The State and the Banking Sector in China

By: Sumil Thakrar

Abstract: The banking sector in China is suffering from bad lending practices, corruption, and large amounts of non-performing loans. This paper aims to broadly assess the extent to which the state’s influence on banks create or exacerbate these problems. A reduction in the influence of the state in the banks is recommended on all levels, whether in forming goals, implementing business decisions, or hiring banking officials. It is assessed whether the health of the sector can be aided by tightening Chinese banking legislation, with particular reference to the People’s Bank of China Law 2003. This option is compared briefly with the vague notion of implementing an ethical code, which is often recommended in popular financial ethics literature.

John R. Boatright[1] broadly outlines four means for a state to ensure its banks operate correctly: government regulation, market forces, institutional design, and ethics or morality.

Suggestions to improve the Chinese banking sector in each of these areas are often tied with concerns of the state’s involvement in banks[2] [3] [4] – both in the central bank (the People’s Bank of China) and the four largest Chinese banks (collectively referred to as the ‘big four’) that dominate the sector. This paper aims to broadly assess the extent to which peculiarities of Chinese legislation, regarding the state’s potential influence on banks, creates or exacerbates the problems currently faced by China’s banking sector, and how reducing the influence of the state on the banks improve the health and performance of the Chinese banking sector.

Recent History

China’s banking sector has tended to open up in recent years, being more liberalized from state control and decision-making.  The two most important laws facilitating this liberalization were put in place in 1995. The Law of The People’s Bank of China (henceforth 1995 PBOC), enacted by the National People’s Congress, concerned China’s central bank, whereas The Commercial Bank Law concerned the commercial banks, including the state-owned “big four”.

Prior to these laws, a huge surmounting problem for the banking sector was that lending practices resulted in the state-owned banks accumulating large amounts of non-performing loans (NPL’s) – loans which, are unlikely to be paid back to the banks. In response, government-owned asset management companies were created in 1998 to deal with NPL’s issued before 1996. These repackaged the NPL’s into viable assets, and then sold them to investors. However, this failed to solve the problem: in 2002, NPL’s still accounted for 21-26% of total lending of the big four, according to the central bank’s report.[5]

Also in 1998, to counteract the deficiency in capital of the state-owned banks, efforts were put in place by the Ministry of Finance to recapitalize the big four, by issuing Renmenbi 270 billion of special government bonds.[6] The Chinese Banking Regulatory Commission was set up in 2003 to separate banking regulation from the Central Bank and into an independent body (which called for amendments to the 1995 laws, to redefine the functions of the central bank).

Another important problem in the banking sector is corruption among bank employees in managerial positions. In one high profile case, Xu Chaofan and Xu Guojun, senior managers of Kaiping City Branch and the Bank of China, stole $483 million in a loan scandal.[7] The Washington Post story paints a picture of the state of the banks that allowed such an embezzlement to take place[8]:

The men allegedly were able to avoid detection for years because the bank invested branch managers with unusual authority, allowing the men to approve loans and asset transfers with a single signature.

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