A $45 billion shot in the arm
Jan 6th 2004
From The Economist Global Agenda
SourceA massive cash infusion for two of China’s largest state-owned banks is just the beginning of a much-needed overhaul of the sickly financial sector
CHINA’S newish prime minister, Wen Jiabao, is a geologist by training. So far, the conversion of his country’s financial system from swadeshi communism to global capitalism has moved at the kind of glacial pace only a geologist could appreciate. But on Tuesday January 6th, the Xinhua news agency announced a great leap forward. At the end of December, it said, the Chinese state injected $45 billion—one tenth of its foreign-exchange reserves—into the country’s two largest banks, dividing the funds evenly between Bank of China (not to be confused with China’s central bank, the People’s Bank of China) and the China Construction Bank.
These lenders are two of China’s “big four” state-owned banks, the other two being Industrial & Commercial Bank and Agricultural Bank. With 116,000 branches across China, these four hold 67% of the country’s deposits and make 61% of its loans. But not all of those loans are likely to be repaid. The government estimates that 23% of the big four’s loans are “non-performing”. Most independent analysts think the true fraction is a third or more. Big as last month’s cash infusion is, it is just a drop in a bucket of bad loans totalling more than 3.5 trillion yuan ($422 billion).
What kind of bank makes loans of which a third will not be repaid? The communist kind. Some of the banks, such as Bank of China, founded by the legendary nationalist Sun Yat Sen in 1912, predate the Maoist takeover, but none of them escaped its wholesale distortion of capital allocation. For decades they made loans based on bureaucratic, not commercial, priorities. Some funds served to prop up bankrupt state enterprises and the legions of workers who depended upon them. Others served social policy of a different kind—keeping cronies happy and palms properly greased. Wang Xuebing, former head of two of the big four banks, lost his job for making dubious loans and lost his liberty for taking bribes.
In a sense, the capital infusion announced this week simply shifts money from one state tentacle to another: $45 billion of foreign exchange, once under the custody of the state’s monetary authorities, is now under the custody of two of the state’s banks. But the Chinese government is hoping gradually to withdraw its tentacles from the banking system, and this latest injection of funds is a necessary part of that process. The state needs to clean its banks up in order to sell them off.
As a consequence, its funds have gone not to the banks in direst need, but to those most ready for the showroom. With a bit of tarting up, Bank of China and China Construction Bank will, it is hoped, make for an initial public offering (IPO) that investors (foreigners included) cannot refuse. Of the big four, China Construction Bank is in the best shape. A stockmarket flotation, perhaps as soon as this year, could raise between $5 billion and $6 billion, according to some investment bankers, who are already keenly offering their services as midwives to the deal. Bank of China, the country’s biggest foreign-exchange lender, which hopes to follow in 2005, could be even bigger. It already has some experience of going public, floating its Hong Kong operations on the territory’s stock exchange over a year ago.
The state will welcome these contributions to its coffers. However, its main purpose in selling the banks is not to raise money but to transform lending in China. The hope is that private banks run for the benefit of shareholders will lend more productively and more prudently than the big four have managed to date. They could hardly do worse. But although privatisation will undoubtedly help, privatisation without competition or regulation brings dangers of its own.
China’s people stash about 40% of their income in their nation’s banks. The big four do not have to chase deposits: deposits come to them. Privatising the banks will do little by itself to sharpen competition—a privately owned oligopoly is still an oligopoly. By the end of 2006, however, this cosy banking market will be shaken up by China’s commitments to the World Trade Organisation. Foreign banks will be allowed to do business in the Chinese currency with Chinese households. If the country’s banks, whoever owns them, do not learn how to compete for deposits, they may start losing customers to foreign entrants that do.
Complacent about the money coming in, China’s banks are also too free about the money going out. Lending by the big four grew by a fifth in the year to October, according to Goldman Sachs. Many economists fear that the Chinese economy is in serious danger of overheating. The central bank has raised reserve requirements in a bid to restrain lending, but to no great effect. Its job is greatly complicated by its desire to maintain a pegged currency: buying dollars at the fixed rate of 8.3 yuan creates a lot of extra liquidity that it then struggles to mop up.
Indeed, the Chinese authorities are caught in a bind. They cannot rein in their banks as long as they maintain their currency peg. But they cannot surrender their peg until the country’s banks are fit enough to live with a currency free to float and capital free to flee. It is a Gordian knot the Chinese state has only begun to unpick.
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