China’s banking sector has traditionally served as a party-controlled watering hole for its inefficient and unprofitable state-owned enterprises, most of which were technically insolvent. The process was simple – issue a loan to an unqualified state applicant, then write off the loan as a bad debt if not repaid. This situation is changing and Chinese banks are attracting the attention of foreign banks who are beginning to see them as investment opportunities rather than potential competitors. Nevertheless, the Chinese banking sector is plagued with several problems.
1. Loans to SOEs: The importance of China’s banking sector as a source of domestic capital is hard to overestimate. Mainland Chinese stock markets are anemic compared to the behemoths of Hong Kong, Tokyo and New York, and the Chinese bond market is virtually non-existent. That leaves banks as the only major source of domestic financing above the table for private companies. Yet loans from state-owned companies continue to siphon off much of bank capital, despite China’s stock markets largely being designed to provide state-owned companies with an alternative source of funding. Many domestic companies resorted to underground institutional loan sharks with their high interest rates, or relied solely on retained earnings for financing. Even though defaults on SOE loans have dropped significantly at some banks for recent lending, the sector as a whole is still suffering from the hangover of reckless lending under earlier more politicized lending policies. .
2. Corruption: There is an ongoing crackdown, but corruption is rampant in many sectors of the Chinese economy, and the government still cracks down on corruption in this or that industry. Meanwhile, the cycle continues. It is tempting to predict that only the threat of bankruptcy due to foreign competition will one day be enough to create the political will necessary for consistent application of the law.
3. Decentralization: China’s banking sector looks fairly centralized on paper, but the hidden problem is the de facto independence of branches away from the head office. Chinese bank branches have been accustomed to operating with much greater independence than is the rule in the West (thus contributing greatly to the problem of corruption), and any attempt to assert control from head office is bound to be met with stiff resistance. local.
However, the moment of truth is fast approaching, as China’s WTO commitments require it to fully open its banking and insurance markets to foreign competition next year. The government is responding by introducing a slew of new regulations to streamline lending practices and cracking down on internal corruption (whether the new regulations will actually be followed by bank branches is a question only time can answer). Banks are responding by listing for IPOs in foreign markets and carrying out American-style “downsizing”, closing branches and laying off staff.
Foreign banks are responding by investing billions of dollars in Chinese banks, which is surprising given the above issues. Additionally, they are acquiring minority stakes that will likely never offer them operational control, in some cases primarily for the purpose of securing access to distribution networks for insurance, credit cards and investment products after 2007. .
No one wants to see Chinese banks wither away from foreign competition – not even their foreign “competitors”, because a Chinese banking crisis would have a significant negative effect on the entire global economy.