China’s sprawling banks are now in the government’s crosshairs, and the coming months will see their entire business model up for discussion.
Since taking office in March, China’s new leaders have said repeatedly they will unleash market forces to rein in excessive lending and improve the banking system’s performance.
Reforms being mulled include more interest-rate liberalisation and greater exchange rate flexibility.
At the same time the government is trying to wean companies off bank loans by bolstering capital markets as an alternative venue for them to raise cash. Analysts are also forecasting the introduction of a safety net for depositors if any small banks go bust before the end of the year.
The task is gargantuan. Policymakers are trying to reform a dysfunctional financial system whilst opening China’s capital account — a process that the IMF said should be “gradual and careful” in its review of China’s economy in May.
To be sure, the risk of a major financial crisis remains low as China could easily bail out its banks if needed and runs its banking sector conservatively. Also, clumsy attempts at reform could significantly increase financial instability throughout the region — as happened when the central bank squeezed liquidity last month in the interbank lending market.
Bankers point to the fact that the financial system may work better if regulators communicated with them more openly and stick to their roles.
Uncertainty is also heightened by the fact there is no formal discount window at the central bank, where all banks would be able to borrow to cover temporary cash shortages at any time, such as in the US and Europe. As interbank lending rates shot up, rumours circulated of smaller banks on the brink of failure. This heightened the panic as there is no clear mechanism in China for banks to exit the market without causing more turmoil.
Financial analysts expect China will start building a safety net this year to protect depositors and to enable failed financial institutions to exit the market without causing system turmoil as soon as this year.
See the upcoming issue of FinanceAsia magazine to read the full story, as well as our special report on the renminbi