By Alexander Jones – alexander.jones@internationalbanker.com
In the recent years, the Chinese economic growth has been increasingly hinged upon the strengths of its banking system. While the major banks of the US and Europe are dependent on massive bailouts to survive, Chinese banks have remained strong under the recessionary conditions. The main factor behind their healthy condition is the unique ability of Chinese banks to manage risk in a prudent manner. While China continued to reform its banking system, it did not copy western countries in their pursuit of the high risk assets. Control of risk appetite helped Chinese banks to remain untouched by the subprime crisis.
Strengths due to risk management and regulations
China has revisited its risk capital requirements and tightened the norms for recognizing and provisioning for the non performing loan assets. In September 2008, for all the listed banks, only 2 percent of loans were classified as non-performing. In 2003, the foreign investment limit was hiked, from 15% to 20%, and the banks fulfilled the norms for Initial Public Offerings. This helped them to meet the norms of higher capital adequacy. Listing at stock exchanges helped improve transparency and accountability. Continuation of reforms along with strengthening of banking regulations with the establishment of the China Banking Regulatory Commission helped the consolidation of a healthy banking system.
The China banking Regulatory Commission is effective in tackling excessive political interference by local governments and control loans distributed to high risk sectors. However, it has also affected the banks’ ability to formulate independent business strategy with regard to loan approval to specific sectors and interest rates.
China, in the nineties, embarked on a journey of privatization and efficiency by transferring factory control from communist party to factory managers. Some of the smaller banks and other state enterprises were sold to private entities and individuals. Organizational transformation of banks as businesses began on a modest scale and China took up WTO membership. Gigantic FDI flow led to accelerated economic growth. The banking arrangement ensured that credit is continuously flowing toward bottleneck sectors, improving the liquidity of the whole economy. Stability of currency and export competitiveness has helped sustainable growth of the banking industry too.
The core of China’s strength lies in development centric ideology and the culture of collaboration in reviewing policies and systems. Funds from mobilized savings in the banking and postal system are channeled to productive public uses, determined and prioritized by central policy. There is also a moral and ethical dimension to its continued superiority, which is aimed at international primacy.
Strategic foreign investors such as Bank of America and AFH (Asian Financial Holdings) holding 14% stake in CCB, in joint ventures and alliances, have enriched the product offerings and services with diversification. Foreign indebtedness is low and risks negligible due to high domestic content of public debt and huge kitty of foreign exchange reserves. The corporate culture of high savings has enabled a generation of internal accruals for investment, needed for the expansion rate seen in China. Economic cooperation and relationship with a large number of emerging market countries has helped Chinese banks to grow.
This appears to be a near term and long term challenge and more compelling compared to other cyclical issues such as Non performing loans and concerns of Wealth management funds offered by poorly regulated trust entities.
The sheer size of the economy and inter-connectivity as well as the linkages of domestic demand are important strengths of Chinese banks. Over half of the banking sector assets are owned by the big four state owned banks, which have remained fully liquid during the 2008 recession, driving a robust economic growth for a number of years. Thus China became the second largest economy in the world, after the United States.
Following are the big four commercial banks of China:
For rural banking needs Agricultural Bank of China;(ABC)
For funding industrial requirements, ICBC, Industrial and Commercial Bank of China;
For infrastructure and construction, (PCBC) People’s construction bank of China; and
For currency trading and international trade, Bank of China (BOC).
In 2008, Industrial and Commercial Bank of China became the world’s largest bank in terms of market capitalization. Ownership diversification due to restructuring helped the banks in improving their credibility worldwide. In addition, a large number of credit cooperatives supplement the role of commercial banks.
Weaknesses and challenges
Chinese banks are also facing some peculiar challenges and have specific weaknesses. One of the weaknesses is the significant autonomy at local government level. Party officials push local investment causing excess inventory and central bank officials, through the local office, are not able to restrain and discipline them. The Central Bank of China has established regional branches, which are mostly similar to Federal Reserve System in the US. China’s local-central bureaucratic structure may be in need an overhaul.
Shadow banking in China, an unregulated parallel financial system mainly lending to high risk SMEs, has become a major risk factor for the economy. Similarly uncontrolled wealth management product offerings of trust entities continue to show weakness and these may impair health of the financial system.
Low penetration of banking in rural areas and counties continues to be a big challenge for China. Similarly banks are heavily dependent on interest income, as the fee income is insignificant, less than 15% of total bank income. Comparatively, in advanced economies fee income can be as much as 40% of total income of banks. Low usage of credit cards in China is another factor deterring international banks.
According to a study by Mckinsey, published in July 2013 (A new direction in Chinese banking) the Chinese share of bank loans for large corporations, which are state owned, reduced from 52% in 2006 to 39% in 2011 and it is projected to reduce further to 33% in 2016. The capital is now flowing to fast growing small corporations, as well as middle class consumers, which have seen accelerated growth. This shift has crucial implications for their strategic business models. The shift in market structure and the consequent changes in opportunities will require a change in the mind set of Chinese bankers and organizational responsiveness, as well as flexibility.
Moving forward, the Chinese banking system has to implement important cost saving measures and improve overall efficiency. A total overhaul of the legal system is needed to handle contract enforcement issues and a change to a more professional approach to lending would go a long way to improve the current banking system.