CHINESE BANKS AND BANKING PRACTICES

CHINESE BANKS

Banks play a dominant role in China both as a place for ordinary Chinese to deposit their savings and as a source for investment of companies Most investments are in the form of bank loans. As of the mid 2000s, 80 percent of financing of the Chinese economy still came from state-owned banks, that often responded more to political concerns rather than economic realities. The result: $200 billion in bad loans, 10 percent of total loans

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“The Chinese banking system is different from anything to be found in the West. Although the Big Four banks are publicly listed and audited by international accountants, their main purpose is not to maximize shareholder returns. Rather, the banks are an arm of the state. Most bank lending in China is directed, at favorable rates, toward businesses controlled by the state.”

Chinese banks---especially the four main ones---are huge. They have tens of thousands of employees and thousands of branches. The staff are often poorly trained and the managers have traditionally responded more to the needs of local officials than to he bottom line and head offices hundreds of kilometers away.

State-control remains the norm in Chinese banking. The Communist Party appoints all the senior bankers. The banks often lend money or don’t based on what the government tells them.The Chinese banking system relies on a flood of deposits from it upwardly mobile population. If growth were to be dramatically reduced and the deposits were to stop flowing in, the economy could become crippled as there would be no money to give out in loans and only bad loans to collect.

Websites and Resources

Good Websites and Sources: Bank and Stock Market Links portalino.it/banks/_cn.htm ; Major Bank Directory gov.cn/misc ; Wikipedia article on Banking in China

Business and Economics: Business Directory for China business-china.com ; U.S. China Business Council uschina.org ; China Business Services Blog chinabusinessservices.com/blog ; Economic and Business News Related to China jlmpacificepoch.com ; Small and Mid Size Businesses in China english.sme.gov.cn ;Asian Development Bank adb.org/PRC ; World Bank China worldbank.org ; International Monetary Fund (IMF) on China imf.org/external/country/CHN ; China Economic Information Office cei.gov.cn ; U.S. Commerce Department’s Office of China Economic Area (OCEA) export.gov/china ; Statistics: China’s National Bureau of Statistics stats.gov.cn/english ; Chinability Blog chinability.com/ ; Nationmaster nationmaster.com ; Economic and Business News The Economist on China economist.com ; China Economic Net en.ce.cn ; China Economic Review chinaeconomicreview.com ; Far East Economic Review feer.com ; Economic and Business News Related to China jlmpacificepoch.com ; China Daily Coverage of Economic Issues chinadaily.com.cn ; Financial Times China ft.com/world/asiapacific/china ; China Perspective thechinaperspective.com ; China Economics Blog china-economics-blog.blogspot.com

Links in this Website: CHINESE BUSINESS Factsanddetails.com/China ; CHINESE STOCK MARKET Factsanddetails.com/China ; CHINESE BANKS Factsanddetails.com/China ; CHINESE RETAIL BUSINESSES Factsanddetails.com/China ; Factsanddetails.com/China ; CHINESE TOURISM BUSINESS Factsanddetails.com/China ;CHINESE TRADE Factsanddetails.com/China ; CHINESE TRADE WITH THE U.S., EUROPE AND JAPAN Factsanddetails.com/China ; FOREIGN COMPANIES AND INVESTMENT IN CHINA Factsanddetails.com/China ; BUSINESS CUSTOMS IN CHINA No. 1 Factsanddetails.com/China ; BUSINESS CUSTOMS IN CHINA No. 2 Factsanddetails.com/China ; GLOBAL ECONOMIC CRISIS OF 2008 AND 2009 IN CHINA Factsanddetails.com/China ; BASIC ECONOMIC INFORMATION ON CHINA Factsanddetails.com/China ; MACROECONOMICS AND ECONOMIC POLICY IN CHINA Factsanddetails.com/China ; THE YUAN, FOREIGN RESERVES AND SOVEREIGN WEALTH FUNDS IN CHINA Factsanddetails.com/China ; CHINESE REGIONAL ECONOMICS Factsanddetails.com/China

First Banks in China

The first banks in China opened in the town of Pingyao in the mid 19th century. The banks were opened by merchants that suddenly became wealthy and needed a place to put their money. The banks made loans, offered remittances and checks, which made the merchants wealthier, and made it necessary for banks to open branches in other cities. At its height Pingyao had 22 banks that were instruments in the trade of silk and tea to Russia and wool and leather from Mongolia. The currency was silver ingots. But just as as quickly as whole system got started it collapsed

The banks were regarded as responsible and incorruptible. Trust among businessmen was high. Some of the routine practices’such as loosening up potential clients with prostitutes and opium---would raise eyebrows today. There was also an element of paranoia. The vaults of the banks were vertical pits dug beneath raised platforms that stored piles of silver. Sleeping mats were placed on the platforms and bank employees sat or slept on the mats around the clock. When money was moved it was watched over by guards trained in the martial arts and armed with halberds axes and maces.

History of Chinese Banks

In the Mao era, Chinese banks were not like Western banks. They were government-directed institutions used primarily to distribute state subsidies and collect taxes and revenues from state enterprises. How much money was given out in loans often little relation with how much was paid back. Chinese banks were terribly over employed. They were not allowed to fail because of worries about the political fallout if they did. Branches managers were appointed by the Communist Part; oversight was lax; fraud flourished.

Edward Chancellor wrote in the Wall Street Journal: “In 1974, the future Chinese premier Deng Xiaoping led a large delegation to the United Nations in New York. Chinese officials discovered, as they prepared for the expensive trip, that the could muster only $38,000 in foreign cash. In those days there were no banks in China except the People's Bank of China, then a department of the Ministry of Finance. Today China's foreign-exchange reserves are fast approaching $3 trillion, and its banks are among the world's most valuable companies. This remarkable success story has occurred against a background of more or less continuous worries about the stability of China's financial system. Lately those concerns have been greater than ever.”[Edward Chancellor, Wall Street Journal, March 14, 2011]

In 1994, Beijing created three new banks that were supposed to act like Western banks, giving out loans based on financial merits and collecting what is owed. These banks failed miserably at their job. They gave out billions in dodgy loans and were cheated out of billions more by corrupt officials and insiders, creating a bad loan crisis. According to a Brooking Institute study in 1997, a third of all they money lent by banks was uncollectible.

In 1998, the People's Bank of China---the state's central bank---reduced the Big Four's reserve requirement. This freed up reserves for the banks to acquire a special-purpose treasury bond issued by the Ministry of Finance. The loan proceeds were then used to recapitalize the banks. Beijing also created asset-management companies to buy the nonperforming loans from the banks at face value. In exchange, these repositories of toxic credit issued notes to the banks. (When these notes became due in 2009, they were extended for another decade.)

China's banks were not hit by the economic crisis in 2008 and 2009 as Western banks were and in many cases jumped in to fill the void, making loans where Western banks couldn’t. In early November 2008, China announced a 4 trillion yuan ($586 billion) stimulus package worth 13 percent of GDP, over two years. The money was spent mostly on infrastructure and social welfare, particularly on railways, highways, low-cost housing, and rural infrastructure, and given to banks to provided low interest loans for home and car buyers and companies in need of financing. In February 2010, bank lending regulations were tightened to reduce risk by more carefully scrutinizing borrowers ability to pay back loans. By mid 2010, Chinese banks were strapped for cash because they had lent out a record $1.4 trillion in 2009 to support Beijing’s stimulus package.

Large Chinese Banks

The Chinese banking system is dominated by four state-owned banks: 1) Industrial and Commercial Bank (ICBC), 2) the People's Construction Bank of China, 3) the Bank of China and 4) the Agricultural bank of China. These banks controls 80 percent of China's financial assets. In 1999, they employed 1.4 million people were in the process of laying off up to 420,000 employees.

In 2010, four of the world’s 10 largest banks, based on market value, were Chinese. In some rankings the world's three biggest banks are Chinese, but none is among the world's top 50, ranked by the extent of their geographical spread. In 2006, China didn’t have a single bank in the world’s top 20. As of early 2010, the Industrial and Commercial Bank was the largest bank in the world by market capitalization and the most profitable.

Industrial and Commercial Bank of China (ICBC) is China’s largest bank in term of assets and the worlds’ third largest by market value ($214.2 billion, a head of HSBC’s $208.4 billion) It October 2006, it went public on the Hong Kong and Shanghai market with the world’s largest initial public offering of $22 billion, exceeding the $18.4 billion raised for NTT DoCoMo, a Japanese cell phone company. ICBC has 153 million customers (2006), 10 million more than the population of Russia. In 2007 it was worth more than Citigroup despite bing nearly insolvent ten years earlier. The Industrial and Commercial Bank of China ranked No.5 on the Forbes list of the world’s leading companies in 2010.

20080316-cconstructionbankcorp liuzhou blog city.jpg The Bank of China is China’s second largest, most profitable and oldest indigenous bank. Founded in 1912, the year China became a republic, it has 12,967 branches in mainland China, 443 in Hong Kong and Macau and 117 outside of China. Owned by China’s central government, it had $382 billion assets in 2000, making it one of world’s 30 largest banks. And had $1.3 billion in pretax profits in 2001. In 2002, 29 percent it loans were regarded as nonperforming loans. It got stock with more bad loans and suffered during the subprime mortgage crisis in 2007 and 2008. suffered The Bank of China made its Shanghai stock market debut in July 2006, with its shares surging 23 percent. Before that the bank had been listed only on the Hong Kong market.

China Construction Bank is China’s third largest bank and biggest property lender. It has 15,000 branches, controls 15 percent of China’s mutual funds and takes care of China’s hundreds of billions of dollars of foreign reserves.

Agricultural Bank of China is China’s largest bank in terms of employees and forth largest bank in terms of assets. At one time it was one of the weakest. Closely tied with the rural economy, it has $500 billion in assets, 500,000 employees, It also has over $100 billion in bad loans (2007) and has a record of fraud and mismanagement. In August 2007, the Chinese government decided to inject $40 billion ton the debt-ridden Agricultural Bank of China. The bank is planning to restructure.

In August 2010,Agricultural Bank of China sold 3.34 billion shares for 2.68 yuan each, raising a total of $22.1 billion, in what was the world’s largest IPO sake ever. Industrial and Commercial Bank of China help the pervious record with a $21.9 billion sale in 2006.

There are 130 commercial banks in China. Other large ones include the Bank of Communications, China’s fifth largest bank in terms of assets, and Huaxia, China’s forth largest publically-traded lender.

Development and Post Savings Bank in China

20080316-bank in China.jpg The China Post Savings Bank, part of the State Post Bureau (China’s post office) is China’s fifth largest lending institution. As of 2005, it held $152 billion, a tenth of household savings. It has 36,000 outlets, 260 account holders and 70 million card holders. See Postal Savings, Communications

The China Development Bank was founded in 1995 and in many measures is China’s most profitable bank. Controlling $260 billion worth of loans, it dominates the domestic bond market and has been the primary source of funding for infrastructure projects such as the Three Gorges Dam and new nuclear power plants. . It is beginning to look more and more abroad for investments. It made $2 billion profit in 2004.

In August 2008, 100 victims of terrorism in Israel filed a suit against the Bank of China demanding that it stop transferring money to terrorist groups. The suit filed in a court in Los Angeles claimed the bank “knowingly assisted Hamas and Islamic Jihad to carry out terrorist attacks” by transferring millions to them. The money, the suit claims, helped fund attack between 2004 and 2007. The money originated from the Middle East and was sent to accounts in the United States from a Bank of China branch in Guangzhou, where it was wired to Hamas ands Islamic Jihad leaders in the Gaza Strip and the West Bank.

Savings Rates and Personal Loans in China

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Qing Dynasty money changer
Many ordinary Chinese keep their money in state-owned banks because they believe the government will bail them out in a crisis. Interest for long-term deposit accounts is often over 12 percent. There have been runs at banks unable to meet withdrawal demands. Such problems are usually solved by the government printing money.

See Savings, Consumer Customs

The service at Chinese banks has traditionally been very poor. Customers routinely have to wait in long longs and when they reach the window they are told to wait in another line.

In 2004, the ceiling on the interest rates was removed, removing obstacles that kept banks from charging what they wanted on loans. The move was seen as one that would allow banks to more act like profit-making, commercial operations.

Business Loans in China

Entrepreneurs and private companies often have a hard time securing loans to expand. Most of the loan money dispensed by banks still goes to state-owned enterprises. So much money is given out to large companies and for large developments and public works projects there is little money left over for anybody else.

There is lot of incentive to take out loans when interest rates are 5 percent and growth is 10 percent and paying back the loan is not always required. Entrepreneurs and private companies that do secure loans often do so by wining and dining bank officials and give them outright bribes, If an officials decides the bribe he receives isn’t high enough the entrepreneur sometimes loses the bribe money and doesn’t get the loan.

There is lot or cronyism and speculation in Chinese banking. Chinese banks it seems are more wont to give loans to well-connected businessmen engaged in speculative ventures like skyscrapers in Shanghai and commercial development on Guangzhou rather helping farmers grow cash crops and raise livestock for which there is a strong demand.

Sun Dawu, an owner of livestock business wh0 wanted to expand but couldn’t get a loan from banks, decided to take deposits from his employees. He gave out higher interest rates than the state banks and promised to build a hospital and schools. Altogether he collected $25 million and used that money to successfully expand his business and provide hundreds of jobs. Fo his trouble he was arrested for overstepping the bounds of business and engaging in government activities. His sentence however was light. he regarded as a hero by ordinary

Illegal Banks and Back Street Loans in China

There are a number of illegal banks of China, especially in Guangdong Province. They are very active in hot money speculative transactions, Many operate out of ordinary stores with signs offering money exchange and transfer services. In recent years there has been an effort to shut them down.

Back street loans are the norm in Wenzhou. In October 2011, AP reported, “Wenzhou's private entrepreneurs, scrappy survivors in an economy ruled by state industries, once thrived on a formula of cheap backstreet loans and low-cost manufacturing. Wenzhou's factory bosses are caught in a dire credit crunch. Pyramids of high-interest private lending are collapsing as companies whose profits are dwindling due to rising costs and weakening demand default on their debts. [Source: Elaine Kurtenbach, Associated Press, October 18, 2011]

The true scale of informal lending nationwide, much of it derived from bank loans originally intended for other purposes, is unknown. But such lending has ballooned because the reluctance of China's state-run banks to lend to small and medium-sized businesses has been compounded by government curbs on credit to cool inflation. Interest charged by private lenders can be as high as 90 percent, inviting comparisons with dodgy investment schemes.

"I have to conclude that this business is now a Ponzi game, relying on new money to pay off the old money," said Andy Xie, a Shanghai-based economist who traveled the Wenzhou region over the past two months researching the situation. "If not checked, this could lead to a national calamity."

Much of the estimated 500 billion yuan ($79 billion) in private borrowing in Wenzhou went not to manufacturing, but instead to potentially higher return investments in property or commodities---or to still more lending by the borrowers themselves. "When banks cut off lending, businessmen went to the high-interest informal lenders, figuring that a month or two later they'd get loans again to repay their other debts. But the banks are not lending so they ran out of cash," said Yu Jingliang, owner of Zhejiang Pacific Paper Co., which deals in disposable moist towelettes and toilet seat covers.

'Rich Sister' Wu Ying Gets Death Penalty for “Fundraising”

Tania Branigan wrote in The Guardian: When she was seven, Wu Ying set her heart on a pair of long-haired rabbits. She tended them devotedly, then trimmed and sold their fur. She was in business. China's capitalist adventure wasn't much older than she was. The two flourished together. In 2006, by the time Wu was 25, she was said to be the sixth richest woman in the country. Now 31, Wu's fortunes have changed dramatically. She is on death row, facing execution for fraud and raising money outside the banking system. [Source: Tania Branigan, The Guardian, March 21, 2012]

Toppled tycoons are often regarded with schadenfreude, but Wu is seen by many in China as akin to a martyr. Intellectuals and powerful business people  even staff and creditors who lost jobs and money when her empire crashed  say her offence was commonplace. Her case has become emblematic of the difficulties of being an entrepreneur under China's system of state capitalism, and of the murky world in which much private enterprise is conducted, with businesses forced to take risks to get ahead. Upholding her sentence this year, a court in eastern Zhejiang province said she had "brought huge losses to the nation and people with her severe crimes, and should therefore be severely punished". The supreme people's court is currently reviewing her sentence. [Ibid]

“Wu's fortunes rose at the same breakneck pace as the Chinese economy. She was smart, hard-working, ambitious. "I don't want to brag about my daughter and say 'she is able'. But everyone thinks so  you can ask them," her father, Wu Yongzheng, told the Guardian. She started work in a beauty salon and then opened her own. Soon she was running a string of businesses including dry-cleaning stores and karaoke bars. Her former staff remain almost star-struck, describing her as gutsy, innovative and pioneering. [Ibid]

“As her business grew, so did her ambitions. In 2006, she shot to national attention when she launched the Bense Group, with companies in areas ranging from wedding planning to logistics. In her hometown of Dongyang she built hotels and a 500-seat internet cafe that never opened. By mid-2006, Wu's investment binge seems to have left her struggling for cash despite the hundreds of millions of yuan (tens of millions of pounds) she had borrowed. She turned to new lenders, paying even higher rates. Creditors began to worry. Then, in 2007, she was arrested. [Ibid]

“Wu was convicted of illegally raising 750 million yuan ($120 million) from investors in 2005-07. "Fundraising" from private lenders is illegal in China, but also commonplace. Banks prefer to lend to state-owned enterprises, sometimes because they are urged to do so but also because it is safer: if it runs into problems, the debt will be restructured and they will not be penalised. Official interest rates for savers are so low  negative in real terms  that lending illicitly is much more attractive than putting your money in the bank. "Chinese companies, especially small ones, need to access funds. Banks have yet to be able to meet those companies' needs and there is a massive amount of idle private capital," Wen acknowledged when asked about Wu's case last week. [Ibid]

“Though she was charged with fraud, there is no sign that this was a Ponzi scheme. There were real assets. Many of her creditors defend her. "This whole case is not Wu Ying's fault. She borrowed money to do business, not to spend on luxuries. If they hadn't toppled her we would have made more money," insisted one, who lost more than 15 million yuan (2.34 million) Supporters claim Wu was singled out because "she annoyed someone" and lacked connections. Some think she upset influential creditors or rivals; some that she refused to pay bribes. Her case is not about enforcing the law, they argue, but about the law being enforced selectively  and excessively  when the interests of money and power coincide. [Ibid]

What the 'Rich Sister' Wu Ying Cases Says About Business and Reform in China

Tania Branigan wrote in The Guardian: Others thought her prosecution and sentence caused the real damage. "Wu's death penalty is a setback for the cause of reform in China," the influential economist Zhang Weiying said. "Judging from this case, how far are we from the market economy? At least 300 years." [Source: Tania Branigan, The Guardian, March 21, 2012]

Few believe China’s current economic trajectory is sustainable. Inefficiency, corruption and wild speculation on anything from property to garlic are common. The environmental and social costs of the boom are rising. Inequality has soared. China's high-octane growth has been driven by investment and exports, while domestic consumption remains weak. [Ibid]

“The liberalised labour market contributed to high exports, which subsidised this extremely wasteful investment by the Chinese government," said Victor Shih of Northwestern University in Chicago. "Now China's trade surplus is shrinking, and shrinking much faster than a lot of people had anticipated.” [Ibid]

“It has been hit by European and US woes, and its growing demand for food and oil must be met largely through imports. "The ability of net exports to subsidise wasteful investment will diminish  perhaps quite rapidly. That will create a big challenge for the Chinese government in the coming two to three years," said Shih. "It will take a few more years before consumption becomes the dominant factor to fuel China's growth.” [Ibid]

“Li Keqiang, who is expected to be the next premier of China, warned: "China has reached a crucial period in changing its economic model and [reform] cannot be delayed." But Alistair Thornton of IHS Global Insight noted: "[Rebalancing] is all that [President] Hu Jintao and [Premier] Wen Jiabao have talked about... I'm increasingly sceptical that it's going to happen." China's optimal growth rate will be around 7 percent in the coming years, he said  but without reforms it could be three or four percentage points lower, with "significant implications for employment, social stability and everything else". [Ibid]

“Many see such links between wealth and power, on a grander scale, as the biggest obstacle to reforms. Others think the risks of instability posed by restructuring finance, state enterprise and the labour market are simply too threatening for leaders. Stephen Green, chief China economist for Standard Chartered bank, suggests a major economic overhaul could nonetheless be on its way. "That something is going wrong is an ever-more common feeling. Second, the belief that a huge crisis is inevitable without serious reform appears to be gaining ground," he wrote recently. But "they have to think very strategically, keep as many people on side as possible, make sure one reform supports another  it is enormously difficult," he said. [Ibid]

Chinese Supreme Court Overturns Yu Wing’s Death Sentence

In April 2012, AP reported: “China’s supreme court overturned the death sentence of an ex-tycoon who was convicted of illegally raising money for her business in a case that prompted a public outcry. The Supreme People’s Court said it was sending 31-year-old Wu Ying back for retrial in her home province of Zhejiang in China’s southeast. [Source: AP, April 20, 2012]

Wu’s penalty prompted an outcry on Internet bulletin boards by supporters who said it was too severe in a system in which corrupt Communist Party officials often escape punishment. The case also prompted debate over the financial difficulties Chinese entrepreneurs face in raising money in a country where the state-owned banking system channels most lending to state companies. Some news reports have said Wu was accused of cheating investors, but details of her case have not been released. [Ibid]

“The communist government has launched a pilot project in Wu’s home city of Wenzhou, known for its thriving private enterprises, aimed at making it easier for entrepreneurs to get bank loans. Like many entrepreneurs, Wu raised money from private lenders outside the government-controlled banking system. Communist authorities have tolerated underground lending as a way to support entrepreneurs who create jobs and tax revenue. But they began cracking down in recent years, apparently concerned about the large scale of borrowing and the possible involvement of state banks and companies. [Ibid]

Bad Loans in China

In 2005, China’s banks had an estimated $205 billion in bad loans (non performing loans). Many think the true figure is around $500 billion, a figure equal to half of China’s annual economic output. Non performing loans may make up 50 percent of all loans and eat up 15 percent to 30 percent of GDP. Chinese banks are believed to have bad loan portfolios that rank with those of Japan but China’s economy is one seventh the size of Japan’s.

As of 2005, China’s big four state banks---Industrial and Commercial Bank of China (ICBC), China Construction Bank, Bank of China and the Agriculture Bank of China---had bad loans worth $125 billion, or 10 percent of their total loans. Many economists believe the true figure is higher.

Bad loans stimulate growth (entrepreneurs can build factories and start businesses with loans they don’t have to worry about paying back) and keep afloat money-losing state-owned enterprises (in many cases with the tacit Beijing approval to keep unemployment rates down). But they also generate waste, mismanagement and leave open the possibility of an economic disaster.

Some banks are technically bankrupt but don’t fail because the state owns them and keeps them afloat using various means. Still there are worries they system might collapse. In some cases banks are issuing new loans to prop themselves up. This strategy could lead to more bad loans, which could create a bubble that might burst with grave consequences as happened during the Asian economic crisis in 1997.

China' state-run enterprises "hold their huge debts like hostages," an analyst for Goldman Sachs told the Los Angeles Times, "forcing the banks to keep paying ransom in the form of new losing order to avoid having to write off old loans.”Getting rid of the bad loans in many cases requires shutting down unprofitable state enterprises that employ tens of million of people. But China needs a sound banking system if it wants to continue attracting foreign investment and keep the economy buzzing.

Edward Chancellor wrote in Wall Street Journal, “In China, the practice of hiding bad loans has become endemic, a practice that has only been possible because capital controls prevent depositors from moving their money off-shore. China's strong economic growth has also allowed the country to dodge the effects of poor capital allocation. Since 2008 China's growth has been driven by rising fixed-asset investment, sponsored by the state and funded by banks. A slew of trophy projects, including the world's largest high-speed rail network and dozens of new airports, threaten yet another mountain of nonperforming loans. [Edward Chancellor, Wall Street Journal, March 14, 2011]

Chinese Banks Make Bad Loans Disappear

According to Fraser Howie and Carl Walter in Red Capitalism the Communist Party "treats its banks as basic utilities that provide unlimited capital to the cherished state-owned enterprises." The result is a banking system that is allowed to carry huge amounts of nonperforming loans and to delay the day of reckoning. [Edward Chancellor, Wall Street Journal, March 14, 2011]

“The recent history of China's banks,” Chancellor wrote, “is one of piecemeal reform combined with Beijing's magical ability to spirit away bad loans. In the late 1980s, a bank-lending binge at the behest of local governments resulted in soaring inflation and a real-estate bust. A decade later, a vast pile of nonperforming loans to state-owned companies had accumulated in the banking system. Bad debts among the Big Four banks amounted to roughly 40 percent of their total lending. ...Beijing came to the rescue. The reform-minded premier Zhu Rhongi brought in Western financial institutions as partners for the beleaguered Chinese banks. Wall Street was hired to introduce modern risk-management techniques to China. More important, the banks were relieved of their bad loans by what Messrs. Howie and Walter accurately describe as "accounting legerdemain."

“For the financial magicians' next trick, in 2005, other nonperforming loans were put into a "co-managed account" with the Ministry of Finance, which in return issued IOUs to the banks that were to be repaid through a combination of loan recoveries, bank dividends, sale of bank shares and tax receipts from the banks. To make matters even more convoluted, in 2009 the banks started acquiring large stakes in the asset-management companies that were still sitting on nonperforming loans from the previous decade.”

By such accounting boot-strapping, China's banks have so far escaped the consequence of their reckless lending at no apparent cost to society. Since Beijing fixes a wide spread between their borrowing costs and what they charge for lending, the banks even appear highly profitable. Yet the true cost has been borne by the Chinese people, who receive artificially low rates on their deposits. The technical name for this policy is "financial repression," which in China is estimated at around 4 percent of gross domestic product. The decline in the consumption share of GDP over the past decade coincided with the period when household deposits were being used to refinance the banking system.

Efforts to Clean Up Chinese Banks

By 2007, bad loans had been reduced to just three percent of total bank assets

Between 1998 and 2005, China spent $400 billion cleaning up its three largest banks. The government poured $105 billion into shore up these banks and more than $300 billion in bad loans was transferred to asset-management companies. Employing a strategy similar to that used by the savings and loan crisis in the United States the Chinese relieved its largest banks of billion of dollars in bad loans, and then wrote off the loans and resold them. The strategy did not work because there were still lots of bad loans remaining.

By the early 2000s, banks were making more profits but not nearly enough to offset the bad loans. In late 2003, China tapped into large foreign reserves and injected $45 billion into two state-owned banks---the Bank of China and China Construction Bank.

In August 2004, China’s Central Bank acted for the first time to bail out a private company because it was worried about the collapse of the company would have on stock market and banks. The company---a conglomerate called the D’Long Corporation that makes everything from jet engines to ketchup---was given a loan package of $1.8 billion. The company had accrued large debts and was placed under controlled of the government and reorganized under it guidance.

An effort is being made to improve rural banks. Rural China is home to less than one sixth of all bank branches, which accounted for only 15 percent of the nation’s deposits and loans. Cities get 19 times more loans per head than the countryside even though 60 percent of China’s people live in the countryside. The efforts including making it easer to set up privately-owned credit cooperatives and strengthen the postal banking system.

In November 2005, the Chinese government announced it would no longer bailout banks for making bad loans. Beijing also hopes that by opening up the banking sector to foreign banks the competition will force Chinese banks to get their act together.

Foreign Banks

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foreign banks
As of June 2006, overseas financial companies had just 214 branches in China, compared with 70,000 for domestic lenders. To gain a stake on China, international banks have spent $19 billion to buy minority stales on Chinese banks.

According to its accession agreement with the WTO China is required to open its banking and finance markets to full foreign competition from 2007. In early 2000s, Beijing began allowing foreign financial institutions to invest in Chinese banks. In February 2005, China allowed domestic banks to set up fund ventures with overseas investors.

In December 2006, nine foreign banks were given permission under WTO rules to enter the Chinese retail banking industry: The decision let foreign banks operate in China as consumer banks, accepting some of the $4 trillion of bank deposits (including $2 trillion in savings of ordinary Chinese) and allowed them to offer credit cards and other financial services. Around the same time the government also said it would ease restrictions of deposits and lending rates as domestic banks became more healthy.

In 2007, foreign banks were allowed to make local currency loans and offer banking services to Chinese citizens. Before that banks has been limited to handling foreign currency business. Still regulations prevent foreign banks from taking over Chinese banks under most circumstances. Foreign ownership of Chinese banks is limited to 25 percent, with no more than 20 percent held by a single entity.

Most foreign banking activity is centered in Shanghai. Many predict that Chinese banks will improve their service or foreign banks will get their customers.

Foreign Banks in China

The nine foreign banks given permission to enter the retail banking industry In December 2006 are:: 1) Citigroup from the United States, 2) Mizuho and 3) Sumitomo from Japan, 4) HSBC and 5) Standard Charter from Britain, 6) Amro from the Netherlands, 7) DBS from Singapore, and 8) Bank of East Asia and 9) Hang Seng Bank from Hong Kong.

The London-based global banking giant HSBC got its start and its initials when it was founded in 1866 as the Hong Kong and Shanghai Banking Corporation. It is only fitting then that HSBC moved its headquarters to Hong Kong in 2010 and is expected to be the first foreign company to be listed on the Shanghai stock exchange. As of early 2010 HSBC had 100 branches in China and expected to open 20 more soon.

In March 2007, HSBC, Standard Chartered Bank, Bank of East Asia and Citigroup have all won approval to offer full services in yuan and foreign currencies in China. London-based Standard Charter has been doing business in China since 1858.

Among thee other foreign banks that have a large presence in China are ANZ of Australia, the Royal Bank of Scotland, Commonwealth Bank of Australia, ING of the Netherlands, Bank of America, Deutsche Bank, Bank or Nova Scotia, Newbridge Capital and Goldman Sachs.

As of January 2005, Citigroup had a 4.6 percent stake in Shanghai Pudong Development Bank. Shanghai Pudong Development Bank is the second largest publically-traded lender in China, with 335 branches, but is a relatively small bank. Citigroup initially bought a 5 percent stake in the bank in January 2003 for $73 million and later increased the stake to 19.9 percent. Citigroup believed that a stake in a smaller bank would help it expand more quickly.

HSBC paid $1.5 billion for 19.9 percent of Bank of Communications. It issues credit cards with the Bank of Shanghai and has a 20 percent stake in Ping Insurance. Mitsubishi UFJ is selling its stake in the Bank of China.

Goldman Sachs lead a group that paid $3.1 billion for a 10 percent stake in the Industrial & Commercial Bank of China. It also paid $100 million for a 7 percent stake in the Shenzhen Development Bank. A consortium led by the Royal Bank of Scotland and Merrill Lynch paid $3.1 billion to acquire 10 percent of the Bank of China. Bank of America paid $3 billion for a 9.1 percent stake in the China Construction Bank.

IMF Urges China to Ease State Controls on Banking

In November 2011, the New York Times reported: “The International Monetary Fund warned China that tight government management of the nation’s banking and financial system was creating “a steady build-up in vulnerabilities” that could eventually damp economic growth. In a 125-page report on China’s financial system, the I.M.F. said that state controls over the economy were partly to blame for soaring property prices, excessive bank lending and mounting local government debt, and that these were among the growing risks that threatened to undermine the country’s economic boom. [Source: David Barboza, New York Times, November 15, 2011]

The report was the latest effort by the I.M.F. to pressure Beijing to quicken the pace of its economic reforms and adopt a more market-oriented approach to banking and finance in the country, which has the world’s second-largest economy. “The existing configuration of financial policies fosters high savings, structurally high levels of liquidity and a high risk of capital misallocation and asset bubbles, particularly in real estate,” the report said. “The cost of these distortions is rising over time, posing increasing macro-financial risks.”

Jonathan Fiechter, one of the authors of the I.M.F. report, said that China had made remarkable progress over the last three decades, but that the country’s integration into the global economy made it more urgent for its banks to operate according to market forces. “Take the training wheels off and let the banking system work,” Mr. Fiechter said. While there is no imminent threat of a financial collapse in China, the I.M.F. said state banks could be “severely impacted” if the economy were hit by several risks at once, like a sharp drop in property prices and major changes to the country’s exchange rate.

In a response to the report, which was completed in 2010 but released Tuesday, China’s central bank said that the report was largely constructive, but added that “several points in the report are not comprehensive or objective enough, and the suggestions regarding the time frame and prioritization of some reform measures lack a thorough understanding of China’s reality.”

In the I.M.F. report, China’s banking and financial system is portrayed as huge, complex and flawed, with state bank lending favoring state companies over private corporations and the financial system creating distortions that affect a wide range of factors, including interest rates, property prices and the exchange rate. The I.M.F. said, for instance, that despite the nation’s spectacular growth, the quality of that growth had become increasingly inefficient. It now takes about $5 worth of investment to create $1 of gross domestic product---about 40 percent more than it takes in Japan or South Korea, the report said. Among the lengthy list of prescriptions that the I.M.F. suggested were strengthening regulatory oversight of the financial system, liberalizing interest rates, giving banks more control over lending and risk management and expanding the authority of the nation’s central bank.

Image Sources: 1) Sumitomo; 2) Lizhou Blog; 3, 4) Columbia University; 5) China Daily

Text Sources: New York Times, Washington Post, Los Angeles Times, Times of London, National Geographic, The New Yorker, Time, Newsweek, Reuters, AP, Lonely Planet Guides, Compton’s Encyclopedia and various books and other publications.

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© 2008 Jeffrey Hays

Last updated August 2012

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