The Development of the Chinese Financial System and Reform of Chinese Commercial Banks

D. Luo

• Publisher: Palgrave Macmillan
• Year: 2016
• Print ISBN:
  9781137454652
• eBook ISBN:
  9781137454669
• Topic: Business
• Subtopic: Business General
• Index: Business

The Chinese financial sector, despite having been developed at a much later stage compared with other developed nations, has achieved substantial progresses over the past decades. By the end of 2014, a total of 16 commercial banks had been listed on the stock exchanges, exerting strong impact onto the market indices and contributing significantly to the country's sustained economic growth. This book reviews the evolution of the Chinese financial system, examining the effectiveness of reform strategies made by the government over the last ten years. The first chapter offers a comprehensive review of the development of the Chinese banking sector and the state-owned banks (SOBs). The second chapter focuses on the efficiency of the Chinese banking sector. Employing data envelopment analysis (DEA) and stochastic frontier analysis (SFA), the author tests the change of efficiency within the Chinese banking sector over the past decade. It also looks at the strategy adopted by the Chinese government as the final attempt in reforming its troublesome SOBs and the effectiveness of such a reform strategy. The next chapter examines the corporate governance practise of the Chinese commercial banks, and the author follows by investigating the effect of the 2007 US credit crunch on Chinese banks and the country's wider economy. Other chapters survey the influence of foreign entry to the Chinese domestic banking sector, and the development of shadow banking in China. The author concludes by discussing the role of the central bank, namely the People's Bank of China (PBOC), and its role in implementing effective policies to promote economic growth.

1

Evolution of the Chinese Banking System

China’s financial sector is mainly comprised of banks, non-bank financial institutions and stock market. Economic reform since 1978 has fundamentally changed the Chinese banking sector, transforming it from a mono-bank model to a system with multi-financial institutions. The banking sector now serves as an important mechanism in resource allocation and risk diversification. This chapter will present a detailed review of Chinese banking system reform. Particular attention will be paid to the strategies adopted by the central government in reforming its state-owned banks (SOBs). In addition, current performance and new initiatives for financial system liberalization will also be discussed.

1.1 Chinese banking system reform

In 1948, the establishment of the People’s Bank of China (PBOC) represented the beginning of China’s contemporary banking system. Thereafter, the system followed a mono-bank model for about 30 years, during which only one bank, PBOC, carried out two roles: policy lending and commercial operations simultaneously. In 1978, the comprehensive economic reform in China also led to substantial transformations to its banking system. The key objectives of the banking reform were to transfer the sector from a centralized, state-owned, monopolistic and policy-driven system to a decentralized, multi-ownership, competitive and profit-oriented system (Yao et al., 2007). The whole restructuring process afterwards could be roughly divided into four stages.

The initial banking reform period of 1979–1985 saw the establishment of a two-tier banking system. It was expected that a more specialized banking system could serve SOEs better and hence enhance the overall productivity and allocation efficiency. Under the new system, PBOC was divided into two components. One division retained the name PBOC and functioned as the central bank. It was responsible for the implementation of monetary policies and the supervision of all specialized banks and non-banking financial institutions. The other division focused on commercial operations and was further divided into four specialized SOBs, namely, the Agricultural Bank of China (ABC), China Construction Bank (CCB), Industrial and Commercial Bank of China (ICBC) and Bank of China (BOC).

Under the planned economy, these specialized banks served as the lending mechanism of the government, channelling funds to SOEs and other agencies under the state’s guidance and instructions. Instead of penetrating and competing across regions and sectors, they only provided funding to SOEs within designated sectors. For example, the ABC was mainly responsible for financing China’s agricultural sector. It offered wholesale and retail banking services to farmers, township and village enterprises, and other rural institutions. The CCB was designed to provide medium- and long-term credit for large urban specialized construction projects, such as infrastructure projects and urban housing development. The ICBC, which was the largest bank in China in terms of total assets, total employees and total customers, concentrated on providing services to commercial and industrial activities in urban areas. Finally, for the BOC, it was in charge of foreign exchange management and the settlement of foreign business transactions. To make it easier for the local residents and enterprises to get access to their services, these four specialized banks have established extensive provincial and local branches across all major cities. However, operations of these branches were under the guidance and administrative control of the respective local authorities rather than the central bank. As a result, insensitive to profitability goals, they were effectively acting as lending mechanisms of local governments to fulfil the regional production and construction plans.

Several years after the preliminary restructuring, the operation of the PBOC and four other specialized banks was widely criticized. Driven by policy lending, the SOBs were used by the state as the ‘soft lenders’ to support highly inefficient and loss-making SOEs and consequently accumulated a large amount of non-performing loans (NPLs). There was virtually no competition among the banks as they were given monopoly power over designated sectors. Such an arrangement breached the nation’s original goal of establishing a market-oriented economy, and thereby greater autonomy in decision-making has been called for in the whole banking system (Chen et al., 2005). To act as a real financial intermediator, the banks should play a more active role in economic development and resource allocation. As a result, the restriction that a specialized bank should serve a designated sector was removed in 1985. The banks could then expand their business scope and compete with one another freely in the market. However, such competition remained quite limited as foreign participation was almost wholly restricted and all the SOBs were still subjected to frequent interventions by both central and local authorities (Yao et al., 2007).

The second stage of banking reform, from 1985 to 1996, can be characterized by the establishment of three policy banks, the implementation of banking legislation and further institutional restructuring. Three new policy banks, the Agricultural Development Bank of China (ADBC), the China Development Bank (CDB) and the Export–Import Bank of China (Chexim), were established in 1994 to take over the government-directed lending functions of the ‘Big Four’. These banks were especially responsible for financing economic and trade development and state-invested projects. In particular, the ADBC supported agricultural development projects in rural areas; the CDB focused on financing infrastructure construction and pillar industries and the Chexim specialized in funding export and import of capital goods.

After the foundation of the three policy banks, the former four specialized banks were officially renamed as ‘commercial banks’ and were expected to be profit-oriented rather than policy-driven. In addition, the Central Bank Law and the Commercial Bank Law were passed in 1995 to strengthen the authority of PBOC and to provide a comprehensive legal framework for the operation of Chinese commercial banks (National People’s Congress, 1995).¹ Under the new regulatory framework, the PBOC was given more autonomy and a legal reference to formulate policy and supervise the financial system. Meanwhile, all other commercial banks were granted a certain degree of operational independence except during certain national emergency situations. However, such separation of commercial and policy functions of the banks was far from complete and neat. With limited branch network and capital sources, service and lending activities of the Big Four could hardly be fully fulfilled by the policy banks. Accompanied by additional pressure from the central and/or local governments, the commercial banks continued to be engaged heavily in policy lending.

Meanwhile, this period also saw the emergence of a two-tier banking system. Although still dominated by SOBs, smaller joint-equity commercial banks (JECBs) started to be set up and operate nationwide.² These banks often took a mixed ownership structure that included the state, SOEs, and private enterprises or individuals. In 1986, the Bank of Communications (BOCOM) was re-established and another two banks, the Shenzhen Development Bank (SDB) and China Merchants Bank (CMB), were founded one year later. The latter soon surpassed the ABC and became the fourth-largest profit maker in the country. In 1988, the Guangdong Development Bank (GDB) was established and it was listed on the stock market in 1992. The only private bank, China Minsheng Bank (CMINB), was established in 1996. All of its shareholders were from private industries and businesses. Later, some other JECBs, including China CITIC Bank (CITIC), China Everbright Bank (CEB), Huaxia Bank (HXB), Shanghai Pudong Development Bank (PDB) and Fujian Industrial Bank (FIB), were also set up or restructured. Thanks to their relative independence from the central or local governments, they were believed to have healthier asset quality, higher profitability and much lower NPLs compared to their state-owned counterparts. Since then, competition within the banking sector has intensified.

The third stage of banking reform lasted for almost five years, until China’s admission to the WTO in 2001. Major events during this period included the reorganization of PBOC, restructuring of some urban cooperatives into city commercial banks, the establishment of four Asset Management Companies (AMCs) and the first round of NPL disposal.

Starting from the mid-1990s, some large cities consolidated their urban cooperatives into city commercial banks (CCBs). They adopted a shareholding ownership structure and were restricted geographically within their own localities. The biggest ones in this group included Beijing Commercial Bank, Shanghai Commercial Bank and Shenzhen City Commercial Bank. By the end of 1998, 88 such banks were operating in China, with total assets, deposits and outstanding loans of RMB 457 billion, RMB 364 billion and RMB 220 billion respectively (Li et al., 2001). Since then, the overall structure of the Chinese banking system has been established by and large.

Despite a rapid expansion of non-state banks, the four SOBs still overwhelmingly dominated the Chinese banking industry. The four-bank concentration ratios of total assets, loans and deposits were 84.9%, 84.3% and 88.5% respectively in 1998, while their profit concentration ratio was only 55.3% (Wong and Wong, 2001). It indicated that the SOBs were large in size but much less profitable than the non-state banks and this could be explained by the following reasons.

The PBOC fixed the interest rate available to different kinds of depositors, so banks with higher profitability and productivity could not repay their customers with better than average interest. Such restriction effectively ruled out price competition in the deposit market. With a large number of branches operating in all major provinces and cities, the four biggest SOBs could rapidly absorb the highest amount of deposits. By the end of 2000, they had about 103,000 branches distributed nationwide and employed more than two million employees (Country Profile, China, 2000). The JECBs and CCBs, however, were constrained in the number of new branches that they could set up each year as they had to comply strictly with the PBOC quotas. Moreover, in order to maintain public confidence in the state banks, the Chinese central government had explicitly guaranteed their deposits. All these preferential treatments helped the SOBs expand their territory rapidly over the whole banking sector.

On the other hand, excessive government intervention impaired the profitability of the SOBs. The PBOC set up mandatory credit quotas for the SOBs to control their lending activities (Mo, 1999). Not only had the credit ceiling been specified, but also the use of funds. Instead of making lending decisions freely according to the assessed risk and return, the SOBs were always expected to support government projects and provide funding to the enterprises that had ‘special relationships’ with the government. As a result, long periods of policy lending has created a large amount of NPLs for the SOBs. Such problem also existed in JECBs and CCBs but much less severely. The degree of state interference was mainly determined by the relationship between the shareholders of the banks and the government; the closer the relationship, the more likely that they would be engaged in policy lending. For instance, Huaxia bank was privately owned by several big enterprises, such as Shougang Group, and the distribution of its shareholders was quite dispersed. The bank was relatively free from both central and local intervention and thus had one of the cleanest balance sheets among all major Chinese commercial banks. By the end of 1999, the NPL ratio of Huaxia bank was only 5.7% compared with the national average of 17.1%, while for the four SOBs, their average NPL was as high as 36.2% at the time (BankScope, 1999). Another bank, SDB, although it was a JECB, due to its intimate relationship with the local authorities, its NPL ratio was recorded at a high level of 23.5% during the same period.

In 1998, the PBOC abolished its credit quota system under which credit funds were allocated to each province and municipality according to a specified quota, and streamlined its 30 provincial-level branches into nine regional representatives distributed in cities like Tianjin, Xi’an, Shanghai and Guangdong. The change was designed to enhance the operational efficiency of PBOC and reduce its close ties with government (Mo, 1999). The senior officials of these new offices were then directly appointed by the PBOC rather than the local governments.

Starting from the late 1990s, the state was forced to clean up the balance sheets of the ‘Big Four’. After more than 20 years of policy lending, NPLs of the state banks had reached RMB 2.5 trillion in 1999. For ABC and ICBC, their NPL ratios were as high as 45% and 39.5% respectively. In order to unload the NPLs from the ‘Big Four’, restore their financial health and increase their competitiveness, four AMCs were funded: Cinda Asset Management Company, China Great Wall Asset Management Company, Oriental Asset Management Company and China Huarong Asset Management Corporation. They were paired with CCB, ABC, BOC and ICBC respectively. In 1999, RMB 1.4 trillion NPLs of the SOBs were stripped off, equivalent to almost 20% of China’s GDP in the same year (Yao et al., 2007). Later in 2000, all domestic banks were required to adopt the five-category loan classification standard to control the creation of new NPLs. In April 2000, another banking rule, which required true names of depositors, took effect. I...

Table of contents

• Cover
• Title
• 1  Evolution of the Chinese Banking System
• 2  Efficiency Analysis of the Chinese Banking Sector
• 3  Changes in Corporate Governance Practice of the Chinese Commercial Banks
• 4  The Financial Crisis and Its Influence on the Chinese Banking Sector
• 5  Foreign Penetration and Its Impact on the Chinese Banking Sector
• 6  Shadow Banking and Its Development in China
• 7  The Role of the Central Bank and the Influence of Chinas Monetary Policy on Asset Pricing
• Conclusion
• Index