Xi, Henan, and China’s Growing Financial Crisis

In July, videos of tanks supposedly rolling onto the streets of Henan circulated online, with many posts drawing comparisons to the Tiananmen Square Massacre. While the video was later refuted – the Associated Press confirmed the tanks were taking part in a military exercise in another city more than 400 kilometers away – the recent incident put the current Chinese banking crisis under the spotlight. Protesters had indeed gathered in Henan after being unable to access their savings and faced violent retaliation from police.

As the 20th National Congress approaches, this crisis raises many questions: What does this crisis mean for the Chinese economy? What has spurred its advent and how does this reflect on Xi Jinping and the upcoming National Party Congress?

The Origins of the Henan Incident

Much of the Chinese middle class invests in real estate. In China, the real estate sector accounts for around 24 percent of gross domestic product (GDP) – almost a quarter of the nation’s GDP. However, debt grew alongside the boom in real estate after 1998. Apprehensive of the financial disaster that might result if the situation remained unchecked, in 2020 the Chinese government introduced a policy to oversee and handle loan regulations for the real estate sector, commonly known as the “three red lines . ” The policy requires developers to meet three criteria to forestall debt risks: a liability-to-asset ratio lower than 70 percent, net debt-to-equity ratio of less than 100 percent, and a ratio of cash to short term borrowings of less than 1.

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In 2021, developers such as the China Evergrande Group – one of the largest property developers in China – defaulted on their interest payments, eventually leading to a slump in the entire industry. By June 2022, the situation worsened: sales and home prices fell, construction dropped, property loan growth slowed, and consumer confidence weakened. Protests erupted across the country over the mortgage crisis and banking crisis, despite the market exhibiting signs of stability.

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China’s financial system is under extreme stress, brought on by its “poor capital turnover , ” liquidity stress, and the global and domestic economic slowdown, fueled by the dynamic zero-COVID policy at home and the Russia-Ukraine conflict abroad. China’s slowdown is causing global anxiety over China’s banks and real estate market. The increased systemic importance and interconnectedness of Chinese banks in the global financial system deepen spill-over risks, which may adversely affect global financial stability. Similarly, the Chinese real estate market is closely intertwined with the global market. A faltering Chinese economy, brought about by a struggling property market that would worsen the banking crisis, would have global consequences.

An Economy in Trouble

On July 10, over a thousand furious customers staged a mass protest at a Bank of China branch in Henan, demanding their savings be returned. The protestors were beaten up by a violent mob of unknown men in white shirts.

The incident in Henan was one in an array of recent protests this year linked to the banking crisis in China. Local banks in China have been plagued by systemic issues and risk, caused by increased housing prices, policy uncertainty, and shadow banking. After the Global Financial Crisis, smaller banks and financial institutions were found to have a greater influence on the interconnectedness and stability of the Chinese banking sector.

Henan’s financial crisis emerged from its provincial capital Zhengzhou, which is considered “ground zero” of the crisis. Over 40 billion renminbi is missing from bank deposits in Henan. Back in April, four rural banks in Henan – Shangcai Huimin County Bank, Yuzhou Xinminsheng Village Bank, New Oriental Country Bank of Kaifeng, and Zhecheng Huanghuai Community Bank – and one in Anhui – Guzhen Xinhuaihe Village Bank – notified depositors that their accounts had been frozen and they would not be able to withdraw money. Further investigations revealed that a private firm, Henan Xincaifu Group, had stakes in all of these banks and had embezzled funds through the use of fabricated loans and internal and external collusion.

Furthermore, not only does central China’s Henan province have to witness the unraveling of the nation’s “biggest bank scam , ” but it simultaneously also has to deal with the mortgage crisis. Clients are boycotting loan payments, given that developers find it difficult to complete and deliver unfinished housing projects. The increasing mortgage boycotts have led authorities to be concerned that more homebuyers will follow suit. Lenders now have to deal with both cash-strapped developers and homebuyer and supplier defaults. The refusal to make loan repayments has resulted in losses being incurred in bank shares, indicating that China’s property crisis will bleed over to the financial system as well.

According to estimates from Jefferies Financial Group Inc., a full default on the stalled projects would lead to an influx of 388 billion RMB ($58 billion) in non-performing loans. A group of 15 Chinese banks, including China’s largest mortgage lender, China Construction Bank Corp., disclosed that the “risks are controllable” as their exposure to delayed projects has been limited. Still, there remains the possibility of instability in the banking system, which could strain China’s economic growth.

Beijing faces a dilemma in dealing with the two-pronged problem. Easing lending regulations for homebuyers may lead to them taking unfair advantage of implicit government guarantees. On the other hand, restrictions on bank withdrawals might make matters worse by debilitating an already unstable banking system entangled with the real estate sector at the core of the matter.

CCP’s Response to the Financial Crisis

According to a Bloomberg report, an emergency meeting was held between the Chinese Ministry of Housing and Urban-Rural Development, major banks, and financial regulators to discuss the growing mortgage crisis. These events have prompted local authorities to set up task forces to focus on resuming work on unfinished projects and mitigating the systemic risks posed by defaulters.

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Chai Xin, a financial markets commentator, said that the Chinese Communist Party (CCP) is most concerned with “wavering public trust” in the Chinese banks. After the protests outside the China Banking and Insurance Regulatory Commission (CBIRC) in Shaanxi on July 14, authorities have moved to reassure citizens that they will be compensated and have promised stricter regulation of pre-sales of houses, to retain public confidence in the banks. The boycotts are politically sensitive as the CCP covets social stability above anything else before the upcoming National Party Congress.

The CCP has made attempts to allay concerns about the banking crisis amid the current mortgage crisis in Henan. A working team has been set up, consisting of the Henan Asset Management Company (AMC) and the state-owned Zhengzhou Real Estate Group, to address and curb the crisis ahead of the 20th National Party Congress. The team will focus on reinvigorating stalled projects, restructuring businesses, and ensuring the completion of housing projects. Premier Li Keqiang has been constantly engaged with the local authorities of Henan to fix the current crisis. Sun Tianqi, the director of the Financial Stability Bureau of the People’s Bank of China, has stated that the CCP is guiding local governments and banks to respond to the ongoing crisis in a manner that fulfils their duty to the people appropriately. He also stated that “99 percent of China’s banking assets are stable and under safe parameters.”

It can be observed that the CCP is attempting to downplay the current crisis and ease tensions flared up by the protests. Moreover, through the actions taken by the party to reverse the damage caused by the crisis, one can recognize that the words and actions of the CCP appear contradictory. Beijing seems to be downplaying the crisis for its global audiences as well. Given that China houses some of the world’s largest banks, there is increased global attention on the CCP’s response to the crisis amid concerns about a possible recession.

How Does This All Reflect on Xi Jinping?

Unlike other forms of government, China’s political structure ensures the CCP’s powers expand beyond the political realm. The party has control over the market, the judiciary, and more, with its chairman, Xi Jinping, at the center. The party has also decentralized its rudimentary roles to local leaders that are part of the CCP, localizing accountability to the local government.

As the Henan protests continue, protestors have made it clear that they are “against the corruption and violence of the Henan government.” They have not mentioned the Communist Party of China; instead, they have invoked a sense of patriotism in their protests and have used Xi’s “Chinese dream” slogan to put forth their appeals to the central government and protest the local government’s crackdown.

Lou Yansheng, the party secretary of Henan province, wrote a public letter addressing the protesters. In the letter, Lou reminded the protesters about Xi’s commitment to ensuring the betterment of the people and said that the CCP became a better leader under Xi’s guidance. Lou informed the protestors that Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era must be upheld and adhered to at the highest level.

The letter also highlighted the steps Xi has taken for progress in Henan through comprehensive reform, uplifting people’s lives, and developing the region. Lou’s letter gives an interesting insight into Xi’s authority and leadership – throughout the letter he repeats that Xi’s policies are essential to adhere to as protests continue. Moreover, the letter reassured the protesters that Xi is observing the situation closely and urged them to keep their complete trust in Xi and the Chinese government’s ability to contain the crisis.

Xi Jinping, sitting atop the political hierarchy, enjoys a lot of public trust, and this is unlikely to change amid the current crisis. According to a study conducted by Tianjian Shi, Chinese citizens have a lot of trust and belief in their political institutions, expressing extreme trust in the CCP, the People’s Liberation Army (PLA), and the National People’s Congress. The study also found that people had a lot of distrust toward local governments, explaining why Chinese citizens have localized their protests. Hence, the national-level CCP remains independent from protests against the local government, despite having overarching control over the entire political chessboard. Nonetheless, civilian protests of such a scale and the impending threat of bank runs pose a hurdle in the CCP’s quest for realizing China’s “rejuvenation.”

As the ongoing banking crisis in Henan unfolds, its impact on the larger political future for Xi Jinping and the CCP remains to be seen. It can be assumed that based on the emergency created, Xi and the central party leadership will look to take control of the narrative and incorporate the financial tensions in the agenda building up to the National Party Congress. Presently, as seen with Xi’s travels within China in the past year, maintaining unity and stability in the “firm leadership of the party” is critical to the political environment. Should the ongoing crisis continue, along with already high public dissatisfaction with the zero-COVID policy, protests against local governments could intensify, forcing Xi to take action to retain public trust.

The piece was originally published by the Organisation for Research on China and Asia (ORCA)