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A clearer path ahead for China's
banks?
By George Zhibin Gu
SHANGHAI - Friday, June 17, was
no ordinary day for the Chinese banking sector,
as news spread rapidly that the Bank of
America planned to spend US$3 billion to buy a 9% stake
in the China Construction Bank (CCB), China's
third-biggest state bank, which has been planning to
float its stock on overseas markets.
Behind the cheering, most Chinese bankers were aware of
a great paradox of China's economy. For the past
26 years, even as China's gross domestic product (GDP) raced
ahead like a bullet train with annualized growth
around 9.5%, the only aspects of the banking
sector that were growing seemed to be the bad
ones: mountainous non-performing loans, capital
misallocation on a mammoth scale, and malfeasance
by bank officials. Indeed, China's banking sector
has been so deeply stuck in the mud for so long
that it has cast a huge shadow over prospects for
the sustained development of the country.
But, at last, real change seems to be in
the air: the urgent need to clean up the banking
mess has become clear to Chinese society. All of
China's "big four" state banks - the Bank of
China, the China Construction Bank, the Industrial
and Commercial Bank of China, and the Agricultural
Bank of China - are suddenly in a hurry to
restructure, reform, and generally clean up their
houses - to be reborn, in fact. The opening up and
listing of this once tightly controlled sector may
be called, without exaggeration, a banking
revolution, and one of the most important steps in
the revolution is the introduction of foreign
banking partners.
Banks dragging the
chain of economic reform
A key cause of the
banking mess was the same underlying issue that
has faced the entire state-owned sector of China's
economy: the government has employed the state
sector for its own use. Practically, this has
meant that the state companies and banks served
the needs of the government, not markets. This
twisted economic structure produced vast problems
for China's economy and society. As a result, even
as other "Asian Tigers" boomed after World War II,
poverty ruled mainland China for several decades,
made worse by waves of political chaos.
Since the economic reforms began in 1978,
private initiatives have reshaped China. Even the
state sector has gone through vast changes. Two of
the most significant changes were the involvement
of foreign investors and the booming domestic
private sector, which has become a major player in
the Chinese economy, alongside the state companies
and banks. All this has resulted in a booming
economy, which has set new records for speed and
scope of economic development. But China's banks
have conspicuously lagged. Their fortunes did not
improve with the brightening economic picture; on
the contrary, they have depended partly on
periodic capital injections for survival.
The underlying reasons lie in the history
of China's banks since 1949. For some six decades,
the state banks have not acted like "real" banks -
that is, independent businesses that are, at least
in theory, accountable to shareholders for their
successes and failures. Rather, they operated like
government units. Their key managers were
government officials who were appointed by the
central government. The actions of their employees
were controlled by numerous government offices at
all levels. In particular, the appointments of
local and regional bankers were often influenced
by provincial and local government agencies in the
area. Because of this high level of official
control, to secure their positions, bank managers
had to constantly pay attention to those
government officials who had the power to
influence their positions. Unsurprisingly, this
affected their professional conduct.
There
were additional problems built into the banking
system. Prior to 1984, commercial loans, in the
Western sense, were non-existent. Instead, all
bank funds were allocated by the government.
Rather than analyzing the creditworthiness of
aspiring borrowers, these banks simply needed to
follow government directives as to how much money
to hand over, and to whom. At the same time,
payment collections were also a governmental
affair. In fact, it is not too strong to say that
all large-scale bank transactions were
governmental affairs.
The government
domination of Chinese banks has made reform highly
difficult. True banking reform would separate the
government from the banks, making them truly
independent. Naturally, not all of the government
officials involved with banking would be pleased
by such an outcome. Yet, without making the banks
truly business-oriented and independent, any
professional, merit-based banking activity would
become next to impossible. Under such
circumstances, it is no wonder that there have
been seemingly unstoppable pile-ups of
nonperforming loans. For many years, the big four
banks have faced this dire situation: for every
$10 loaned, only $8 was collectible.
The
need for reform of the sector has become so clear
it cannot be ignored any longer. Unfortunately, in
Chinese society, the same entity that has the most
to lose from reform - the government - is also the
only entity that can initiate reform. The
sometimes-halting progress of reform efforts
reflected this dilemma.
The history of
bank reform
Serious banking
reform only began in
1999, the year the average nonperforming loan rate
for the big four banks reached a crisis level of
39% - a rate even worse than the distressed South
Korean and Thai banks which had non-performing loan
(NPL) rates around 35% during the Asian financial
crisis of 1997-98. One can hardly blame the
Chinese media for naming the big four banks
"troublemakers" - they had created huge troubles
indeed, given that the big four controlled some
70% of China's financial assets.
Since
1999, major loan write-offs as well as capital
injections have taken place. The first write-off
mounted to $170 billion for the big four banks and
occurred around the same time as an injection of
about $35 billion of fresh capital into these
capital-depleted banks. Second, four asset
management companies (AMCs), designed along the
lines of the US's Resolution Trust Corporation
(RTC), which was formed in 1989 to clean up the
S&L (savings and loan) mess, were created in
1999 to handle the written-off assets from each of
the four big banks. These four AMCs have tried in
all sorts of ways to dispose of debts. Although
the percentage of original capital they have
recovered has typically been only 20%, or less, of
the original book value, their activities
nonetheless represent a highly positive change.
Not only Chinese buyers but many leading
international banks such as Citibank, UBS, and
HSBC have actively acquired assets from the AMCs,
to the mutual benefit of both sides. Indeed,
resolving the Chinese banking mess has become an
international business.
On the
institutional side, huge efforts have focused on
reducing the unwanted interference coming from
government offices at all levels. In particular,
the People's Bank, China's central bank, has
replaced the the old provincial branch offices
with new regional offices. By design, these new
regional offices are independent of local and
provincial government establishments; it is hoped
that this will allow for more effective,
independent supervision of the banks.
Lastly, in 2003, one additional dramatic
change occurred with the establishment of the
China Banking Regulatory Commission (CBRC), which
has taken over the oversight role formerly
performed by the central bank. In general, the
banking reforms to date have been heavily
influenced by the previous experience of other
countries, particularly, though not exclusively,
the US (for example, China's AMCs were also
influenced by South Korea's KAMCO agency, which
very successfully performed an RTC-like role after
the 1997 crisis).
The CBRC's reform
strategies
The CBRC is pursuing three new
strategies for banking reform. One is to list all
Chinese banks, especially on overseas stock
markets. To gain market confidence, the government
has been injecting more capital into the big four
banks. Also, it has warned small retail banks
about potential closure if they fail to perform
satisfactorily. Because these small banks are
controlled by local and provincial-level
government units, the issuance of this warning
shows the government's level of determination on
banking reform.
The second strategy, equally
significant, is a new accountability measure. If
internal abuses occur, then the two managerial
layers above will be held responsible. If this
measure works as intended, it will be a
tremendously positive shock to the banking system,
due to the notoriously high level of malfeasance
within the ranks of bank management. Thousands of
corrupt employees, including dozens of senior
bankers such as Liu Jinbo, the ex-chief
executive officer of the Bank of China (Hong
Kong), have been arrested for stealing funds.
The third strategy is to allow Chinese banks, including
the big four, to form strategic partnerships with
foreign banks, along with permitting foreign
entities to buy shares in the banks. This
has naturally opened the door for a much greater
foreign presence in the Chinese banking sector. In
this case, World Trade Organization (WTO) requirements
have forced the government's hand: foreign banks
will gain complete access into China by 2007 under
WTO rules, so time is running out to clean up the
banks. As in other sectors of China's economy, the
sight of incoming foreign "wolves" is making the
domestic "sheep" run faster.
Foreign
involvement
As a result of the CBRC's moves,
numerous foreign investors and banks have become
significant shareholders in Chinese banks. In
particular, HSBC holds 19.9% of the Communcation
Bank, China's fifth-largest bank, whose shares
are freshly listed on the Hong Kong Stock Exchange.
HSBC also was allowed to have a seat on
the board as well as two vice presidential positions at
the bank. At some smaller banks, the government has
allowed foreign investors to become controlling shareholders.
This is what happened to the Shenzhen
Development Bank, a Shenzhen-based small retail
bank whose shares trade on the Shenzhen Stock
Exchange. The new controlling shareholder is
Newbridge Capital, a US venture capital firm.
Since late 2004, it has reorganized the bank's
management; the new chairman and the new CEO
are two highly experienced US bankers.
Such
hands-on foreign management has pointed to a new
way to shore up China's dire banking situation,
and may turn out to be a realistic way for future
progress. The foreign involvement also suggests
how difficult it would be for China to create
modern banks without the employment of modern
management and accountability as well as
well-defined ownership.
It should
come as no surprise that borrowing international
knowledge and experience can hasten China's
movement toward a modern financial sector; this
has been true in many other areas of the Chinese
economy. But the new mentality of learning from
outsiders is nonetheless very meaningful. After
all, the gradual creation of modern banking
systems has been a universal phenomenon in
developed countries; in no case did countries
start their development with a fully modernized
system. The US had many hard lessons along the
way, of which the 1929 stock market crash, which
resulted in a comprehensive set of financial
reforms, was only the best known.
Banking reform
through openness has been a strategy successfully
employed by many nations, including those
in Asia. The South Korean case, in which greater
foreign ownership and an AMC-like NPL clearance
agency were employed, is now widely seen as a
major success story that greatly helped the
country to bounce back quickly from the 1997-98
Asian financial crisis.
At the same time,
it must be said that achieving this new openness
is by no means easy. The Japanese banking system
has struggled since the 1991 collapse of the
bubble economy to extricate itself from the
financial meltdown created by traditional
cross-holdings between banks and their corporate
clients, among other causes. Japan Inc has been
trying hard to introduce foreign talent,
permitting foreign participation in the financial
sector, and adopting international standards to
deal with the problems. These are certainly
positive changes. But it remains unclear whether
the Japanese reforms have been as successful as
South Korea's, or whether Japan's economy can ever
recover the upward momentum that now characterizes
China's.
Behind the foreign
buying
Though the
Chinese government sees the banking
mess as a huge burden, many foreign banks and
investors see the potential for great rewards. In
the case of the Bank of America (BoA) buying into
the CCB, the potential upside is large indeed.
From the BoA's point of view, China has
fundamental advantages over the US: a much
faster-developing economy (although the US economy
remains larger, and will for some time), and the
access to the vast personal savings of the
Chinese, who famously have among the highest
savings rates in the world. The pool of Chinese
savings is rising steeply year after year, while
US personal savings are flat. Buying into a huge
Chinese bank like the CCB was perceived as the
quickest way to tap into this immense and growing
pool of capital.
The Construction Bank is
the third biggest bank in China, with 14,500
branches that serve 136 million retail clients and
all the top Chinese corporations. In 2004, it had
around 13% of China's total deposits and $472
billion in assets. By making itself both a
shareholder and a hands-on partner, Bank of
America has immediately established itself as a
major player in China. But the BoA's involvement is
not limited to capital investment. It wants to
send 50 bankers to help manage the Chinese bank,
especially the risk-control aspects of the
business.
The BoA/CCB deal is almost
certainly a harbinger of further foreign activity
in the sector. It seems very likely that the three
other key banks - the Industrial and Commercial
Bank, the Bank of China and the China Agricultural
Bank - will also gain significant foreign
partners; this could happen at any time. A major
motive of the three banks' desire for foreign
partners is their aspiration to be listed overseas
as soon as possible. But a great deal of work with
regard to internal restructuring and improvement
remains. Huge problems have accumulated for many
decades, and reaching the present level of
financial soundness and modernization has already
required massive efforts.
Lessons for
the future
Openness to the outside world, in
terms of both equity investment and the deliberate
adoption of "best practices" from
overseas, is indispensable in resolving the
banking mess. Greater foreign involvement will
bring with it modern, professional management much
faster than could be developed from China's
resources alone. Overseas managers can help
China's banks to achieve greater transparency,
accountability and superior risk management,
ultimately leading to globally competitive
financial institutions.
The most important
lesson of the bank saga is that banking problems
will inevitably become government problems if the
banks are built into the government structure and
made to serve government needs. Falling into this
trap caused the country a great deal of pain and
lost economic opportunity, from which it is only
beginning to escape. For a "real" bank, every $10
in loans should bring back $10 in principal, plus
a variable amount of interest. The simplicity of
this benchmark will make it straightforward to see
whether China's banks have become "real".
But achieving this will be anything but
straightforward: it will demand a complete package
- clear, consistent government regulation;
well-defined ownership; and accountable
management. Sustained efforts will be needed, and
there are few shortcuts in sight. But moving the
banks' problems from the political sphere back
into the business sphere will bring many long-term
rewards: independent banks, by directing capital
to the enterprises that need it most rather than
the enterprises with the best guangxi
(connections), will provide China's economy with
the sustained boost that it needs to complete its
historic task of catching up with the rest of the
world.
George Zhibin Gu,
business consultant based in China, is the author
of a newly released book, Made in China:
Players and Challengers in the 21st Century
(Portuguese edition, www.CentroAtlantico.pt) as
well as a forthcoming book, China's Global
Reach: Markets, Multinationals, and
Globalization (English edition, Fall
2005).
(Copyright 2005 George
Zhibin Gu.) |
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