Some unorthodox thoughts on China's unorthodox financial sector

摘要

China's banks are undeniably in serious financial straits. Citigroup (2002) has estimated that the ratio of nonperforming loans (NPLs) at the four biggest state-owned commercial banks (SOCBs) to be about 35 percent at the beginning of 2002, and that the average capital adequacy ratio (CAR) of these four SOCBs to be 5 percent. In short, the bank recapitalization in late 1998, which had raised CAR to over 8 percent, was a wasted effort. The primary reasons for this rapid deterioration in the financial health of the banks are that the composition of the customer base has not changed, so that state-owned enterprises (SOEs) remain the biggest borrowers, and that there has been intermittent pressure on the banks since 1997 from the government to expand investment credit in order to combat deflation, and to expand social stability loans to reduce firm closures. The result is that the SOCBs are now in need of another round of recapitalization. In this situation of a fragile banking system, China has committed itself to opening up the banking system completely within 5 years of WTO accession (which it joined in December 2001). Foreign banks could conduct transactions in foreign currencies from the beginning of WTO membership, conduct transactions with the local corporate sector in Renminbi after 2 years, and conduct transactions with local households in local currencies after 5 years. Although foreign banks are likely to compete only in the coastal cities, at least in the initial period, the pressure on domestic banks could be high as the big four banks earn almost all of their profits from about the coastal cities. Because there is no explicit depositor insurance in China, the obvious question is whether depositors will believe that thee foreign banks will drive the SOCBs into open bankruptcy, and hence rush to withdraw their savings from the SOCBs, setting in motion the vicious downward spiral of credit contraction, leading to business failures, rendering sound financial institutions insolvent, and contracting credit further.