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CHINA'S MAKEOVER
Timid banks hinder
reform
By Francesco Sisci
Previously:
Political
reform on tap
Trimming
the fat
BEIJING - At the end of 2002,
China's outstanding deposits were 18.3 trillion yuan,
more than US$2 trillion, an increase of 18.1 percent
over the previous year. Outstanding loans were 14
trillion yuan, an increase of 14.4 percent over the
previous year. These two figures alone tell everything
about the issue of bad and non-performing loans (NPLs)
of China. The problem is not that banks and financial
institutions are inefficient, it is that they lend too
little, not too much.
The difference between
deposits and loans is 4.3 trillion yuan, or more than 30
percent of the total of outstanding loans. NPLs are
officially reckoned at 20 percent of all outstanding
loans, so even if all NPLs were to become bad loans,
something impossible because a part of those loans could
be recovered, banks would have more than enough money to
cover their losses. In the late 1990s the fear was that
bad debts and NPLs were too high compared with deposits,
and if all the NPLs went bad, banks would not have
enough cash to refund all debtors. This is no longer the
case.
As the figures show, there is a new
reality - banks are too cautious in lending their money
and keep a huge amount idle. This is because they want a
backup for the NPLs. But this new caution is costly in
terms of growth. Interests on deposits are about 1
percent but interest on loans can be about 5 percent.
There is a huge spread, borrowing money is extremely
expensive and this explains the NPLs. Large borrowers
from state-owned enterprises (SOEs) have little
incentive to return their money on time, that is, banks
won’t punish their bad behavior with fines or
confiscation. Both the bank managers and the chairmen of
the SOEs are state employees but often the SOE chairman
has a rank higher than the bank manager, so how can the
bank force the debtor to return its money? It can try
persuasion, creating the curious phenomenon of bank
managers wining and dining large debtors to get them to
repay their loans.
Furthermore, the banking
structure tolerates NPLs as a form of state subsidy or
support. In fact there is very little use of rollover
debts. Many of the NPLs in the West would be rolled-over
debts, of the kind any large companies in the world has
without raising any trouble or doubt. The difficulty
with some Sino-foreign joint ventures with millions of
dollars' of investment in China and billions of assets
abroad is that they do not get financed for their
cash-flow cycle, the time between the delivery of the
merchandise and its payment. That creates a bottleneck
for the growth of the company, which has to put down
some cash to self-finance its business cycle.
On
the other hand, depositors in China are far more
accepting of regulation than their counterparts in the
West. For withdrawals of over $10,000 they have to call
one or two days in advance, and even then they are not
sure about getting their money, but nobody protests.
Even if new restrictions were to be introduced they
would be accepted silently. Banks in China are not seen
as serving their clients, they are seen as another arm
of the state, which uses banks for such things as
investigating tax evasion. Banks have difficulties in
cashing checks from another bank or from out of town.
Complex procedures are necessary for such services and
the use of debit cards (unlike with credit cards, the
money must be in the account and when funds are
exhausted the debit card is suspended) is spreading
among consumers. The result is that a large part of the
Chinese economy is cash-based and operates outside the
banking system or finds its way to comparatively
discreet Hong Kong.
Interest on loans for small
and medium enterprises (SMEs) can be quite large,
normally about 10-15 percent, sometimes even greater.
The banking system, because of its restrictive policies,
is imposing an extra burden to SMEs, which could grow
faster if they paid less interest - that is, if they
were supported by the banks. If we project this
situation to the national level, we must take into
account that some 70 percent of gross domestic product
(GDP) is created by the non-state sector (mostly SMEs)
using some 30 percent of all outstanding loans (see
"Trimming the fat", February 5, link above). The
percentage is the opposite for the state sector. Even
small changes of the lending system to favor SMEs would
create extra growth for China without increasing the
money flow. This would help solve the issue of NPLs, as
SMEs are more efficient and less in need of support even
to roll over their debts.
But SOEs own, at least
in theory, about 70 percent of all China’s assets, so
from this point of view it is right for the banks to
lend 70 percent of all outstanding loans to them, and
the rest to the entities that own the remaining 30
percent of national assets. This is the crux of the
matter: SMEs have little or no collateral to offer
because some of their collateral was obtained through
tax evasion or exploiting the loopholes of the law. To
have better access to credit they need a better law to
protect and fully legalize their assets, thus allowing
them to expand. Here the new civil code is fundamental
to allow the change. The new protection of property
rights could reveal a different picture of the assets in
China and thus swerve loans toward the new assets. If
this were possible NPLs and bad debts could be minimized
and the banking system could become more efficient.
In the past years China has promoted growth with
investment in infrastructure, which has long-term
financial returns but is helping creating a unified
market in China. Highways have shortened transportation
and communication times and thus have linked the lagging
west with the more efficient east. These investments
were necessary and if anything they were overdue; they
have burdened the state coffers but have also
distributed some wealth among the inland peasants hired
as construction workers for building the roads. China
needs infrastructure improvements. Roads must be built,
but with better efficiency within the banking system.
Chinese numbers present inconsistencies and are
often unreliable. Perhaps it is worth viewing them from
a reliable vantage point: foreign trade is difficult to
tamper with, as foreign trading partners should
logically mirror foreign trade figures. Forty percent of
China's GDP is created through foreign trade. This
figure is just too large for a country like China. Even
in Japan, a classic trading country, foreign trade
accounts for less than 20 percent of GDP. A trip to the
Chinese interior allows one to see many peasants
relatively well off, with houses, TV sets and air
conditioning. If anything, official figures may
underestimate China's GDP and its growth, one reason
there are growing arguments for the revaluation of the
yuan.
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