More regulation, please: bank reform in China

Wang Xue-bing, ChinaƆs eminent banker, outlines what it will take.
If any one person is the face of everything that is possible for China’s state-owned commercial banks, it is Wang Xue-bing, the former president and chairman of Bank of China and since early 2000 the president and CEO of China Construction Bank, as well as chairman of its joint venture with Morgan Stanley, investment bank China International Capital Corp.

Yesterday (Tuesday), at a talk in Hong Kong sponsored by the Asia Society, Wang gave an intelligent, clear and humour-tinged vision of the enormous reforms needed to make Chinese state banks competitive in a post-World Trade Organization environment. Given that the top four state commercial banks account for 70% of financial resources in China, it is a most urgent task.

He argues that creating internationally competitive banks requires an integrated strategy of institutional reform, bank operations reform and broad financial innovation. This is in contrast to the step-by-step approach that has guided Beijing since Deng Xiaoping alluded to a blind man crossing a river by feeling the stones.

Perhaps his most striking point is that the problems at banks – operational inefficiency, high risk, poor quality, bad resource allocation – are not just because bank officials are poorly trained and make errors. It is because of innate contradictions in banks’ ownership structure and corporate governance. The state owns these four banks; the state regulates them; the state dictates lending policies; the state determines savings, deposit and lending interest rates.

Wang argues the relationship between the banks and the government must be clarified, and modern principals of corporate governance must be instituted so that bank managers can both run the bank without state interference, and also be accountable for their decisions. This then will spur banks to implement internal risk management controls, and will assist them to raise capital and incentivize their staff.

Ownership must change as well. Wang notes the establishment of asset management companies (AMCs) to rid banks of bad loans was modelled after the United States’ Resolution Trust Corp. in its savings and loans crisis: a state AMC buying debts from other banks. In China, the state owns both the banks and the AMCs, a conflict of interest that has undermined the programme. Wang says the banks must be corporatized and listed on stock exchanges to avoid moral hazard issues.
Interestingly, Wang says this is not the same as a call for enshrining private property into China’s constitution. “I don’t think private ownership is better than state ownership,” he says. He cites Singapore’s Government Investment Corp. as a state-owned entity that is well-run. Rather for Wang, it is a question of the state clarifying its role vis-a-vis the banks and the banks’ objectives.

Ronnie Chan, chairman of Hang Lung Development and moderator at Wang’s talk, noted, however, that GIC’s investment record is not as good as Wang seemed to think.

Wang also called for reforms to China’s market mechanisms, so that policies about interest rates, money supply and exchange rates are liberalized and bond, money and derivatives markets are deepened. Allowing banks into futures, for example, will allow them to hedge risk. This all requires a clear regulatory scheme that fosters competition.

Another obstacle is the taxation system. Wang notes the corporate tax is 35%, while for commercial banks taxes amount to over 60%. Foreigners get tax breaks in special economic zones, further worsening banks’ competitiveness and restraining their ability to deal with bad loans or grow assets. In particular, Wang dislikes the business tax levied on banks in addition to income taxes. This tax has already been cut from 8% to 5%, but Wang calls for it being abolished, arguing that each 1% cut translates into over RMB9 billion ($1.09 billion) of extra assets on the balance sheet.

The banks themselves, as these reforms are implemented, must first concentrate on their advantages – pick sectors, regions or clients that they can use to build a competitive business – and from there go international. China Construction Bank, for example, is targeting four specific markets, such as mortgages, and neglecting the rest.

Again, Wang puts this into the perspective of someone involved in a socialist market economy. Underwriting mortgages to upscale Shanghainese people is not, as he sees it, blessing private property. Wang puts it into context: how did the Communist Party conquer the Nationalists? By winning over the peasantry by offering them land. Today, Wang says, the state commercial banks are beholden to facilitate giving people access to decent homes. Therefore mortgage banking is a social responsibility, not a call for property rights.

Banks must also institute better management and instil a sense of corporate culture among their far-flung workers. This is key to selling restructuring, but hard: Construction Bank has 420,000 employees that need to learn about credit and risk. As things stand, banks are too unwieldy to adapt.

Wang likens them to dinosaurs that were so massive, it took several minutes for nerve impulses to reach their brains. “Chinese banks remind me of dinosaurs that needed five minutes just to realize someone had bitten off their tail,” he says. This returns to the ultimate problem, the conflict of interest between bank and state. Today, bank officials are also government officials. They must become able to make independent, accountable decisions.

Wang is not calling for the state to retreat from the economy, only to make its role more defined. “China is not deregulating,” he says. “It is regulating.”

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