Chinese Mini-Bank Runs: Show ‘em the Money and Deposit Insurance

The other day I posted here of a mini-run of a small Chinese rural bank in progress. 

What course of action has been taken in order quell the run? 

Well, Show ’Em the money!!! Literally.

From the Guardian: (bold mine)

Rural banks in China's eastern city of Yancheng stacked piles of money in plain view behind teller windows to calm depositors queueing at bank branches for a third consecutive day, following rumours they had run out of cash.

According to residents of Sheyang county, panic began on Monday with a rumour that a branch of one local bank turned down a customer's request for a 200,000 yuan (£19,500) withdrawal. Banks declined to comment and Reuters was unable to verify the rumour.

The affected institutions are tiny compared with the scale of China's financial sector, and the rush for cash appears to be an isolated incident so far. Rumours found especially fertile ground there after a failure of three less-regulated rural credit co-operatives last January. Yet the news caught nationwide attention, reflecting growing public anxiety as regulators signal greater tolerance for credit defaults.

Well did show 'em the money work? Unfortunately not. (bold mine). From the same article...

Despite repeated appeals from local officials for calm, by Tuesday the run had extended to another local bank, the Rural Commercial Bank of Huanghai, residents said.

Earlier on Wednesday police and security guards stood by as dozens formed a long queue outside while an electronic sign urged depositors not to be worried by rumours.

The governor of Sheyang county, Tian Weiyou, posted a two-minute video statement on the county government's website on Wednesday, urging depositors not to panic. In it he said: "Please be assured that the People's Bank of China and the rural commercial bank system will ensure the interests of all depositors will be protected. The county's rural commercial banks will ensure that there will be enough funds for depositors to withdraw at any given time."

As one would note, "tiny" and "isolated" in the above report seem to have been negated by "extended to another local bank"

What this instead shows is the periphery-to-the-core dynamic in motion or the contagion from the fringe moving into the center.

The article goes on to advocate deposit insurance as a solution to the banking system's debt problem. 

But deposit insurance will signify a short term solution that comes not only at the cost of taxpayer money but also increases systemic risks from moral hazard—tendency to take on more risks because the costs of the risks will be borne by another party—in the long run.

As International University of Geneva Professor Frank Hollenbeck explained at the Mises Institute (as applied to the US) [bold mine]

Deposit insurance is one of the two factors which allows banks to take such risky gambles. Created in 1933, it is a perfect example of government policy that ultimately will be determined to have done more harm than good. It was supposed to reduce risks, but has done just the opposite. When governments provide flood insurance the private sector would never consider, people then build homes in areas prone to suffer from severe flooding.

Prior to deposit insurance, people were careful about where they deposited their money to pay rent or food bills. If a bank ran into trouble by undertaking poor lending practices, people would quickly try to pull their money out of the bank. Bank runs were a good thing because runs served to force banks to be extremely careful about their lending practices. The threat of a bank run maintained sound incentives.

Deposit insurance is a perfect example of Frederick Bastiat’s parable of the broken window: what is seen, and what is not seen. For about 70 years, bank runs have been eliminated; giving depositors what some would say is the illusion of protection. That is what is seen. What is not seen is, without insurance, banks would have been taking much less risks with deposits, and governments would have been less able to finance spending through bank purchases of their bonds.

In other words, deposit insurance is a privatize profits-socialize losses transfer mechanism that works in favor of the banking system charged to taxpayers.

And this also means that a lot today’s global financial and economic imbalances, aside from inflationism, stems from many other price distorting regulations such as deposit insurance. 

Two wrongs don’t make a right. 

China's problems has been about massive accumulation of unproductive debt fueled by fractional reserve banking, thus markets should clear such imbalances.

Meanwhile, the periphery to the core “run” on Chinese institutions continues…
 
Updated to add: With the shrinking availability of domestically sourced liquidity as the financial spigot have been closing, Chinese developers have reportedly tapped on a new way of financing: cross border Commercial Mortgage Backed Securities (CMBS).