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China's $45 billion bank headache
By Li Yong Yan
BEIJING - In
a desperate and unprecedented move, China has pumped
US$45 billion into two of the big four state-owned
banks, encumbered by bad loans to lumbering state
enterprises. This is part of an effort to improve the
nation's finances and prepare the financial institutions
to join the international marketplace in 2006. The
consequences are uncertain.
The government
announced on Tuesday that it has paid $22.5 billion each
to the Bank of China and the China Construction Bank.
The amount, intended to shore up the banks, was paid out
of Beijing's $400 billion foreign reserves. The
transaction was intended to help shore up the banks so
that they could sell stock for the first time, China's
central bank, the People's Bank of China, said in a
statement on Tuesday.
In another move toward
reform and liberalization, since January 1 the
government has allowed financial institutions to
dramatically adjust their lending rates to reflect the
risk profiles of clients, many of them very high risk.
The other two of the big four banks are the
Industrial and Commercial Bank of China and the
Agricultural Bank of China. For years they have been
lending to unprofitable state enterprises and hold
astonishingly high levels of non-performing loans.
The $45 billion injection of capital is designed
to increase the two banks' capital adequacy ratio over
the minimum 8 percent level required under the Basel
Capital Accord, a financial framework devised by Basel,
Switzerland's Committee on Banking Supervision. Its
intent is to improve safety and soundness in the world
financial system.
The money transfusion is one
of the first concrete steps to speed up the
commercialization of state banks. More significant,
Beijing hopes that this fresh capital will contribute to
the nation's financial stability in general and help the
banks better cope with upcoming international
competition. In 2006, China's banking sector will be
opened to foreign financial institutions and investment
bankers under its World Trade Organization (WTO)
obligations.
Though this large capital relief is
short term, it will also pave the way for the fully
state-owned banks to be listed on the stock market in
order to raise more capital. Since the state banks have
never fully and publicly disclosed their financial
status, nobody knows for sure just how inadequate the
capital ratio is in the big four banks. By most
estimates, none is over 7 percent, except for the Bank
of China.
But a poor capital ratio is only part
of the problem facing China's state banks. A bigger
threat to the financial health of the country is the
mountain of bad debts bearing down on the
under-capitalized banks. How bad are the bad debts? The
government, like its banks, doesn't give hard
statistics. The only admission from the Central Bank is
a percentage: the average of bad loans at the big four
stands at 22.2 percent. It is known, however, that the
equivalent of $181.6 billion in non-performing loans has
been assigned to assets management corporations
fashioned after the US corporations set up after the US
savings and loan debacle of the 1980s.
Another
$242.1 billion worth of bad debts is expected to
disappear from the balance sheets of those four banks in
the near future. More dramatic developments are
expected. Overseas rating agencies estimate the total
non-collectable debts in China's financial institutions
at $600 billion. If those agencies have an inside track,
then observers and investors could brace for another
$176 billion recognized as having been unrecoverable
loans.
The banks face a monumental task: writing
off huge bad debts, providing for new, possibly
questionable debts and increasing their capital ratio to
a generally accepted level - all concurrently and in
short order. Time is running out. For these banks to
make enough profits to meet the challenges, it will take
at least 20 to 25 years, assuming the economy is growing
at the current rate and no additional large debts
accrue.
By that time, however, the
well-capitalized, efficient and innovative foreign banks
that are waiting in the wings will have eaten the
Chinese banks for breakfast, lunch and dinner - and it
remains to be seen whether there is a tomorrow for the
domestic financial institutions. The reason: after 2006,
China will be obliged to give equal and non-differential
treatment to foreign banks that can then capitalize on
their financial strength to offer a variety of
time-tested products and services to Chinese clients.
There will be no limits on the establishment of branches
and range of offerings.
As a result, they will
gain open access to China's capital markets, against a
backdrop of market-based interest rates and most likely
a freely convertible local currency. Beijing will have a
harder time keeping its banks in business once WTO
obligations are fully met. The irony is that nearly all
of the bad debts piled up at the state banks are
attributable to the government's own mismanagement and
widespread corruption by its own employees.
Multi-billion dollar government-financed
projects are sometimes shut down the very day they are
completed. A petrol chemical plant is built in a city
with no oil production of its own, and too far away from
the nearest sea port. A thousand-mile gas pipeline is
constructed before it is learned that the supposed
supply is a non-existent gas well faked by local
officials to inflate their "achievements". One bank
president absconded with a billion dollars. Another
high-flying banker lent millions to his golfing pals,
who then vanished from the greens, and seemingly from
the face of the earth overnight. The waste is enormous
and devastating.
Beijing, aware of these
problems, has vowed to root out the corruption at
financial institutions and improve management of the
assets. To supervise the injection of the $45 billion,
the government has set up a new watchdog group chaired
by the head of the National Foreign Reserve Bureau.
Regulations even prohibit the funds from being converted
into yuan, making them less easily pocketed.
It
is uncertain whether the capital injection, oversight
and other efforts will be effective.
1)
Regardless of how many layers of oversight committees
the government creates, or how hard the banks in turn
work on improving their risk management, upgrading
information systems and cutting costs, the banks are
still wholly controlled by the government. They have
little autonomy and no power to adjust interest rates
based on market conditions. They are expected to
continue to be secretive about their balance sheets.
The government will still call all the shots,
from appointing management teams to withdrawing funds at
a moment's notice for such contingencies as "stability
keeping money" - in effect, the alms given to the
laid-off workers during Spring Festival to help them
financially and demonstrate the government's concern.
A telling reminder: when Zhu Rongji was
appointed premier in 1998, he proclaimed with much
fanfare that he would turn around the ailing state-owned
enterprises (SOEs) in three years. Asked why he believed
he could accomplish this extraordinary feat, he replied:
"Because if SOEs don't turn around by then, it will be
too bad". And too late. That doesn't inspire much
confidence. Those SOEs nationwide are now in deeper
trouble than ever - and the Bank of China and Bank of
Construction themselves are SOEs.
2) On the
technical side, banks are insatiable in their demand for
capital. To bring in more revenue, they must continue to
absorb savings and increase loans. That will further
dilute their capital ratio, so they will need more money
to keep their head above the 8 percent Basel Accord
requirement for the capital adequacy ration - not to
mention the added risks of the new loans.
Of
course, the banks can finance their business expansion
and stay above the Basel requirement by raising money
from the stock market and/or by issuing secondary debt
notes. It is still unclear when or where these two banks
will be listed - the Shanghai or Shenzhen stock
exchanges, Hong Kong's exchange, even the New York Stock
Exchange's American Depository Receipt program. If a
foreign institution buys up to the maximum allowed 20
percent of a listed company, will the government allow a
US or British national to sit on the board of a Chinese
national bank?
3) A new Capital Accord (Basel
II) will be implemented in 2006. The modified financial
framework aims to improve the security and soundness of
world banking in three areas: greater risk sensitivity;
encouraging international banks to employ internal
methodologies, supervisory review and market discipline
for measuring risk and capital requirements; and
promoting flexibility through various approaches and
incentives for better risk management.
Institutions subject to the accord are required
to maintain a minimum ratio of regulatory capital to
total risk-weighted assets of at least 8 percent. The 8
percent level is risk-adjusted; that is, the 8 percent
is arbitrary, and conditioned on the safety of the
assets in a bank's balance sheet.
What kind of
quality and risks are assigned to China's banks? Here
again, there is not enough transparency to make an
independent assessment, raising further questions about
the outcome of Beijing's efforts to rescue the banks.
Other risk factors in the banks' operating environment
must be taken into consideration, including the economic
outlook, the fragile structure of the financial system
and the quality of banking regulation and supervision.
It will take much more than a few billions to
get the banks off life-support and stage a financial
turnaround.
(Copyright 2004 Asia Times Online
Co, Ltd. All rights reserved. Please contact content@atimes.com for
information on our sales and syndication policies.)
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