ABC, NPL's and the government's taxation dilemma

Song Xianping, research director at the Agricultural Bank of China, talks frankly about NPLs and political pressures which are slowing reforms down.

There's been much talk of commercial banking reform in China. What steps has Agricultural Bank of China taken?

Song: Banking reform in China is experiencing the lull before the storm. An important aspect is the funding of the reform programme. But right now everything is in limbo ahead of the 16th Party Congress this autumn, which will determine the leadership changeover. In the wake of the February working commission on banking reform, no systematic programme has yet been laid out. But in any case, the real decision is made at the State Council level, which approves or vetoes the suggestions from the PBOC. At the moment, it's similar to before US elections. There's not much going on because nobody knows who will be responsible afterwards. But I think a blueprint will appear soon after the Party Congress. At ABC, the crux of the issue is that while we recognize the need to turn ourselves into a genuine commercial banking entity as soon as possible, our rate of reform is determined by government policy.

What steps are the banks thinking about at least?

Every bank has a different approach and a different profile. Bank of China has already done a foreign listing. ICBC says it wants to do a listing within the next five years. China Construction Bank says it wants a strategic investor, either domestic, or rather better, foreign. Every bank has its peculiarities. For example, here at ABC we are saddled with an image of having an agricultural orientation, especially in terms of loans.

Are you subject to policy lending?

Total outstanding loans amounted to Rmb 1.7 trillion last year. Our policy lending amounts to Rmb 270 billion -16% of the whole. This is allocated to poverty allocation, especially in the western, rural parts of the country, for projects such as improving farming production and infrastructure. Within that amount we can choose the projects, choose how to spend the money, for Rmb 70 billion. Policy lending is a historical burden, which we are keen to change. But in the major cities, Beijing, Tianjin and Shanghai, we chase good clients and compete with the other banks on a competitive basis. Unfortunately, this is an aspect of ABC which isn't widely recognized.

What about funding the private sector, which is underfunded despite contributing so much to GDP?

It is are high risk. They are generally small scale companies and not transparent. For us, they are not very profitable. The main problem is that since interest rates are fixed, although within a 30% band, we can't charge them higher interest rates to compensate for the added risks. I suspect most bankers around the world would agree this does not make them attractive. Also, not many are listed, limiting disclosure. The problem is that in China, there are not many good clients, and when one appears he's hunted down by all the other banks. But we are even wary of the big clients after the huge US corporate failures.

What reforms has ABC undergone?

Obviously, given abuses in the past, the process of making loans is being changed. We're trying to completely remould our internal management systems and become more commercial. We have divided the loans marketing department from the loans approval department. If a loan exceeds a certain amount, the loan is referred back to the head office. At the head office, the loans committee decides whether to approve the loan via an open vote. If two-thirds approve, the loan goes through. Also, our marketing is more professional. Previously, clients came chasing us. Now, we go chasing clients we think are quality prospects. We then establish a formal, professional relationship. The marketing is now done centrally, rather than at county levels. This means focusing on big, quality clients instead of letting the branch offices set the agenda.

Have you changed your personnel management policies?

Yes. Originally, our staff were treated as civil servants. Now, it's much more competitive. Certain staff are set three year targets, and promotion and remuneration are increasingly based more on merit than seniority. We offer bonuses for good work. Traditionally, our organization has been overstaffed and inefficient. But we have laid off, or sent home, around 75,000 employees, cutting our staffing level to around 500,000. We know this is still a huge number - we have the largest number of staff of any of the Big Four banks. We want to cut our numbers further. We're also hiring top graduates and postgraduates. And we've started a vigorous programme of specially trained investigators, half of dozen of whom descend on one of our 36 provincial banking centres at unexpected times to comb through the books and check the branch's conduct is regular.

How is the situation with non-performing loans?

Our NPL levels stand at 30%, although I know foreign analysts calculate them as much more than that! What I'd like to emphasize is that they are slowing down. Since last year, our NPLs went down 4.3%, or Rmb 15 billion. In the first six months of this year they have gone down a further 2%. This is due to a healthy, growing economy, and choosing better clients. We also disposed of a bunch of bad loans to an asset management company.

Some clients, some of the state owned enterprises, have been able to pay back some of their loans thanks to the improving economy. And we have been taking defaulting clients to court, which has produced some results. But we are still constrained by the government's policies in handling non-performing loans. We have to conform to very stringent conditions before we can apply to write off a loan. So the question of how much further NPLs will go down is a difficult point, especially with the world economy in such a poor state.

More freedom to handle non-performing loans would, however, certainly give us room to bring them down further. For example, we would like to offload our policy loans completely onto the Agricultural Development Bank of China, which is a pure policy bank - ie it doesn't take deposits, and finances itself through long-term bonds and its loans are directed by the government.

I believe the Ministry of Finance is concerned about the tax revenue it would lose if you provision for you NPLs.

There's a big difference in the attitude between the PBOC and the MoF. The PBOC wants us to move towards international standards as soon as possible, to enable us to be competitive following our entry to the WTO. In contrast, the MoF previously made it difficult for us to write off loans, because that would affect our profitability, and hence the income tax we pay the government. Until recently, we were only allowed write-offs not exceeding one per cent of bad loans every year. This has been changed to a sliding scale, depending on the bank's level of profitability. We're now permitted to use our profits to provision for bad loans at a rate of 2%-3% per year. But the whole process still requires government approval. This makes it cumbersome and bureaucratic. But the MoF has realized that if we, the bank, don't write off the loans, the government will have to do it a later stage anyway. We are state-owned after all.

So we are now able to write off at a quicker rate, especially after our profits shot up to over Rmb 3 billion in the first six months of this year, compared to Rmb 1.15 billion for the whole of last year. Deposits increased by Rmb 49 billion, and loans increased by Rmb 117 billion. The interest rate spread in around 3%. This spread contributes the majority of our total profits.

And you also suffer from quite a punitive tax regime.

Tax from the banks is a very important part of government revenue. Yes, we pay a 33% corporate tax rate. But that's down from 55% in the past! We also pay a extra tax, known as an operations tax, set at 6%. Two years ago it was 8%. But it's going down 1% every year. We've complained about this tax, and hope it's going to be cancelled. We don't like this tax, whether we make money or not, we still have to pay it. But the MoF's attitude is changing for the better.

What's the situation with your capital adequacy ratios?

It doesn't correspond with the Basel Regulations stipulating 8%. We have core capital of 120 billion and total assets of 2.6 trillion. We are discussing the problem with the government. There are two solutions. We could get rid of all our policy loans worth Rmb 270 billion to an asset management company or to one of the true policy banks. Or we could rely on the government to boost our capital levels. We hope that with cost cutting and rising profitability, and with one or both of these aids, we can put the loan problem behind us.

What impact did the listing of Bank of China (HK) have on you?

I don't believe a listing necessarily solves a company's problems. If you look around, there are lots of listed companies with problems, both in the US and in China. Although this has not been discussed with the bank's leadership, I am attracted to a financial holding company solution. The opportunities of cross-selling insurance, consumer loans and asset management products would be terrific and these areas are very profitable.