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Chinese banks and over-hyped bailouts
Ben Larkman

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Two of China's Big Four banks, the China Bank and the China Construction Bank each received US$22.5 billion last month from China’s foreign exchange reserves, in the hopes that the banks can be brought into the sphere of international competitiveness. The Business Post reports the Chinese government intends to pour another US$40 billion of its foreign exchange reserves into the biggest of the Big Four, the Industrial and Commercial Bank of China.

Not Enough

Keep the money in perspective. In the past five years, the government has spent nearly US$200 billion on the banks. Most of it was spent in 1998, with the government buying bad debt off the banks. Ever since, the government had been peddling off the bad debt at pennies on the dollar to foreign and domestic bidders alike.

Independent analysts estimate the Big Four banks are currently saddled with more than US$400 billion in bad debt. That is almost 40 percent of all loans. Lending grew by 20 percent last year, despite policies to restrict lending. Simple arithmetic puts the addition to bad debt last year in the same ballpark as this year's bailout.

Chinese officials hyped up the bailout as a step toward restructuring the banks, and bringing them close to international standards in time for 2006, when, according to its World Trade Organization agreement, China is supposed to open up its financial sector to foreign competition.

"The reform aims to turn the two selected banks into commercial banks in the real sense,” quotes the China Daily from a report by the government mouthpiece Xinhua News. “They will establish standard corporate governance... as well as a good mechanism for fiscal restraint and internal risk prevention.”

For “good mechanism for fiscal restraint,” read: a way to stop the banks low-level officials from giving out loans to hopeless business ventures. And for “internal risk prevention,” read: stopping rampant corruption. It is unlikely the government will achieve either anytime soon.

Giving Out Loans

Most discussion on Chinese banks is done under the assumption of Western-style capitalism, where firms aim to maximize profits. Capitalistic banks evaluate the risk loan applicants represent, and choose whether to lend on the basis that someone cares whether the loans get paid back.

In Communism, firms don't maximize profits; they meet quotas. The Central Planning Committee sets output quotas, which filter down to state-owned firms in the form of input and output instructions. In this context, profits are as meaningless as prices, which are both set by the government. Firms have what economists call “soft-budget constraints,” which is to say output quotas are the bottom line, and if firms have to take losses to meet their government set output quotas, then the government bankrolls the losses.

Andy Xie of Morgan Stanley said: “The problem is not capital. The problem is that China's banks are still not real banks. They are tools of the Communist Party.”

China is moving away from this system, but the two-tier manner by which it has been implementing economic reform has left much of the old Communist system intact, and losing money. A recent report by the World Bank states that more than half of China's 174,000 state-owned enterprises are losing money. According to China's National Bureau of Statistics, the state-owned enterprises employ about 75 million people. If the Chinese government managed to cut credit to these enterprises, half would go bust, and tens of millions of workers would become unemployed.

From this perspective, claims by government officials that they will cut credit to money-losing businesses aren't plausible. As the Communist system crumbles away, bank credit is all that keeps most of the old economy afloat.

Stopping Rampant Corruption

In the Chinese banking system, corruption manifests as the giving out of loans in quantities and at interest rates that aren't in line with government policy. Unfortunately for the odd scapegoat official, government policy isn't what's written down. Take the persecution of Falun Gong for example. In 1999, tens of thousands of practitioners were arrested months before any law existed banning the group. What counted then, as now, was not any law, but the whim of former President Jiang Zemin, who had decided to eliminate the group.

Corruption in China starts at the top, which makes it hard to believe any anti-corruption policy is anything more than talk. For example, the son of former President Jiang, Jiang Mianheng, obtained billions of dollars worth of low-interest loans to finance a raft of high tech enterprises. Jiang took over a good portion of China's information technology sector with his endless stream of credit, which led to him being dubbed China's “Prince of Technology.”

Corruption at the highest levels is supported by favors to lower levels. While Jiang Zemin and his so-called Shanghai Faction dominate the Chinese Central Committee, don't expect corruption to diminish.

What About China's WTO Commitments?

China committed to opening up its banking sector within five years of its accession to the WTO in 2001. The commitment was to phase in the presence of foreign banks in China over five years.

According to the Trade Representative's report to US Congress on the matter of Chinese compliance with its WTO commitments: “China’s uneven and incomplete WTO compliance record can no longer be attributed to start-up problems. ... In a number of different sectors, including some key sectors of economic importance to the United States, China fell far short of implementing its WTO commitments, offsetting many of the gains made in other areas.”

The government is dragging its feet in implementing even just the initial steps of letting foreign firms do business in China. And where it has opened up the market, the report to Congress states, the People's Bank of China has stepped in to impose higher-than-international-norm working capital requirements and other restrictions, making it hard for foreign banks to enter the Chinese market.

It's not hard to understand why. The Chinese banking system is insolvent. So long as Chinese depositors have nowhere else to go with their savings, the status quo can be maintained.

If foreign banks are allowed to take deposits from Chinese citizens, the Chinese banking system faces a bank run like never before seen in the world. The first chance they get, every Chinese person who understands that the state banks don't have enough cash to pay out all deposits will try to be first in line to get their money out of the state banks. When 1 billion of the biggest savers in the world find out their savings are gone, they'll be angry. Don't expect the Chinese government to let that happen anytime soon.

When 2006 rolls around, the financial world will be coming to the same conclusion human rights activists came to years ago: China's signature on international treaties isn't worth a whole lot.

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