China’s Incomplete Banking Reforms
By Wendy Dobson and Anil Kashyap
Abstract
China’s four largest banks (the Big Four) are state-owned commercial banks with over 60
percent of Chinese banking assets. The government is reforming them to make them more
competitive with foreign bank entrants expected in 2007.
The focus of this paper is to explore the contradiction between the government’s competitiveness
goal and continued majority state-ownership. The exploration begins with an examination of the
government’s three-part reform strategy: (a) clearing up legacy non-performing loans (NPLs)
and recapitalizing the banks; (b) finding international strategic investors to modernize their
management; and (c) listing on the Hong Kong Stock Exchange to induce greater transparency.
The risks to this strategy are then examined: (a) recent rapid loan growth which will produce a
new stocks of NPLs in the next few years; (b) an economic slowdown which will hurt the banks’
corporate customers, also causing NPLs to rise again; and (c) foreign bank entrants “cherry
picking” their best customers and threatening their future profitability. The likely size of the
predicted NPL problem is then estimated, using alternative measures based on reported losses of
their main customers, the state-owned enterprises, regional data on deposits and loans, and data
on losses per average loan. .
The authors argue these risks can be reduced by removing the contradictions in the government’s
goals. They conclude with proposals for alternative incentive systems that are more consistent
with bank efficiency.
Final Draft
China’s Incomplete Banking Reforms
By Wendy Dobson and Anil Kashyap
Paper presented at Canadian Economic Association Annual Meetings, Montreal, May 2006
As China’s government has opened the economy and liberalized economic policy since the late
1970s, state ownership and control of many of its industries has been transformed. At the outset,
state-owned enterprises (SOEs) were the main employers and produced all goods and services.
Their financial requirements were met through state subsidies and loans from the state-owned
banks that dominated the financial system. Until 1984 the Peoples Bank of China (PBOC), the
central bank, owned the banking system, collecting deposits from its branches across the country
and directing capital to uses directed by policy makers. After 1984 deposit and lending functions
were turned over to four state-owned policy banks whose loans continued to supply SOEs with
their working capital requirements.
Since the mid-1990s, the SOEs have been transformed. Their numbers have been reduced by
mergers, closures and privatization. Today, the Big Four state-owned banks are also being
transformed. They are now expected to operate like internationally competitive commercial
banks even while they are owned by the state and still enmeshed in the legacy of years of
directed lending. When the drive to rationalize the SOEs and commercialize these banks began
in earnest in the mid-1990s, the banks disclosed large stocks of non-performing loans to the
SOEs that accounted for more than 20 percent of GDP in 2000.1 Governments have moved to
deal with these debts by restructuring the SOEs, but employment and worker concerns have
typically trumped the banks’ right to have their loans repaid.
The sustainability of the government’s approach is challenged by China’s WTO commitment in
2001 to remove the remaining restrictions on foreign bank entry at the end of December 2006.2
Since making that commitment, the central government has stepped up the drive to make these
banks competitive, rather than part of the fiscal arm of the state. The official goal is to
internationalize the banks; indeed, the current bank regulatory framework in many ways meets
international best practice. The source of uncertainty is in implementation, given the internal
contradictions in the banks’ incentives.
This paper examines the efforts to internationalize the Big Four banks in the light of continued
state ownership. First, we assess the government’s three-part approach to improving their
efficiency: (a) clear the non-performing loans (NPLs) off their books and recapitalize them; (b)
find international strategic investors; (c) list them on the Hong Kong Stock Exchange and expose
them to the scrutiny of market analysts and international investors. We estimate the cost of
clearing up the NPLs paying particular attention to unrecognized loan losses. We then examine
the government’s approach to improving the banks’ operating efficiency in the context of the
1
This was the publicly acknowledged level when this ratio was first discussed by the Governor of the PBOC.
The China Bank Regulatory Commission has set targets for foreign bank participation at 2 percent of domestic and
foreign exchange assets on a market-consolidated basis and 20 percent of foreign currency assets.
2
2
contradictory incentive structures implied by its continued majority ownership. In the final
section we present three alternatives, two of which address this contradiction: (a) stay the course
(and face risks of continued inefficient operations including new foreign competitors in key
profitable businesses and new NPL problems); (b) restructure banking relationships to promote
future efficiency; and (c) restructure the banks into lower-risk lending operations.
Background on China’s domestic banking system
China’s domestic banking system consists of a large number of institutions, almost all of which
are owned by various levels of government (Tables 1 and 2).3 Dominating the system are the Big
Four state-owned commercial banks (SOCBs) that include the Bank of China (BOC), China
Construction Bank (CCB), Industrial and Commercial Bank of China (ICBC) and Agricultural
Bank of China (ABC). These banks are the focus of this paper (and the terms Big Four and
SOCB are used inter-changeably).
Until the mid-1990s, the Big Four were the main source of funds to the state-owned or –
controlled industrial enterprises which regarded bank debt as working capital; businesses losses
and default were dealt with by additional lending. Since 1995, governments have transformed
these enterprises by restructuring, selling or closing thousands of them. By 2004 the number of
industrial SOEs (as distinct from government services agencies) had fallen below 32,000 and
employment in these enterprises had dropped by 17 million people, to 20.5 million from 37.5
million in 1998.4 The handling of the debts of defunct enterprises has been a contentious issue
between the center and local governments because of the local priority to minimize the impact on
employees rather than to repay (government) creditors.
To understand the challenges of reforming the SOCBs, an understanding is also required of their
inter-connectedness with industrial SOE reform. In 2003 the State-owned Assets Supervision and
Administration Commission (SASAC) was created as a special non-government organization in
the State Council to manage the state’s capital assets. In 2005, SASAC controlled 176 large
industrial SOEs most of which satisfied five criteria --as essential to national security, natural
monopolies, producers of public goods, important natural resources or as “pillar industries” (such
as high tech). Further, the head of SASAC has stated that SOEs which are not among the top
three in their industry (that is, capable of becoming a national champion) should be prepared to
be acquired by some other firm.5 SASAC has also announced its intention to complete a “last
round” of government funded enterprise closures by 2008, with as many as 2167 SOEs with 3.66
million employees being closed. The government will foot the bill for debts and closure costs,
3
Minsheng Bank is one exception, set up in 1996 by the All China Federation of Industry and Commerce.
China Statistical Yearbook (CSY) 2005, Table 14-9; Garnaut et al. (2005:90) reported a drop in overall SOE
employment between 1995 and 2003 of 43.8 million people. The industrial SOE refers to the “material production
sector which is engaged in extraction of natural resources and processing and reprocessing of minerals and
agricultural products, including mining, processing of agricultural products including textiles and footware,
manufacturing including steel and chemicals production, energy and minerals processing, machine building,
production of gas and water; electricity generation; and machinery repairs (CSY 2005:524).
4
5
Naughton (2004).
3
but in future “all… closures should be market driven bankruptcies and conducted according to
bankruptcy law”.6
A key to the future prospects of the Big Four is the performance of the remaining industrial
SOEs. On average they are highly leveraged. Garnaut et al (2005) report a 2001 survey of 683
firms most of which had bank loans from the Big Four that were overdue, with an average RMB
50 B owed to creditors per enterprise. The banks, for their part, have tried to recover their debts
by seizing SOE deposits, but the SOEs then withdrew their deposits and moved to cash
transactions or set up new private firms and left the debts in the old entities. In some instances,
the Asset Management Companies (see below) were complicit in creating such structures.
A report by Moody’s and Citibank in October 2005 suggests these practices continue because of
the continued bank domination of the financial system. The report focuses on 686 of China’s
largest listed companies and criticizes them for their continuing reliance on short-term bank
lending; as much as 50 percent of their borrowing is for a year or less and nearly every dollar of
profit has been offset by new loans.7 The Economist (2005) reports that “bank assets have
ballooned to almost 30 trillion yuan ($3.7 trillion) in 2004, or 210 percent of GDP. That is the
highest of any big economy, says Nicholas Lardy at the Institute for International Economics in
Washington, DC: India is at 170 percent, Brazil 160 percent and Mexico 100 percent.”
The central government’s aim for the SOCBs is to commercialize them without changing its
ownership since they are regarded as a key instrument of its economic control. The “model” for
commercialization is to clean up the NPLs; bring in strategic investors to contribute new capital,
management techniques and products, and list them on international stock markets to force
international standards of transparency and market discipline.8
With these many business and regulatory constraints what are the prospects that the SOCBs will
operate efficiently? We first assess available data on loans and NPLs to compare the estimate of
total impaired assets with the capital bases of the Big Four. After determining the size of the
capital deficiency, we then look at the recent policy decisions that were aimed at improving
efficiency. We conclude by studying several options for further reform.
Clearing up the NPLs
By official estimates from the China Banking Regulatory Commission (CBRC), total NPLs in
the banking system were $290 B at the end of 2003, representing 15.9 percent of total loans and
20.5 percent of GDP. This total had fallent to $164 B and 8.58 percent of loans by the end of
2005.9 In 2004, the CBRC ordered the Big Four to cut their average NPL ratios below 15
percent by the end of 2005. Simultaneously the banks are expected to have capital equal to 8
percent of their risk-weighted assets. Taxpayer financing required to achieve these targets
6
Naughton (2005b) who also notes that up to 2004, 3484 SOEs were closed through
government-funded programs affecting 6.67 million employees.
7
Areddy (2005).
Garnaut et al (2005); authors’ interviews and CBRC, SASAC websites.
9
CBRC website.
8
4
depends on three factors: the size of losses associated with the acknowledged bad loans that are
embedded in the banks’ portfolios, the amount of financing that can be raised from nongovernment sources to help bring the banks capital levels up the international minimums, and
additional losses on loans that are bad but not yet recognized. We review these three
components in turn.
Embedded Portfolio Losses on Recognized NPLs
The statistics on bad loans in the Big Four are subject to various interpretations, hence a range of
figures are quoted for any particular statistic. One overarching problem is that if a loan may not
be fully repaid, it does not follow that the loan will be fully defaulted upon. For almost all
purposes, the relevant figure is not simply the total loans that are due to be repaid, but instead the
difference between this figure and what will be ultimately collected. For instance, this figure
represents both the taxpayer exposure and the size of the capital injection that will be needed to
make the banks solvent (although even more money would be required to comply with the
international minimum capital requirements). As a rule, the largest estimates for bad loans
presume that nothing will be collected and thus massively over-state the ultimate losses.
This problem is compounded by the subtleties of systems used to classify loans that are at risk
for not being repaid. In January 2002, the CBRC adopted the Bank for International Settlements
five-category loan rating system. Besides the healthy loans, the banks also identify other loans
that are at risk and hence potentially require special attention. The official guidelines suggest that
the borrowers of these loans are expected to be able to service the loans currently but repayment
may be adversely affected by specific factors. In practice, however, these loans can be past due
for less than 90 days, but are still considered to be performing.10 The banks are supposed to
identify three types of loans as non-performing. These loans are separated according to whether
the loans are merely substandard in quality, from those where collection is acknowledged to be
doubtful, from the loans that are unrecoverable (and hence deemed lost). In principle, these
distinctions are supposed to reflect the expected recovery rates, but banks have considerable
discretion in the extent to which they recognize the problems and put loans into the worst two
categories (doubtful and unrecoverable).
The discretion in classifying loans makes it difficult to compare these three categories across
banks and leads most analysts to aggregate all three categories into a catchall NPL category. The
aggregation in turn further complicates comparisons of estimates. On the one hand, even if two
experts agree on a specific estimate for a bank’s NPLs, the implied ultimate losses could differ if
the mix of substandard, doubtful and unrecoverable loans differs. On the other hand, two
different estimates for total NPLs could imply the same ultimate losses.
With these caveats in mind, comparisons of these loan statistics from different sources, including
those reported by the banks and the CBRC appear in Table 3. At the end of 2005, CBRC
reported that NPLs in the entire banking system totaled $164 B (a decline of $126 B from the
10
The China Construction Bank in its prospectus, page 180, indicates that special mention loans that loans that are
much more overdue might still be classified as deserving special mention if they are fully secured by collateral or
pledges.
5
$290 B total at the end-2003 cited earlier). Of the total at year-end 2005, $134 B (82 percent)
belonged to the Big Four; a share that had remained almost static over the two years. We suspect
that nearly all of these loans are Category 4 and 5 – and that this would be particularly true of
ICBC and ABC which are acknowledged to have poorer quality assets due to their historical
missions.
Since 2001, reported NPLs have declined from a peak of nearly 35 percent to the 15 percent
target in 2004 (Table 4). The records of the individual banks vary greatly (Table 4) with CCB
and BOC substantially more advanced than the other two. As discussed below the decline in
NPL ratios at CCB and BOC was achieved in preparation for planned initial public offerings.
This progress has been made through a variety of means: assets sales, cost reduction measures11,
but mainly because of the growth in new loans that averaged nearly 13 percent per year between
2001 and 2004 (Table 3, line 2).
Converting these figures into losses requires us to make assumptions on recovery rates for the
bad loans. To gauge the recovery rates we look at the Chinese experience involving loans taken
off the banks’ books in 1999 and 2004. In each of these cases loans were transferred to asset
management companies (AMCs) and the AMCs were charged with recovering as much as
possible.
The bookkeeping regarding transactions are complicated and can easily lead to confusion about
the ultimate recovery levels. In the 1999 transactions, four asset management companies (Cinda,
Huarong, Great Wall and the Orient) took loans of $168.2 billion off the books of the Big Four.
The AMCs acquired the loans at book value and then subsequently sold the loans, recovered the
assets through workouts, or managed debt-equity swaps. As there is no unified public record
offering details of the different transactions the ultimate recovery rate cannot be calculated
accurately. But available estimates suggest recovery rates of between 10 to 25 percent, with
estimates centering around 20 percent.12
What is known is that the efficiency of these AMCs in dealing with legacy loans has been low.
A June 2005 report by the National Audit Office (NAO) gave “details of $8.6 billion misused by
the debt-clearing agencies at the forefront of China’s banking reforms”.13 The Ministry of
Finance was criticized for the opacity of how its funds are used. The NAO noted its findings in
audits of the AMCs included such irregularities as thousands of fictional employees.
11
Available annual reports for 2004 report NPL ratios as follows: BOC: 5 percent (without defining it) as a result of
a large sale of NPLs to CINDA, one of the AMCs, in 2004. CCB reports a 3.92 percent ratio for the same year.
ICBC does not include such a ratio in its online report for 2003.
12
For example, CSFB (2002:9) estimates 30 percent; CSFB (2002:17) quotes S&P credit rating agency as assuming
20 percent; Rodman (2005a) estimates 20 percent in 2004. Caparusso (2004:6) suggests that, “‘rules of thumb’ on
bad debt recoveries based on AMC experience are: expect 5% recovery rate on Category 5 (loss), 35% on Category
4 (doubtful) and 60% on Category 3 (sub-standard).”
13
Economist.2005.”Uncooking the books”. July 9:34-5.
6
Anecdotal evidence suggests other problems: one is that the AMCs are doing little more than
shuffling paper; by informal estimates, the cost of clearing up one dollar of NPLs required two
dollars of AMC management resources. Caparusso (2004) estimates that of the initial 1999
loans transferred to the AMCs, only 40 percent had been addressed as of June 2004. More
generally, Calomiris et al (2005) review the experience with AMCs in other emerging market
countries with large banking sector losses and conclude that AMCs are generally ineffective in
helping stem crises unless the legal environment is strong.
In 2004, as part of the preparation for CCB and BOC IPOs 14 the government injected $45 billion
into these two banks. Foreign exchange reserves were used to bring capital adequacy ratios up to
8 percent once the banks had written off their remaining bad loans. This transaction took place in
several steps. Initially, the PBOC used foreign exchange reserves (in the form of US Treasury
Bonds) to establish a new PBOC subsidiary, the Central Huijin Company (also known as
“Huijin”).15 Huijin then used the bonds to acquire the loans from the two banks in return for an
equity stake. According to Caparusso (2004) the loans were transferred at prices below book
value, and then auctioned to the AMCs at a further discount; the transfer prices and discounts
varied depending on the ratings of the loans, but a conservative estimate for the total losses on
these loans would be 70 percent, with an upper bound of as much as 90 percent.
The purpose of this second set of transfers was to clear sufficient NPLs from the balance sheets
of the CCB and BOC that NPL ratios reached the low reported levels in Table 4. These levels
should be viewed in this context (as opposed to evidence that the banks had achieved the
improvements in their loan books through internal improvements).
In spring 2005, ICBC received a $15 billion transfer through the same type of mechanism and
transferred $35 billion NPLs from its balance sheet to the AMCs.16 Analysts estimate that
between $50 - 80 B will be needed to clean up the ICBC balance sheet and improve capital
adequacy with full provisioning for NPLs.17
14
CCB’s IPO took place in October 2005; BOC’s is planned for some time in 2006.
The Central Huijin Company is also known as China State Administration of Foreign Exchange (SAFE)
Investments. Huijin was formed in late 2003 as a holding company for the state’s stakes in the SOCBs. It was
formed with the injection of PBOC foreign exchange reserves which it invested in BOC and CCB in return for major
shareholdings in these two institutions. Huijin then assigned six directors to BOC and four to CCB. Its mission is
described as a “visible hand” promoting SOCB reform and ensuring that stockholders obtain “competitive
investment return and dividend proceeds…and…establish a sound corporate governance structure” (Economic
Observer 2005).
16
China Daily. 2006. “CBC improves following restructuring”. January 20.
Huijin represents a new instrument for the PBOC, replacing the traditional lending approach to bailouts. Huijin
makes investments on which it expects a return, especially as the Big Four complete initial public offerings. As
Huijin realizes returns on these investments, the income stream could be used to bail out smaller financial
institutions. Huijin’s growing influence has attracted some pushback from other bureaucracies in Beijing,
particularly the Ministry of Finance. By one account, Huijin’s unexpectedly small (only $15B) injection into ICBC,
a much larger SOCB than the first two, was limited by MOF to a stake equal to its own injection so that each would
have a 50 percent stake in the bank, and equal power to make appointments.. Huijin’s future is the source of some
speculation: if the SOCB bailouts are a one-time event followed by initial public offerings, Huijin could evolve to
become an administrator of state-owned AMCs or a state investment company similar to the Singapore
government’s investment vehicle (Shih 2005).
17
News Express (Xin Kuai Bao), February 24, 2005 as reported in China Online February 25, 2005.
15
7
The cumulative result of the 1999, 2004 and 2005 transfers is that the government has already
spent $228.2 billion to remove NPLs from the Big Four ($168.2 B plus $60 B). Conversely, the
reasons for declining NPL ratios are injections of capital and offloading NPLs to asset
management firms Given the stock of the NPLs that still reside inside the AMCs it is too early
to tell how much of this might be recovered. But, assuming that recovery rates of 25 percent
continue to prevail, then costs would be roughly $171 billion (or roughly 10.4% of 2004 GDP).
As emphasized above, however, the full cost to the taxpayer also depends on the costs of
removing new NPLs and any additional bank recapitalizations.
Capital stakes by strategic investors
Additional capital made available to the Big Four by strategic investors will help to limit the size
of state capital injections, but the size of such stakes in a single bank is limited to19.9 percent for
a single foreign investor and no more than 25 percent for all foreign investors. Larger stakes will
mean the banks will be treated by the regulators as foreign banks.18 During the June-September
2005 period investments of around $13 billion were made in the Big Four (Table 5). In addition,
CCB raised $8B on the Hong Kong Stock Exchange. This transaction was preceded by an earlier
IPO by the Bank of Communications, China’s fifth largest bank.
In summary, to this point we have reviewed how the Big Four have removed NPLs from their
books and recapitalized using injections from government sources, offloading NPLs to the asset
management companies, and attracting strategic foreign investors. Together, these measures are
valued at $193B ($171B plus $14B in strategic investments plus $8B from CCB’s public
offering).We assume that as of 2004, CCB and BOC removed or wrote off all legacy bad loans,
but available details on ICBC lead us to conclude that the $15B injection from Huijin is far
below what is ultimately required for a similar restoration of its balance sheet. In addition, we
must ask about the loans still on the books of CCB and BOC. Many of these were made during
the lending binges in 2003-2004.
Unrecognized Loan Losses
What does all this imply for future NPLs? There is broad agreement that the losses for ABC are
likely to be the worst of the Big Four. Besides the fact that agricultural loans were generally less
profitable than industrial loans during the pre-commercial period, ABC has been behind in its
modernization during the last five years. As of 2004 Caparusso and Khoo (2005, figure 32)
report that its pre-provision profit rate on assets was only 36 basis points (compared to 140 basis
points and 119 basis points for BOC and ICBC), and that it made no bad debt provisions.
Assuming that the NPLs for ABC in Table 4 are all category 4 and 5, so that a recovery rate of
20 percent prevailed, then the losses on the acknowledged bad loans would be $67 billion.
18
As of late 2005, eight city commercial banks, the Bank of Communications and the Big Four have attracted
foreign investors.
20
Official estimates by CBRC for the 2000-02 period put new NPL formation at 2-3 percent of new loans; but if one
assumes that it takes two years or more for a loan to become non-performing, the NPLs could be three times CBRC
figures, ie as high as ten percent (Rodman 2005a).
8
Looking ahead there are two fundamentally different views of potential losses. The optimistic
assessment is based on three assumptions. One is that once the ABC NPLs are moved off its
balance sheet, all of the legacy problems will have been dealt with. The second is that the
creation of new NPLs is relatively low. For instance, CCB’s Offering Memorandum reports that
as of June 30, 2005 only 3.9 percent of loans are non-performing. This figure combines the
NPLs to older customers (i.e. those who had some outstanding loans prior to 2001) and new
customers. The percentage of the loans being made to new customers is rising (and as of June
30, 2005 was 56.5 percent of total loans) and the new loans are much better quality (with NPL
rates of 2.36 percent compared to 7.10 percent for older customers). The third assumption is
that the macroeconomic conditions that have prevailed over the last few years will continue.
More specifically, there will be no economic slowdown or recession in the near term.
In this rosy scenario the banks will continue to upgrade the quality of their loan portfolios,
substituting new healthy borrowers for older weaker firms. Within a few years exposure to the
money losing SOEs will be minimal and so there will be no need for another substantial bailout.
Implicit in this view is that the package of regulatory and governance reforms, discussed below,
brings about sufficient change in management and governance incentives that banks achieve and
sustain new levels of efficiency and profitability. We review the available evidence in the next
section.
The pessimistic view presumes at least one (and perhaps all) of these three assumptions will not
hold. In terms of currently existing NPLs, Morris Goldstein (2004) notes that historically in other
countries experiencing rapid loan growth about 40 percent of the loans made in the rapid growth
period go bad. Loan growth since 2000 has been phenomenal (Table 3, line 2). Lardy (2005)
notes that during the 1994-96 economic downturn 40 percent of loans made in a smaller lending
binge between 1989-93 became nonperforming “…even on the rather lax loan classification
criteria prevailing as the time”. We address the prospects for a downturn in the last section.
Caparusso and Khoo (2005) emphasize that, during the high levels of growth the average
maturity of loans has been lengthening. They note that medium and long-term loans accounted
for 21 percent of total loans in March 1997 and had risen to 43 percent by December 2004.
They also note that many of the loans are made so that principal is paid only at maturity (the socalled ‘bullet’ repayment structure) which further eases near term credit burdens. Thus, current
statistics are likely to understate potential losses not only because so many of the loans have not
been out long enough to go bad, but also even the ones where the borrowers are in trouble might
be hidden until the principal comes due.
Finally, there are concerns that the race to prepare the major banks for IPOs may be leading to
overly optimistic assessments of loan quality. Rodman (2005a) observes that concerns about this
“second wave” of NPLs is warranted by the appearance of Category II loans (special mention)
due to weak loan assessment techniques and pressures to be under-provisioned to maintain net
earning and capital adequacy ratios.20 If we assume that only 10 percent of the net new lending
9
from 2002 to 2004 eventually winds up as non-performing, this implies that all of the decline in
the level of NPLs shown in the banks annual reports (Table 3, line 3) is erased.21
Recognizing these caveats, there are at least two ways to estimate the possible magnitudes of
these hidden losses. The first recognizes that by far the majority of SOCB loans were to SOEs
and uses SOE reported losses to anchor estimates. A key assumption is that SOE losses accord
one-for-one with NPLs. Industrial enterprise statistics report that cumulative SOE losses between
December 1999-2005 totaled $64 B (Table 6 column 9), a figure that was $49.3 B a year earlier,
and one that accords closely with the $48 B we know was spent during that period on NPL
cleanup at the Big Four. Further, annual losses averaged $8 billion between 2000 and 2004
(Table 6 column 8), rising nearly 60 percent in 2005 to $13 billion. This large increase is
explained by excess capacity and falling profitability in a wide range of industries.22 Since
demand is once again expanding in the affected industries, it is reasonable to extrapolate the
earlier average annual losses of $8 billion to 2008 (when SASAC has declared that SOEs must
stand on their own) bringing unrecognized at least $24 billion.
An alternative estimating method is based on SOE employment declines. We know that 12.3
million workers were laid off from the SOEs between 1999 and 2003. Assuming that the $48
billion capital injections into the banks compensated for what were mostly SOE losses realized
as NPLs by the banks, and that an additional amount will be realized at the Agricultural Bank of
China which has yet to be restructured (we assume $6.7 billion, or 10 percent of projected losses
will be from industrial rather than agricultural enterprises), the total rises to $54.7 billion. The
cost per worker would have been $4447. We also know that SASAC expects a further 3.66
million workers to be dismissed from SOEs slated for restructuring by 2008, which brings
potential future losses to the Big Four to around $16.3 billion.
A third approach is to apply detailed estimates of loss rates for existing and new customers
available from CCB’s June 2005 prospectus prepared for its IPO. Applying the (higher) loss
rates for pre-existing customers and the (lower) rates reported for new customers, we estimate
the average loss rate at 4.6 percent in 2004. We use this rate for all four banks and apply it to the
total stock of loans reported in the China Statistical Yearbook for that year (Table 4, 2004 loans),
giving an extremely high estimate of hidden losses totaling $59.8 billion.
In summary, we use three different approaches to estimate the hidden losses at the Big Four that
are likely to surface during the next three years. These losses range from a low of $16 billion to a
high estimate of nearly $60 billion. We think the higher number is closer to the truth. The
lending boom in 2003-2004 underlines the government’s difficulties with restructuring stateowned banks so that their managers are accountable for efficient performance. We review the
incomplete state of these reforms next.
Reforms to increase operating efficiency
21
The bank figures imply of drop of 317B RMB between 2002 and 2004 and the total loans expanded by 3100 B
RMB.
22
See The Economist (2006).
10
Looking beyond the period when the consequences of the lending boom will be realized, a
crucial variable in banking reform is emphasis on permanently improving their operating
efficiency through bank restructuring and modernization. Major efforts are being made to reengineer credit processes, set up risk management systems and train staffs in modern
management systems and techniques with the help of the international consulting and human
resource management firms. Shanghai authorities have experimented with a centralized credit
checking agency to help retail banking operations to know their customers. The central bank has
announced plans to expand this service nationally. As well, the banks have been trimming their
staffs and cutting costs.
Regulatory oversight is much strengthened. CBRC policies and leadership are increasingly nononsense and reflect best international practice. Huijin’s senior officials have clearly stated their
commitment to senior banking officials’ appointments on objective, rather than party
membership, criteria. CBRC has given the Bank of China and China Construction Bank
extremely detailed operating targets (Table 7) according to CSFB (2005).
But these reforms are insufficient to resolve the underlying conflict in bank incentive systems.
The reform strategy implicitly substitutes “directed management” by government owners for the
old approach of directed lending.
The CBRC has directed the Big Four to achieve standards of best international practice in parts
of their operations and strategy, but not in all. Requirements for their capital and operating
structures and practices are clearly to achieve best practice. Yet doubts persist that they are
making credit decisions based primarily on creditworthiness criteria (although the CBRC has
said “no more directed lending”). They are being encouraged to price for risk; lending interest
rates have been liberalized (although deposit rates have not, providing the opportunity for
healthy income from spreads) but they lack the skills and technology to evaluate and monitor
risky (and potentially high-return) customers. It is easier not to make such loans. Indeed,
regulators’ priorities are to reduce NPLs; little is said about how profitability targets might be
achieved. In addition, while employment has declined there is no indication that, for example,
managers are free to sever large numbers of employees who lack the experience and skills
required to operate a modern bank rather than staff a government department that hands out
working capital.
Changes in bank governance reflect the ambiguities of continued government ownership.
Lessons from many banking crises in both developed and developing countries point to the
importance of a governance framework that creates accountability at the very top of the
organization: accountability by a board of directors made up largely of knowledgeable people
from the private sector who are not associated with the bank as customers or suppliers and whose
primary responsibility is to hire, evaluate (and fire) the CEO. As the Big Four progress towards
an ownership structure that includes public investors, the Chair has been separated from the CEO
position but the involvement of Communist party officials, while declining, continues to be
pervasive throughout the organizations. Bank heads are members of the Central Committee
11
(Naughton 2004); the CEO is often also the party secretary; bank performance is discussed at
party meetings.23
Indeed, this problem affects CBRC’s regulatory authority as well. Shih (2005b:40) notes:
Because these institutions are either wholly or partially state-owned, they have
Communist Party committees with propaganda, organization, and discipline and
inspection subcommittees. In addition to reporting to the party secretary of the institution,
who often serves concurrently as the chairman of the board, the discipline and inspection
committee reports to the Party Disciplinary and Inspection Committee at a higher
level…..Because of the existence of a wide array of monitoring institutions, the CBRC
merely controls the most technical and in some way least important aspects of financial
supervision.
Recent changes at the top of CCB in the wake of a management scandal indicate some awareness
of the need to reduce political influence which is still pervasive. For example, in March 2005,
when the Chair of CCB was removed in the wake of a scandal, he was replaced by the thenChair of Huijin-SAFE. CSFB(2005) reports that regulators have directed the BOC and CCB
boards to include 7 directors appointed by Huijin as the major shareholder, 3 from management
(the bank governor and two deputy governors), 3-5 independent directors, and possibly 2
directors from strategic investors. “Among the directors only 4 will also be member of the
Communist Party Committee …(which include the chairman, governor and two deputy
governors – ie, they will be minority”(sic). Shih (2005b) also reports CBRC threats that jobs
will be jeopardized if NPL ratios begin to rise again. If true, such admonitions likely lead to
distortions and misreporting to avoid the consequences of bad news.
Anecdotal evidence indicates that independent (foreign) directors and senior managers installed
by strategic investors find themselves hampered by the parallel political structures. One manager,
for example, pointed out the anomaly of performance and strategic issues being discussed
separately at party meetings and the board. In another example, a senior manager recruited from
abroad one day found the ranks of employees in his department seriously depleted, only to be
informed that they had been sent to Party School for the day. He had not been informed in
advance. An independent director also summarized the revealed role of the independent director
as being one of advisor to management, but management not being accountable to the Board in
the increasingly formalized way that characterizes international best practice.24.
The ambiguity in accountability affects financial performance in at least two ways. First,
although official rhetoric indicates that the banks have been freed from directed lending, it is far
from clear that they would refuse credit to one of the large SOEs the central government has
designated as a national champion if, for example, the SOE were to bid for foreign assets at
inflated prices. Second, one obvious legacy weakness is the bifurcation between the headquarters
of the SOCB and its local branches. Would the branches stop lending to a SOE if the local
government insisted the loans continue? Again, anecdotal evidence indicates that managements
are beginning to deal with the bifurcation by centralizing credit decisions. This approach makes
23
24
It is worth noting that the pervasive role of the party does not appear in the CCB’s offering memorandum.
Authors’ personal interviews.
12
sense; such institutions have traditionally had decentralized management structures that allow
branches considerable autonomy; hence local relationships and loyalties are quite likely to be put
ahead of orders from distant bank headquarters. But while re-centralization may reduce
unprofitable traditional relationship lending, this may be at the expense of higher- risk littleknown entrepreneurial enterprises which are emerging throughout the country but whose growth
is widely acknowledged to be constrained by lack of access of funding – at any price.25
Banks are unusual institutions. Their key roles in finance, their role in addressing the asymmetric
information problems of finance, and their vulnerability to bank runs and loss of confidence
require the central bank to stand ready as a lender of last resort if a single bank gets into trouble.
In return, banks accept close government supervision of their performance which gives rise to
moral hazard (bank managers and directors taking more risks than they would do if they were
subject to the same market test as industrial companies must do, i.e. face the prospect of
bankruptcy). Reforms in developed countries aim to increase the instruments for market
monitoring of banks, through issuance of subordinated debt, external ratings by credit rating
agencies and requirements for more disclosure in public reporting of risk management, for
example.26
In China, the Big Four are becoming more subject to market monitoring but appointments to
their boards and management as well as attitudes of their depositors and customers are still show
evidence of moral hazard. Capital injections and continued government involvement in the Big
Four’s governance (through government directors on their boards and party appointees among
senior managers) undermine claims of bank independence. Depositors also believe they have
blanket protection of their deposits even if the rate of return is low. Some reports indicate the
central government intends to introduce deposit insurance, suggesting that the days of blanket
protection maybe numbered, but no date has been set. Moreover, even if the formal rules change
it remains to be seen whether depositors would actually be forced to bear losses should a bank
fail.
SOE privatization has revealed conflicts of interest between the central and local governments.
Most of the SOEs belong to local governments but their main creditors are the Big Four banks.
The decentralized structure of the Chinese fiscal system means that local and central budgets are
separate, so the costs of disposing of NPLs fall to the central government. The central
government guards its own interests in minimizing its burden of the SOE restructuring costs by
protecting the Big Four27. The central government also has other interests: the SOCBs, like the
large SOEs, are seen as potential international brands. They still dominate the national banking
system with thousands of employees in branches throughout the country.
Some of these problems will only be fixed through time given Chinese propensity for
incremental improvements through “gradual and controlled change” rather than through a big
25
26
Pointed out to the authors by Loren Brandt, among others.
CSFB (2005) reports that CCB and BOC have issued RMB 50 B subordinated debt as Tier 2 capital.
27
The complexity of interests involved in SOE restructuring, described in Garnaut (2005) include
the Ministry of Finance, the Ministry of Labor, the SASAC and local governments as well as
labor unions.
13
bang. But will they be fixed? The basic contradiction between the government’s objective for
efficiency and competitiveness and its determination to retain ownership and control is proving
difficult to address. Many analysts and other observers accept these inefficiencies, and conclude
that while capital account transactions continue to be controlled, any crisis will be local rather
than systemic in its consequences and that the central government has the resources and the time
to persist with its incremental strategy. In this paper, however, we have estimated the sunk and
potential costs of continued inefficiency and conclude that alternative strategies are desirable if
the banks are to achieve the strength and soundness they will need to compete, both domestically
and internationally. In the next section, we explore three alternative strategies.
Alternative strategies for strengthening the Big Four
The expressed goal of the Chinese authorities is to see the Big Four become “normal”
internationally competitive banks. In the preceding analysis we have identified serious
contradictions in the banks’ incentive structures that force them to perform social functions
(maintaining SOEs and SOE employment) . Government ownership persists; relationship lending
to SOEs persists. Left unaddressed, the banks are doomed for the foreseeable future to being low
yield utilities at best, and vulnerable to economic downturn and crisis, at worst. We see three
alternatives: (1) continue the incremental reforms to make them into normal commercial banks;
2) split them into good banks and bad banks and allow the good banks to partner with foreigners
or other private banks (or just force them to abandon the commercial lending business, wind
down the bad loans and let non-state owned banks become China’s commercial lenders); or 3)
separate them along deposit taking and lending, and make them into narrow banks which are
permitted to invest in mutual funds that might include securitized pools of loans. In this section,
we evaluate each of these alternatives in turn
A. Stay the course -- further strengthen the Big Four
The current model of bank recapitalization relies on the banks to cut their NPLs and on foreign
partners to modernize their management systems. Both the CCB and BOC have moved forward
on this model as has the Bank of Communications, China’s fifth largest bank.
Performance criteria
We first apply several performance criteria to evaluate the record on controlling new NPLs and
growing the quality of new loans through better credit decisions and risk management practices;
growth of earnings; better management and reduced moral hazard through greater independence
from political pressures. On each criterion we see progress but not enough to eliminate our
concerns about the risks of this alternative.
1. Control the NPLs
NPLs offloaded to the AMCs in 1999 removed legacy loans from the days of directed lending.
The SOCBs have since been directed to prevent NPL ratios from rising. But that goal can also be
met by increasing loan growth – as shown in Table 3. Indeed, available evidence indicates a
number of problems with resolving NPLs that came on the banks’ books since the 1999 transfers.
Many of these loans have accumulated since 1996 and the only permitted route to dispose of
14
them is through the AMCs, which have their own problems, as discussed below. Regulations
also prevent the banks from selling loans directly to investors at fair market value.28
The quality of new loans – particularly in the steel, automotive and real estate sectors -- is also a
cause for concern. In 2005, the auto industry experienced excess capacity as customers curtailed
purchases and payment pressures began to bite; by some estimates the NPL ratio on auto loans
was as much as 50 percent.29 Seizing assets is made difficult by lack of the necessary institutions
and legal uncertainties. In the real estate sector, a private mortgage market has developed since
1998 in which first time home buyers can borrow up to 80 percent of the value of the property.
The recent housing boom has created a fast-growing mortgage market for banks. Indeed, by
CBRC estimates real estate loans accounted for 16 percent of outstanding bank loans in that year,
up from a mere 5 percent in 1999. Rodman (2005a) estimates actual real estate exposure of the
banks to be as high as 30 percent of total loans. Official concerns about the sustainability of the
real estate boom are such that in late 2004, PBOC raised interest rates, lifted the cap on rates
banks could charge for such loans, raised the minimum requirement for down payments and
restricted banks’ lending to the real estate industry (banks still finance 70 percent of China’s real
estate developers). In 2005, following further restrictions imposed through the tax system, price
drops in some urban markets raised concerns about a market crash.30
2. Grow earnings
Traditionally, SOCB earnings come from the spreads permitted between what they must pay to
savers and the higher rates they charge borrowers. In 2004, ICBC’s operating profit was $7.7 B
while CCB’s was $2.7B, almost all was gained from high spreads and used to write off bad
debts.31 This aspect of the regulatory environment creates a sense of complacency in the banks.
Traditionally their customers were corporate: SOEs, many of which are losing their competitive
advantage. The banks’ future lies in consumer loans, but the problems in autos and (potentially)
mortgages underlines the need for institutions like credit bureaus to assist them in evaluating the
risk profile of potential borrowers.
3. Better management
Both CCB and BOC have had scandals in the past year and subsequent management shakeups.
Although the central government has moved towards a greater separation of the Party from bank
decisions by reducing the number of positions allocated to Party members, SOCB management is
still controlled by Party members, and bank performance and strategy continue to be discussed at
Party meetings as well as at the Board. There is evidence of streamlining at the banks, with older
employees being encouraged to retire early. One estimate puts the liabilities for such retirements
in the neighborhood of RMB 15 B.32
Banking regulators have sought out foreign strategic investors to provide new skills and products
to help the SOCBs diversify their business lines and monitor their performance. But the hoped28
Wang et al (2004).
29
Rodman (2005a).
Rodman (2005a).
31
Wang et al (2004).
30
32
Rodman (2005a).
15
for impact may be unrealistic in light of the small ownership shares that are permitted. Just how
much influence can they have on the strategies and operations of the sprawling Big Four? That
will depend on at least three things: (a) the management positions allocated to them, (b) the
openness of the banks’ top managers to new disciplines on risk and credit management systems,
and (c) the way senior managers deal with decisions reached in party meetings from which
foreign managers are excluded.
4. Reduced moral hazard
In preparing this paper, we were impressed by the widespread attitude – in the literature and in
interviews – that the banks will again be bailed out by the government if this becomes necessary.
This impression reflects moral hazard: the expectation among potential investors, borrowers and
depositors that bank assets are implicitly guaranteed by government leads to greater risk taking
than if they faced risks of potential losses. The Big Four are assumed to be too big to fail.
The central authorities show some concern about continuing moral hazard. There is sporadic talk
about introducing a deposit insurance system, insuring a portion but not all of a saver’s deposits,
to replace the blanket guarantee. But a specific timetable has yet to be introduced.
In summary, as this discussion indicates, at least two of the Big Four are making progress
towards the goal of becoming normal banks, but much remains to be done in executing the
existing strategy. Ultimately, they must increase their resilience to shocks and uncertainty. We
evaluate two major risks next.
Risks
The SOCBs face at least two major risks in the next two years: a slowing Chinese economy and
stiffer foreign competition after December 2006.
An economic downturn: The past two years of growth at near-double-digit rates are in part due
to large amounts of capital spending that have created excess capacity. Real investment in 2004
grew at an 18 percent annual rate and accounted for nearly half of GDP. The government,
realizing this rate is unsustainable, moved to rein in the boom with higher interest rates,
administrative controls on bank lending and new taxes on property speculators in the large cities.
At the same time, rising energy costs and excess capacity have squeezed the margins of many
companies. Money and credit growth has slowed to 10-15 percent from 45 percent a year earlier.
But the boom has encouraged banks to take risks and make loans to low-quality customers; with
eroding profit margins, worries are growing that these credits will turn up within two years as
new NPLs.33
Foreign bank entry: Within the next two years foreign banks will be permitted to enter domestic
currency businesses. CSFB (2002:51) reports that even in the activities permitted in 2002 (trade
finance, foreign exchange settlement and loans) business is expanding with FIEs and JV
customers. Ninety percent of SOCB income comes from spreads. Yet CSFB (2002:53) states the
33
Bank of China 2004 annual report, for example, notes that in 2003 its loans were distributed as follows:
manufacturing (26 percent); commercial services (20 percent); real estate (10 percent); residential mortgages (13
percent). Non-accrual loans were 14 percent of total loans in that year.
16
most lucrative part of the market is still very concentrated with 20 percent of Chinese savers
accounting for 80 percent of bank saving. For both these reasons the potential for new products
offered by foreign entities is considered to be enormous.
Von Emloh and Yi (2004), for example, enthuse about foreign banks’prospects. Domestic banks
are unable to serve high net worth customers effectively because they lack risk assessment skills
in retail lending and a sales-and-service culture. Foreign banks targeting these clients will be able
to take local-currency deposits and offer RMB-denominated credit cards, mortgages and other
personal lending products as well as life insurance and mutual funds. These authors estimate
potential growth in these markets at 30 percent a year.
As in other developing countries, foreign banks will bring benefits: new techniques and products
that will be imitated by domestic rivals, and new skills that will be spun off as trained employees
move into domestic businesses. In addition, some retail businesses such as credit cards will
require domestic partner to provide brands to attract new customers.
Bur stiffer competition brings risks: foreign banks tend to skim off the best customers, especially
in the early stages of liberalization when domestic institutions still hold loans carried at fixed
rates while foreign competitors are able to set higher rates for new loans and deposits. The
disadvantaged institutions then attempt to compensate by taking high-return, but high-risk
activities, especially if their deposits are insured. Foreign banks may also provide selective
servicing, focusing on profitable market segments and leaving the less profitable segments, such as
retail banking in rural areas, to domestic competitors (who may face pressures to remain in such
locations).
These risks imply significant consequences for the Big Four: a slowing economy will accelerate
the appearance of new NPLs among corporate customers whose margins are already eroding from
higher energy and commodity prices. Lacking adequate loan loss provisions, the banks will once
again be forced to turn to the government for help. The development of a new banking solvency
crisis would undermine public confidence in the banking system. Whether it would provoke a bank
run is debatable since Chinese banks are highly liquid. A liquidity problem would only occur if
depositors move to alternative channels – such as the foreign banks. But their presence is still too
small for this impact to be significant. But the Big Four do risk losing lucrative customers to
foreign banks as corporate customers and high net worth retail customers in lucrative coastal
markets migrate to skilled and customer friendly foreign banks. CSFB (2002) predicts that the
foreign bank market share will be 5 percent in 2007, rising to 10 percent by 2012 and accounting
for 2.5 percent of total bank assets.
Worst case scenarios seem possible: that these risks, either singly or together cause a classic
banking crisis in which SOCB depositors flee, or to a twin currency and banking crisis in which
interest rates are unexpectedly raised pushing many corporate customers towards bankruptcy.
What about a rosy scenario? The best case will be one in which the SOCBs slowly increase their
efficiency and achieve profitability, but far less than their foreign competitors; they are dogged by
the moral hazard of government ownership that undermines the incentives to see them run as
17
efficiently as possible – and by the people in their ranks lacking the incentives as well as the skills
and technologies to manage credit and risk.
In sum, while the banking regulatory incentive framework is a credible one and government
shows determination in its “directed management”, these changes fall short of what is necessary to
create an incentive structure that promotes efficiency thoughout the organization: through the
alignment of incentives for bank directors, managers and employees with those of depositors and
borrowers. We do not believe that progressing further down this road will bring about the
necessary transformation. Instead, as Anderson (2005) has noted: the SOCBs are more likely to be
low-margin, lumbering utilities that will continue to lose market share. China’s most
internationally competitive banks are likely to be smaller in size, perhaps newly created institutions
or ones that foreigners control.34
B. The good bank – bad bank alternative
The preceding discussion illustrates why alternative strategies need to be considered, ones that
have been shown in other countries to be more effective in transforming the SOCBs into normal
banks.
The strategy of offloading NPLs to AMCs is a variant of the “good bank – bad bank” model used
in Japan and other countries to clean up non-performing loan portfolios following banking crises.
In the good bank-bad bank structure, NPLs are isolated into a business within the bank according
to clear principles. First, the “bad bank” is separated from the rest of the organization, and
particularly from those who made the loans and formed the customer relationships. Second, an
excellent business manager is given authority to make all decisions: from initial appraisal of each
asset’s break even point to the management decisions about writing off the credit, merging the
asset with other assets, or working it out.
Third, and essential to changing the incentive system, the bad bank is given stature within the
organization. Its manager’s authority should include direct access to and support of the CEO and
the Board of Directors. It receives its share of senior management time, and every person in the
organization is given a clear career path for the time when the bad loans have been disposed of
(thus encouraging them to focus on the job at hand without worrying “what about me?”). Fourth,
the managers are given leeway to undertake hands-on management, traveling if necessary to
monitor progress and engage in the management of the assets. Finally, the assets in the bad bank
are subject to transparent reporting and monitoring by stakeholders with respect to the magnitude
of the original problem followed by regular public reports on progress in recovering or otherwise
disposing of the portfolio.
The AMC route probably made sense in China in 1999 when the remarkable magnitude of the
SOCBs’ bad loans became more apparent. They have been directed to offload all NPLs by
December 2006. But their structure is problematic. First, they are the only permitted route for
offloading any new NPLs. Second, they are expected to be profit making enterprises, yet their
regulatory framework requires that they receive, and sell, NPLs at book value rather than at fair
34
See, for example, Financial Times, August 22, 2005.
18
market value.35 Third, the AMCs also have contradictory incentives: they are expected to work
themselves out of a job; indeed without a constant deal flow, their staff will be out of work. When
there are no apparent rewards or a strategy for redeploying staff at the end of the process, the focus
on the business at hand becomes blurred by questions about “what will happen to me?” Thus
progress in clearing the bad loans has been slow and new ones have appeared in both the AMCs
and the banks. Indeed, some AMCs are considered to be close to insolvency themselves.36
Fourth, they are reluctant to use public auction bids as indicators of fair market value for fear of
being accused of selling state assets too cheaply. In the past five years only 4-5 open auctions have
taken place.37 Yet in Taiwan both public and private auctions have been used to dispose of $10.6B
worth in NPLs, about 60 percent of which were acquired by foreigners. South Korea, in contrast to
both Taiwan and China, has been much more aggressive in writing off, merging or closing more
than 60 percent of the NPLs that appeared during the 1998 banking crisis. Its banking system is
now considered to have successfully transited from crisis to restored health.
In sum, we believe the Big Four should be restructured to segregate within the banks the new NPLs
that have emerged since 1999, giving stature to the “bad bank”and staffing it with excellent
management dedicated to resolving the NPL problems, and ensuring that these customers do not
receive new loans or special consideration. This approach, based only on objective considerations
of clearing off the bad loans and severing deadbeat customers will, of course, have political
implications that political masters may not be willing to bear. In that case, a third option should be
considered: turning the SOCBs into narrow banks.
C. Narrow Banks
In this option, we would separate the Big Four along deposit taking and lending, and make them
into narrow banks. Using their extensive branch networks they would continue to accept
deposits, but these deposits would be intermediated in a very narrow range of assets, all of which
are low risk and pay low interest. We would allow them to invest in mutual funds that might
include securitized pools of loans.
Radical as this option might sound, it would stop the flow of tax payers’ funds into the banks.
Right now the tax payer is expected to clean up behind them. The Big Four continue in business
because they are major employers, major sources of capital for the SOEs and one of the main
repositories for private savings. Why not reduce their burden to becoming a reliable repository
for small savers?
Their other functions should be offloaded to the state. If the government stays the present course,
the Chinese tax payer will again be on the hook to clean up NPLs. These resources would be better
allocated directly to the social security system to address the central government’s social stability
concerns. Take the $168.2 billion (17 percent of 1999 GDP) the tax payer has already paid for
the legacy NPLs, plus the $60 billion (5 percent of 2004 GDP) capital injections that have
35
Wang et al (2004).
Rodman (2005a).
37
Rodman (2005a).
36
19
already been spent on the banks. Such funds spent directly on a social safety net for SOEs
layoffs might have underwritten a larger transformation than has occurred.
Conclusion
This paper has examined China’s efforts to modernize the Big Four banks that still dominate the
financial system. We conclude that if the contradiction between this goal and the social goals
valued by the state owners is to be resolved, other strategic alternatives should be considered.
Resolving the contradiction is necessary for the Big Four to be normal internationally
competitive banks rather than state-owned utilities that continue to misallocate China’s huge
volume of savings. Continuing with the current strategy is an improvement over the past, but
implies these banks will be a significant, inefficient and risk-prone feature of the Chinese
business environment. The alternatives are either to restructure the banks to segregate dealings
with existing dead beat customers from new customers and business opportunities or to face up
to the reality that the existing ownership structure is consistent only with low-risk low-return
banking activities.
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22
Table 1. Structure of the Chinese Banking Industry
As of December 31, 2004
Total Assets
Deposits
Number of
Institutions
Amount
Market
Share
Amount
Market
Share
Loans
Amount
Market
Share
(in billions of RMB, except number of institutions and percentages)
Big four commercial banks…………..
Other national commercial banks(1).....
City commercial banks……………….
Rural credit cooperatives(2)…………..
Urban credit cooperatives……………
Foreign-invested commercial banks…
Others(3)……………………………..
4
12
112
32,876
681
211
149
16,998.1
4,827.1
1,724.5
3,157.8
180.0
513.7
4,276.0
53.7%
15.2
5.4
10.0
0.6
1.6
13.5
14,618.1
4,180.1
1,396.3
2,784.9
158.9
126.3
1,792.1
58.3%
16.7
5.6
11.1
0.6
0.5
7.2
10,248.1
2,931.7
924.2
2,005.8
102.4
254.8
2,620.9
53.7%
15.4
4.9
10.5
0.5
1.3
13.7
Total………………………………
34,045
31,677.2
100.0%
25,056.7
100.0%
19,087.9
100.0%
________
Source: China Construction Bank Offering Memorandum based on PBOC, banks’ annual reports, 2004 Monetary Statistics of Financial
Institutions.
(1)
Also known as “joint-stock commercial banks.”
(2)
Consists of rural commercial banks and rural credit cooperatives.
(3)
Consists of policy banks, the postal savings bureau, finance companies, trust and investment companies and financial leasing companies.
Table 2. Assets, Deposits and Loans for the Four Major SOCBs
As of December 31, 2004
Total Assets
Deposits
Approximate
number
of branches
Amount
% of
total
Amount
% of
total
Loans
Amount
% of
total
(in billions of RMB, except number of institutions and percentages)
Industrial and Commercial Bank of
China ………………………………
Agricultural Bank of China(1) ……...
China Construction Bank…………..
Bank of China(2) …………………...
Total……………………………..
Memo: 12 National Commercial Banks _
______
21,223
31,004
14,458
11,307
5,589.9
4,013.8
3,904.8
3,489.6
32.9%
23.6
23.0
20.5
5,000.0
3,491.5
3,489.4
2,637.2
34.2%
23.9
23.9
18.0
3,635.3
2,590.1
2,225.6
1,797.1
35.5%
25.3
21.7
17.5
77,992
_5,467
16,998.1
4,827.1
100.0%
14,618.1
4,180.1
100.0%
10,248.1
2,931.7
100.0%
Sources: China Construction Bank Offering Memorandum based on Banks’ annual reports.
(1)
Calculated on a consolidated basis.
(2)
If calculated on a consolidated basis, Bank of China ranks second based on total assets among the big four commercial banks as of
December 31, 2004.
23
Table 3. NPLs in China’s SOCBs: comparative estimates
(comparisons of available data; all data in RMB billions)
2000
8947
2001
9731
2002
10517
2003
11699
2004
13652
1. GDP
2. Total Loans
Na
Na
9089
8008
7639
A. CSY
B. Bank Ann.
10667
9941
8489
7426
7452
Reports
3. NPLs
1575.1
1924.5
1994.4
Na
2121.6
A. UBS
B. Bank Ann.
1593
1961
1910
1520
1522
Reports
4. NPL ratio
15.6
20.1
24.7
Na
33
A. UBS
B. Bank Ann
14.94
19.73
22.5
34.9
28.6
Reports
13.2
15.9
na
na
na
C. CBRC
81 - 86
85
78
5.Loans/GDP 83.7 - 85 76 - 83
(%)
15.6
18-19
16.4-16.8
11.5-11.7
6. NPLs/GDP 17-23.7
Sources: GDP: CSY
Loans, NPLs: UBS analyst report 03/05 citing CBRC data; Bank Annual Reports; CBRC
website.
24
Table 4. Reported SOCB NPLs, by bank (2000-2004)
(RMB billion)
BANK
1.ABC
2000
Loan
1484.3
2.CCB
1386.4
3.ICBC
2413.6
4.BOC
1505.8
5.Total
loans
GDP
7452.2
(5305.8)*
8946.8
9731.5
10517.0
11689.0
13651.5
Loans/
GDP
(%)
83.3%
76.3%
80.7%
85.04%
78.14%
NPL
___
2001
Loan
1646.2
281.0
(20.27)
831.0
(34.43)
1505.9
409.6
(27.20)
152.16*
(28.6)*
1585.3
2688.9
7426.3
(4353.1)*
NPL
___
2002
Loan
1913.0
291.4
(19.35)
792.0
(29.45)
1766.4
436.1
(27.51)
1519.5*
(34.9)*
1816.2
2994.0
8489.5
2003
Loan
2268.4
NPL
472.3
(24.7)
268.0
(15.17)
760.9
(25.41)
NPL
695.5
(30.7)
193.5
(9.12)
720.7
(21.24)
2122.1
3392.9
408.4
(22.49)
1909.7
(22.49)
2157.4
351.2
(16.28)
1961.0
(19.7)
9940.9
2004
Loan
2590.1
2225.6
3705.3
2146.5
10667.4
Notes: *Loans and NPLs for only 3 reporting banks
1. China Construction Bank 2003 data (based on the 2003 Annual Report) differ, from the data reported in 2004
Annual Report of CCB where the loan balance is 1995.9 and the ratio of non-performing loans is 4.27 percent.
2. NPL ratio (the ratio of non-performing loans to total bank loans, percent) appears in parentheses.
3. The ratio of non-performing loans is based on the BIS five-category loan classifications.
Source: Financial Statements in the Annual Report of each bank.
Table 5. Strategic Investors in the Big Four SOCBs
Foreign Investments in banks: 2005
Target
Industrial &
Commercial
Bank of China
Bank of China
China Construction
Bank
Agricultural Bank
of China
Acquirers
Goldman Sachs
Allianz
American Express
Royal Bank of Scotland
Merrill Lynch )
Li Ka-shing Foundation)
UBS
Bank of America
Temasek
Sources: “China Banks” . Goldman Sachs. February 2, 2006.
25
Share (%)
10
Deal value
(US$ B)
3.8
Month
announced
Aug-05
5.16
4.84
3.1
1.5
Aug-05
1.6
0.5
9
5.1
na
2.6
1.5
Na
Jun-05
NPL
692.3
(26.7)
87.3
(3.92)
703.6
(18.99)
109.89
(5.12)
1593.2
(14.94)
Table 6. Industrial Enterprise Statistics
Total SOE
Industrial
#
Industrial % loss SOE loss Employment
Date Enterprise making making % (millions)
33.9
Dec-99 154882
29.0%
15.3%
30
Dec-00 158749
24.2%
11.9%
26.8
Dec-01 168799
23.4%
10.1%
24.2
178876
Dec-02
21.0%
8.4%
21.6
Dec-03 193483
19.1%
6.7%
20.5
219463
Dec-04
18.2%
5.1%
na
Dec-05 266090
17.9%
3.7%
Source: CEIC
Total
YTD
Total
Total YTD
Losses at
CCB,
Industrial
State Cumulative ICBC, and
Enterprise Cumulative Control SOE losses
BOC
Losses Since 1999 Enterprise since 1999
NPLs
130.035
130.035
85.143
85.143
1521.6
102.764
232.799
61.577
146.72
1519.6
111.241
344.04
68.857
215.577
1437.4
107.29
451.33
63.319
278.896
1265.5
107.225
558.555
62.676
341.572
900.9
123.979
682.534
66.948
408.52
na
192.300
874.834 102.617
511.137
Table7. Target Performance Indicators for the SOCBs
(percentage)
Indicator
Targets 2005
Targets 2007
Return on assets
Return on equity
Cost-to-income ratio
NPLs ratio (A)
Capital adequacy
Largest client exposure
to capital (B)
NPL provisioning
Coverage (C )
0.6%
11.0
35-45
3-5
>8.0
~1.0
>13.0
35-45
3-5
>8.0
<10.0
<10.0
60-80
>60-80
Notes:
A. Ratio is NPLs to total loans using BIS 5-category classification
B. This is measured in compliance with a2004 guidelines that require full provisioning for NPLs
C. Measured as total provisioning to total NPLs; BOC target is 60 percent and CCB target is 80 percent, with
further increases required by 2007.
26