The global economy finds itself in a synchronised slowdown, with growth downgraded to as low as 3% in 2019, the lowest since the Global Financial Crisis. Adding to the economic tensions is COVID-19, which has brought the world economies to a near shutdown phase as they adopt preventive measures inclusive of complete lockdowns. What is more concerning is the fact that the two major engines of global growth, the United States of America and China, are the worst hit among many others. What makes the economic crisis worse in China? It is the worsening predicament of the banking sector which becomes a matter of immediate concern as China’s banking sector is three times larger than the size of its entire economy. The gigantic Chinese banking sector is capable of dwarfing out banking sectors in other parts of the world, including that of the United States of America.

The 2019 China Financial Stability Report published by the People’s Bank of China officially deems 586 out of 4,379 Chinese lenders to be ‘high-risk’. The figures came into light only after the failure of a third bank within three months as national economic growth manifested a 30-year low. The Hengfeng Bank has become the third bank, after Baoshang Bank and Bank of Jinzhou, to suffer an economic collapse after a $40 trillion debt. But the Chinese government isn’t exceedingly famous for its honesty and transparency, thus the reported figure is likely masking the true extent of the banking quandary.

The Chinese government has bailed out many of the high risk lenders. Precarious private shareholders have been effectively replaced by the ones backed by the state, often weaker in terms of their finances. The fact that bailouts are offered only for companies whose bankruptcy has a grave adverse impact on the economy as a whole and not just on a specified sector, cannot be ignored. Moreover, any amount of bailout allocated to this sector will have a domino effect on the Chinese economy which will be several times greater. For instance, the banking system calls for a 5-6% bailout which is equal to 20-24% of the Chinese GDP. A bailout of 20% of the GDP is a non-viable deal for any economy, even if it is China. The numeric is a statement of the fact that any pebble aimed at the banking sector shall bring ripples to the entire economy that in turn will shake China’s status of being a global economic power.

The People’s Bank of China conducted a stress test in the first half of 2019 on 1,171 commercial banks, 7.7% were stated to be at ‘extreme risk’ and deemed incapable of absorbing even a light shock, 13.6% will probably not be able to endure the financial crisis that shall follow. In November, Yingkou Coastal Bank and Yichuan Rural Commercial Bank – despite boasting healthy capital adequacy ratios – suffered bank runs as customers rushed to withdraw cash, fearing that the banks would close down, displaying a lack of confidence in banking institutions. The current situation is very similar to the one that cropped up in the late 1990’s. Towards the end of 1997, 20% of the main banks were non-performing, which was equivalent to a value of ¥1.19 trillion on the books of state-owned banks, which was deemed to be equal to 15.6% of the GDP. In order to resolve these crises and recapitalise the banks, ¥270 billion of special government bonds were issued and injected by August 1998. Walking on the same rope, the Chinese government is peddling its way through the crisis by adopting a somewhat similar technique. Today, the interbank market has been injected with around ¥2 trillion by the People’s Bank of China after the Baoshang Bank collapse. Along with this, a helping hand of the sovereign fund, China Investment Corporation, the Central Huijin Investment Company is injecting ¥60 billion into Hengfeng Bank. One of the 12 nationwide joint-stock banks in China, Hengfeng Bank is stacked up with non-performing loans and the situation became grimmer as the bank’s former president was handed out a death sentence for purloining funds.

Despite the similarities, overlooking the different macroeconomic situation shall prove fatal to the Chinese economy in the present scenario. The key antidote for the crisis back then was the spurt of hyper economic growth in the early 2000’s. If China wants to avoid tormenting its economy with the inevitability of bad loans and its weakening banking structure, it will have to aim for a masterful economic growth. However, this stands as a challenge with the outbreak of COVID-19 and its likely aftermath on the global economy. Secondly, continuous evolution over the years has resulted in an entwined and fragile banking structure. The financial system in modern times has given rise to an integrated market that ensures banking transactions are speeded up and are facile in nature. Since the speed of transactions and their impact on the economy is brisk, it also means that any kind of shock in the structure is transmitted faster than ever before.

The corporate and interbank customers suffer heavy losses, the volume of negotiable certificates of deposit—which are securities traded between financial institutions for short-term liquidity—has plunged by 90%. The situation threatens to cause the entire banking system to seize up as small and medium-sized banks are heavily dependent on liquidity in the interbank market.

The crisis should be an eye-opener for the administration as it calls for reforms in the entire financial system which has been overreliant on its banking sector for channeling funds. The fact that the financial structure has changed barely in the last fourteen years is an explanation for the crisis at hand. The world continues to keep a close watch on China, as this crisis is far too big to ignore because any large scale disruption in the driving engine of the global economy will lead the other economies into recession.