China and the Black Swan: Baoshang Bank of Inner Mongolia

By Jeremy Howard Oct.19,2019

            This is our story of a modern-day crisis stemming from the insolvency of a central bank in China. The Baoshang Bank of inner Mongolia has now ceased to exist and the ripples from the demise is still hampering the economic system of China—and ultimately, the world. This gloomy introduction is meant to shape your understanding of what a Black Swan event is. The truth of the matter is most people on the street have no idea of what a Black Swan event is or even the impact it has on their lives, namely economic security. Jim Chappelow (2019) defines the Black Swan Event as:

“…an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. Black Swan events are characterized by their extreme rarity, their severe impact, and the practice of explaining widespread failure to predict them as simple folly in hindsight.”

Due to their unpredictable nature, Black Swan events can cause catastrophic damage as they unfold, severely impacting national and even regional economies. The Baoshang Central Bank Black Swan event initiated in May 2019 and continues to cause mayhem to this day.

Nassim Taleb coined the term Black Swan event in his 2007 book about events quite similar to the current Baoshang Central Bank crisis. His book was released just prior to the financial meltdown of 2008. Describing the financial meltdown of 2008 as narrated by Taleb, Chappelow (2019) said,

“The term was popularized by Nassim Nicholas Taleb, a finance professor, writer, and former Wall Street trader. Taleb wrote about the idea of a Black Swan event in a 2007 book prior to the events of the 2008 financial crisis. Taleb argued that because Black Swan events are impossible to predict due to their extreme rarity yet have catastrophic consequences, it is important for people to always assume a black swan event is a possibility, whatever it may be, and to plan accordingly.”

Chappelow (2019) further explained that if a broken system is allowed to fail, then that strengthens the system against future events. The failure of the Baoshang Bank was such an event, which caused the Chinese Communist Party (CCP) to step in and take over day-to-day operations. Ultimately, they were forced to shut down the bank entirely lest its failure infect the entire Chinese economy.

Now that we have defined the black swan and its importance, the question is when did the Chinese government take over the bank and why. In the Business Insider, possible catalysts included recapitalized struggling banks and forced merges (Lopez, 2019). The strange thing is, the Baoshang Bank takeover was the only situation made public. While there appears to be several factors that contributed to the failure of the bank, there is a general them surrounding general business management in China and apparent instability. To maintain growth of the system, banks have to extend more and more credit—some of it that ends in delinquent loans, with interest rates as high as 18-24% (Lopez, 2019). Inevitably trapped in a system doomed to fail, the CCP was forced to close the bank permanently. The closure has caused severe financial distress for the CCP, with the impact continuing to interfere with bank to bank lending, the Chinese Credit Markets, cash flow, and general liquidity. Lopez (2019) of Business Insider explains that the Chinese economy has been slowing for some time, and even President Xi Jinping has been warning that things would get more difficult economically. Xi had also noted that the trade war would not be responsible for the financial collapse—that it was already imminent regardless.

There is no mercy in the banking industry. Dealing with money is a complicated job and those you entrust with your money are not always smarter than you. There is a lot of trust given to bankers and now people are starting to reconsider that trust. Since 2008, people lost a lot of faith in the system. There is a lot chatter that another black swan event could threaten the banking system again. What then? Are you prepared to withstand the crash of your bank? If your answer is no, then you may to seriously consider your financial plan. Particularly if you are holding all your eggs in one basket—and that basket is the bank.

References:

Chappelow, J. (2019). Black Swan. Investopedia. Retrieved from:

https://www.investopedia.com/terms/b/blackswan.asp

Lopez, L. (2019). There are three reasons China just took over a bank for the first time in 20

Years, and 2 of them are a huge deal. Business Insider. Retrieved from:

https://www.businessinsider.com/china-baoshang-bank-takeover-why-it-matters-2019-5