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Banking on China
January 2008
Paul Melly, International Trade Today
Five years ago, more than 20 per cent of the combined loan book of China’s big four state banks was categorised as ‘non performing’ – ie, they had debts that were being serviced erratically if at all. Today, that figure is down to less than 10 per cent. As a measure of the reform progress that has undoubtedly been made in transforming a financial system still shaped by its roots in the state socialist economic era, these statistics are as good as any.
The risks have been greatly reduced, but they have not yet entirely disappeared. The market economy has arrived, but some of the old communist economic foundations remain in place.
Indeed, what’s true of the banking sector also applies to other features of financial life in the People’s Republic.
For example, a number of credit information agencies now provide information on Chinese buyer companies. But although the situation has been improving, it is not always possible to get access to full annual accounts unless the buyer enterprise itself agrees to the release of the data.
The exchange rate of the yuan is set in the interbank market, yet is effectively controlled by the authorities and held at a level that is artificially low, given the buoyant performance of the Chinese economy.
In the first half of last year, GDP was growing at an astonishing annualised rate of 11.5 per cent, with investment booming and exports surging ahead – helped, not least, by the artificially weak level of the yuan. But over-capacity in car manufacturing and steel and the property market could see some businesses run into financial problems.
Still, such caveats should not detract from the underlying truth: China is a huge and growing economy that offers many financially viable business opportunities for UK firms, provided they take sensible precautions to protect themselves against the risks that do exist.
The base of Chinese industrial production continues to broaden and diversify and local companies tend to save substantial reserves from which they then fund new investment. But although clean payments and cash against document arrangements are used, payment delays are still common and, therefore, many experts still advise foreign business partners to use letters of credit (or alternative tools such as credit insurance or forfaiting).
Despite the growth and modernisation of the economy in recent years, there are, perhaps, two major reasons why China still poses business risks – the sheer speed of development, and the residual inheritance from its old state-controlled communist economic system.
Inevitably, the pace of growth creates dangers. As in any country, new or fast evolving businesses are often shallow-rooted and at risk of over-reaching themselves; they may not have had time to establish internal disciplines and risk controls, while attempts to develop new trading lines will sometimes fail.
After all, Europe has also often seen that it is during periods of economic boom that insolvencies and payment failures become more common as some companies make over-optimistic judgements or take on commitments they later find they cannot meet.
However, some other risks are particular to China and its distinctive history. It was only 12 years ago that the Beijing authorities introduced a law to commercialise the operations of the big four state banks – China Construction Bank, the Bank of China, Agricultural Bank of China and the Industrial and Commercial Bank of China.
Meanwhile, the old state socialist system had left the banking system burdened with a mountain of bad debt. Under communism, banks were expected to extend credit to a wide range of state enterprises as a form of funding support and without reference to their financial strength or readiness to repay.
Once the big banks were expected to operate on commercially viable lines, this clearly posed a problem. So the government had to set up asset management companies to take on these books of old loans and repackage them at a discounted value, so that they could be sold on cheaply in the investment market.
The authorities also allowed the creation of new joint stock commercial banks, such as Everbright, Huaxia, the Shanghia Pudong Development Bank and the Industrial Minsheng Banking Company. Operating along business lines from the outset, these have been notably more disciplined in extending credit than the state banks used to be. The China Banking Regulatory Commission reports that in the first quarter of 2007, only 2.78 per cent of the loan book of the joint stock banks was non-performing – compared with 8.2 per cent for their public sector counterparts.
The commission itself was created in 2003, in a move that separated regulation from the other central bank functions of the People’s Bank of China (PBOC), just as the UK had done with the formation of the Financial Services Authority.
In a further reinforcement of regulatory systems, an insolvency law was introduced on 1 June last year. This established a system largely modelled on the US Chapter 11 procedures for putting a crisis-struck enterprise into administration and reaching agreements with creditors on a way forward.
The measure is applicable to public sector enterprises as well as private sector firms and could thus slowly help to overhaul the state-owned part of the economy. It should also draw a sharper line between those state enterprises that are supposed to operate as self-supporting businesses and those that are effectively government agencies.
However, considerable challenges remain. Business in China still carries distinctive risks.
Many payment wrangles continue to end up in legal dispute and flaws in business governance and regulation are still a problem. Moreover, the state-owned Chinese banks have been slow to tighten up their lending practices, and this could store up problems for the future in some cases.
As recently as early 2006 – less than a decade after the authorities had to create the asset management companies to take over the old portfolios of bad loans – state-owned banks were continuing to take a rather uncommercial approach to new lending.
A study by the IMF found that, in general, they did not take account of the borrower’s risk status when they agreed the price of loans. Lending, the Fund found, was driven mainly by the amount of funds the banks had available and failed to reflect the performance of the borrowing enterprises.
Meanwhile, the asset management companies had recovered only 21 per cent of the cash value of the old non-performing loan books, which compares poorly with the clear-up rate achieved by recovery programmes in other Asian countries after their financial crisis of 1997-98.
Still, this more modest progress has to be set in context. It would never have been realistic to imagine that an nation that is home to a quarter of the world’s population and had a 50-year history of state socialist economics could modernise its financial and banking systems as rapidly as Far Eastern market economy countries less than a tenth of its size.
