Central bank decides overseas listing will provide impetus to reform.

Newspapers and magazines at home and abroad have taken great interest in the topic of state-owned bank (SOB) listings recently. Early this year, the country's four large SOBs each disclosed their timetables to allow their shares to trade in stock markets. The China Construction Bank (CCB), the Bank of China (BOC), the Industrial and Commercial Bank of China (ICBC) and the Agricultural Bank of China (ABC) are scheduled to list successively in the following four years (2004-07) after completion of share-holding restructuring.

Preparations for listing overseas can be seen as a part of China's current banking reform. The move, however, has drawn attention from the US-China Economic and Security Review Commission which submitted a report to the Congress this past June. The report described the "implications" for investors of Chinese banks seeking listings on global capital markets as "serious," because US investors could significantly "overpay by buying into these enterprises without full knowledge of the scale of the non-performing loan (NPL) problem."

Why Seek a Listing?

Zhou Xiaochuan, Governor of the People's Bank of China, the central bank, told representatives to the spring meeting of the International Finance Commission, held at Shanghai's Pudong Shangri-La Hotel in April, that the listing of banks is the key issue concerning China's banking industry.

Zhou grinned while presenting a rhetorical question to the audience before rolling out his analysis. "Why should the government press banks to adjust their managing structure instead of changing management personnel or waiting three or five years before seeking ownership restructuring, and hence listings?"

"state-owned commercial banks have encountered or will encounter the problems facing any state-owned enterprises (SOEs)," claimed Zhou. For example, the head of a SOB, which the CPC (Communist Party of China) Central Committee's Organization Department appoints, has limited decision-making power. SOBs, like all SOEs, are not market-oriented and generally lack an effective incentive mechanism.

"Commercial banks and government organs are too akin. The banks are trying to change this," said the governor. However, no bank officials will abdicate power without external pressure, which has prolonged the reform of China's banks.

The CPC made clear two years ago in the Resolution of the 16th National Congress that reform of the nation's SOEs is a compelling notion. The logic that they finally embraced was that SOE stagnation can only be rejuvenated through diversifying ownership and improving management structure. The idea, according to Zhou, "suits the reform of state-owned commercial banks as well."

Zhou raised the question of why banks are going for trading in stock markets overseas in such a hurry. "Because they lack money?" He then declared in a frankness that surprised his audience, "Yes, banks in China are lacking money," which is needed for capital expansion, reduction of non-performing loans and meeting requirements for a capital adequacy ratio.

"Yet [this] is not the main motivation for listing, " Zhou emphasized. The real reason is that banks lack the internal impetus to reform or restructure ownership without trading in the stock market. Public monitoring supplies sufficient pressure for a listed bank to establish an information disclosure and accounting system to consider stockholders' rights, which, Zhou believes, will promote efficiency among commercial banks.

Another factor making reform and listing urgent is the fact that foreign banks are to be allowed to offer more services.

Usually, the top 10 percent of a commercial bank's clients bring 80 percent of its profit. By the end of 2006, China's financial market will open entirely to foreign banks to allow them unrestricted operation rights, which means "fair play" between them and domestic banks in any service. Chinese banks will need the efficiency and competency to compete with their foreign counterparts for big clients, which are vital to any large bank.

Banking reform in China needs even greater competition and more pressure from the outside, Zhou concluded.

Problems With State Banks

The Central Government was motivated by three factors to decisively follow through with banking reform. Zhou Xiaochuan elaborated: lessons drawn from the Asian financial crisis of 1997, demands for reducing the NPL ratio that has been as high as 40 to 50 percent and seeing the merits in transforming the way large SOEs operate.

"Many people now think that state-owned commercial banks can't make ends meet because they suffer from high NPL ratios," said Zhou.

But Zhou insists that a whole picture of China's banking reform can be made possible only through an exhaustive analysis of factors underlying NPLs.

According to his assessment, nearly 30 percent of Chinese banks' non-performing assets (NPA) are more or less due to wrong decisions in promoting economical development of various local governments.

"Fortunately, this practice is history," Zhou said, "Local governments are putting an end to administrative intervention in the operation of local commercial banks."

Another 30 percent of non-performing assets (NPA) are due to problems with state-owned enterprises to which banks grant loans. These include bad performance and ownership restructuring that brought banks losses. The Central Government, according to Zhou, "has already begun to address these problems."

About 10 percent is a result of flaws in law and regulation. For example, defects in the liability system of current bankruptcy law have led to the evasion of debts. Another 10 percent is due to the closure of some non-performing enterprises by the government as part of economic restructuring.

Commercial banks themselves are responsible for the remaining 20 percent of NPAs, which, according to Zhou, is "a huge number that makes it impossible to ignore the problems commercial banks have had during their adaptation to a market-oriented system."

Despite all these problems, Zhou is still optimistic about future banking reform.

Zhou noted that commercial banks have already shifted to focusing on adopting market-oriented organization and obtaining independence in choosing diversified clientele. Loan regulation of state-owned commercial banks throughout the 80s and 90s obligated SOBs to provide credit to SOEs, regardless of performance.

The proportion of SOE clients of commercial banks has shrunk considerably in the past two decades. Statistics from the People's Bank of China show that loans granted to SOEs are less than half of the rest.

New financial legislation is set to pave the way. The National People's Congress is currently drafting new bankruptcy, security and corporation law. Law that limits government involvement in banking administration and ownership is seen as key to facilitating successful reform.

At present, commercial banks in China cannot keep pace with the market because of incomplete financial tools, products and services. However, they still have some advantages, such as unmatched access to the huge domestic market, which puts domestic banks in the position to indirectly finance China's economy.

Capital: The Great Divide

Zhou admitted that China's road to banking reform would be bumpy. "The high NPL ratio of banks is among the great challenges the government is facing in banking reform."

The reform underway has used existing resources to offset non-performing loans, explained Zhou, "The Central Government has begun to use foreign exchange reserves to invest in banks and rid them of NPA to qualify them for listing."

Zhou said that the CCB and BOC were selected to pioneer the overseas listing of China's SOBs because they had the lowest NPL ratio among the four large SOBs."

There has been heated debate over how the Central Government can effectively put new non-performing assets under control after its investment in SOBs. Zhou said that both the CCB and BOC are establishing corporation management structures in accordance with the Corporation Law and looking for major investors vital to their long-term strategy.

The central bank and the China Banking Regulatory Commission, the industry watchdog, have decided to establish a strict capital system, and stick to requirements for the capital adequacy ratio and required reserve ratio, which is stipulated by the Basel Capital Accord.

Beyond Listing

Some opine that getting banks listed should be the ultimate goal of Chinese bank reform. They would also argue that banks seek more financing channels to make up for capital shortage and to provide incentives for management.

There is more to it than that.

The definitive goal of bank reform is to turn state-owned commercial banks into true corporate bodies in the market. The process of listing banks is to bring upon them enough pressure to establish a corporate management structure and sever governmental tampering.

Successful reform is the only way to protect the interests of investors.

(Beijing Review August 5, 2004)