total of $131 million.
Source: Buchholz, Katharina. August 18, 2023. “Chinese Housing Market: Boom & Bust.” Statista.
Enter the Banks
By November 2021, the sheer size of the loans to developers like Evergrande began taking their toll on Chinese banks. Foreign investment dried up, and comparisons to the US Savings and Loan (S&L) crisis proliferated. As the housing market continued to collapse, several mid-tier banks went under. This was expected, but it wasn’t until relatively recently, when 40 Chinese banks disappeared, that global markets began to take notice.
China has always maintained a small banking sector that serves its rural population. Many are notoriously mismanaged and also lent heavily to real-estate developers, thus exposing themselves to the housing crisis. Of the 40 banks that disappeared, a more accurate description is an informal merger with Liaoning Rural Commercial Bank.
Receptacle Banks & Safety Nets
Banks like Liaoning were set up to be receptacles for bad banks. Established in September 2023, roughly five more banks like Liaoning have cropped up since then, all serving the same purpose. While fewer banks might make it easier on regulators moving forward, critics argue that filling bigger banks with smaller, underperforming, and mismanaged banks only creates large, bad banks.
Meanwhile, the larger banks that survive do so under the tacit agreement that the government will step in with support should the bank fail. Systemic risks are prevalent in countries like China, where the government is the principal, if not the majority, owner of the country’s predominant banks.
Global Fallout
In late 2023, China saw overall foreign direct investment turn negative for the first time in 25 years. Capital outflow exceeded inflows by approximately $12 billion in Q3 2023. Chinese debt continues to climb at an uncomfortable pace, typically a harbinger of prolonged periods of tepid economic growth or a financial crisis.
The biggest losers in the face of a potential Chinese implosion are firms that rely on domestic Chinese consumption. Companies such as Volkswagen, Apple, and Burberry receive significant annual revenue from the Chinese consumer market, and a slowdown would affect their bottom lines.
Another industry that would take a hit is raw materials and commodities producers. China buys a lot of copper every year, so countries that rely heavily on copper exports, like Chile or Australia, for example, would feel a Chinese slowdown. The same can be said of the countries where China has invested heavily through its Belt and Road Initiative. Should the economy contract, those projects would likely suffer delays.
However, perhaps the biggest worry about a Chinese collapse is not economic but political. If Xi faces intense domestic backlash due to a worsening economy, a war with Taiwan is a perfect distraction to gin up nationalist sentiment. We saw a similar playbook in World War II.
