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China's banking system a ticking time
bomb
By Lynette Ong
China's
banking system is like a ticking time bomb. Saddled by
mountains of bad loans and insufficient capital base,
collapse of the state banks will cause an implosion of
the Middle Kingdom, predict many doomsayers. Many say
time is running out as foreign competitors are slated to
pry open the banking sector in 2006, as China pledged to
open up the sector as part of its commitment to the
World Trade Organization (WTO).
However, whether
or not foreigners are allowed to compete is beside the
point - as any trade bureaucrat will tell you, there is
more than one way to dodge WTO obligations. The key
issue: if unreformed, the ailing state banks will indeed
drag the Middle Kingdom down.
Two of the four
state-owned banks, the Bank of China and the China
Construction Bank, have each received US$22.5 billion to
plug the massive holes in their capital bases. The $45
billion (373 billion yuan) cash infusion by the
government comes from the country's foreign-exchange
reserves, which topped $448 billion at the end of 2003,
the world's second-largest, thanks to the surge of "hot
money" flowing into China from speculators eager to
profit from a revaluation of the yuan.
These two
banks are widely expected to be floated on the stock
market in the next one to two years. The recent move
represents a government's attempt to "dress them up",
making them appeal to potential investors.
The
initial public offering (IPO) is expected to raise $5
billion to $6 billion for the government. While raising
capital may be the intention of most owners of private
companies when they go for an IPO, this isn't what the
Chinese government wants most. The authority is hoping
that by floating them on the stock market, the market
and the new shareholders will discipline the banks, and
that will make them run like "real commercial banks".
There is little "market discipline" in the
banks' lending - many of the loans are state-directed to
support the faltering state-owned enterprises that
hemorrhage millions of dollars every year; while shying
away from private enterprises, often small and
medium-sized, which are rapidly growing and creating
jobs for the economy. Starved of seed capital, these
entrepreneurs often have to rely on savings from
families and relatives, or turn to underground creditors
who charge exorbitant interest rates. Lack of access to
the capital market is a major impediment to the
mushrooming of these private enterprises.
Why
the Bank of China and China Construction Bank?
These two banks appear to be the best in the barrel
of rotten apples. Traditionally each of the four state
banks has its own specialized role: the Bank of China
provides trade finance for dealings with foreign
companies; the China Construction Bank provides funds
for construction and fixed-asset investment; while the
other two - the Agricultural Bank of China and the
Industrial and Commercial Bank of China - specialize in
agricultural lending and working capital loans to state
industrial enterprises, respectively. Their market
niches come as a blessing for the Bank of China and the
China Construction Bank - trade financing and housing
loans are growing far more swiftly than credit to rural
enterprises or state-owned industrial companies, which
are the turfs of the other two state-owned banks.
Against the backdrop of a rapidly expanding
economy, the Bank of China managed to trim its
non-performing-loan ratio to just under 18 percent at
the end of October last year, and the China Construction
Bank to 11 percent. So far, the Bank of China is the
only bank with a capital adequacy ratio over 8 percent,
which is the minimum required by the Basel Accord, an
international convention on banking standards.
Both banks also appear to be profitable. In the
first three quarters of last year, the Bank of China and
the China Construction Bank were reported to be making
pre-tax profits of 20 billion yuan ($2.4 billion) and 9
billion yuan ($1.08 billion) respectively. Though these
figures have been adjusted for bad loans, many observers
still question the ways in which loans are classified in
the Chinese banking system. But this hasn't stopped big
investment bankers from eagerly queuing up to advise
them on their forthcoming market debut. The Bank of
China also saw the oversaw the public listing of its
Hong Kong unit two years ago.
Is $45 billion
going to solve the problem?
Restructuring the bad
debt is indeed critical in for the banks to carry on.
Taken together, the non-performing-loan ratios of the
four state-owned banks range from 22 percent to 40-50
percent, depending on whether one trusts the numbers
produced by the China Statistical Bureau or independent
credit analysts. They are technically insolvent by any
standard.
However, by cleaning up the balance
sheets or listing them on the stock market, the
government is only treating symptoms of the problem and
not addressing its root cause, which is poor corporate
governance. After all, this isn't the first bailout the
banks have received - the last two totaling 1.7 trillion
yuan ($205 billion) were handed out in 1998 and 1999.
Why would it be any different this time?
The
state banks still suffer from poor corporate governance.
There is no independent management committee, board of
directors or supervisory council that create checks and
balances on those key power holders or curb the use of
power for personal gains. There is also inadequate
internal control mechanism to regulate the flow of funds
against misappropriation. Bank managers face an
inadequate reward system, which often means they have to
resort to kickbacks and bribes to supplement their
paltry officially sanctioned salaries.
In such
an environment, it is not difficult to conceive why a
bank manager would not keep rolling out loans to
state-owned enterprises, even though they are fully
aware there is little prospect of recovering the loans.
In fact, it is well known in China that bank managers
have a disincentive for lending to private enterprises
because they could lose their jobs if a loan to a
private company goes under, but not if it's a
state-owned firm. It is commonplace in China for mayors
or party officials get top appointments in banks as a
retirement package.
It is this entanglement of
politics and finance that makes reforms of the banking
and the state enterprise systems an extremely arduous
task for the policymakers. Writing off bad loans or an
IPO isn't going to untie the knot if the banks are not
forced to confront the fundamental problem.
Lynette Ong, an economist by training,
is a long-term observer of the Chinese economy. She is
working on her doctoral thesis on the political economy
of China's rural financial reforms. She writes from
China and the Australian city of Canberra. She can be
contacted at LHLO@lycos.com.
(Copyright 2004 Asia Times Online Co, Ltd. All
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