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Is meltdown of the Chinese banks inevitable?
China Economic Review 13 (2002) 382 – 387
Is meltdown of the Chinese banks inevitable? Yiping HUANG* Citibank and Salomon Smith Barney, Hong Kong, China Received 20 August 2002; accepted 29 September 2002
Keywords: Chinese banking system; Meltdown; Foreign competiton
1. Big problems The health of the Chinese banking system has come under a spotlight since the beginning of the East Asian financial crisis in 1997. In early 1998, the People’s Bank of China (PBOC) estimated the average proportion of the nonperforming loans (NPLs) at 24% in the four major state-owned commercial banks (SOCBs)—the Bank of China (BOC), the Industrial and Commercial Bank of China (ICBC), the Construction Bank of China (CBC), and the Agricultural Bank of China (ABC).1 This was much bigger than those of the pre-crisis Thailand, South Korea, Indonesia, and Malaysia (Huang & Yang, 1998). But China maintained strong GDP growth in the following years without major financial instability.2 China’s entry into the WTO on December 11, 2002 revived the anxieties about sustainability of its banking system. China promised to grant, within 5 years after joining the WTO, foreign banks market access and to remove geographic and client restrictions. Two years after the WTO, foreign banks will be allowed to do local currency business for Chinese firms, whereas in 5 years, they can do local retail business. The WTO agreements became effective on February 1, 2002.
* Tel.: +852-2501-2735; fax: +852-2501-8235. E-mail address: [email protected] (Y. Huang). 1 ‘China central bank governor on financial situation,’ People’s Daily, March 7, 1998, Beijing. 2 There were several incidents of bank runs in southwestern and northeastern provinces in 1998 and 1999, but all of them were settled quickly. 1043-951X/02/$ – see front matter D 2002 Elsevier Science Inc. All rights reserved. PII: S 1 0 4 3 - 9 5 1 X ( 0 2 ) 0 0 0 9 5 - 0
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Y. Huang / China Economic Review 13 (2002) 382–387
Can Chinese banks survive the foreign competition? For China watchers like Chang (2001), the answer is definitely negative. Some optimists, however, take comfort in domestic banks’ national branch networks that no foreign bank is likely to be able to build within a short period. This is true. What is also true is that the SOCBs generate 95% of their profits from about half dozen of the coastal cities, including Shenzhen, Guangzhou, Xiamen, Shanghai, Tianjin, and Beijing. Unfortunately, these are the battlefields where foreign banks will come and fight. There is concern that the banking problems grew bigger during the past years. Official data, which are based on the recently implemented international loan classification system, show the average NPL ratio at around 23% in mid-2002. Our estimate is 35%, considering the huge unrecognized bad assets, illustrated by recently revealed BOC scandals in both New York and Liping of Guangdong (Bonin & Huang, in press). These ratios, 23–35%, still exclude the 1.4 trillion yuan already transferred to the four asset management companies (AMCs) affiliated to the four SOCBs. Therefore, the NPLs of the whole banking system actually account for 40–50% of total outstanding loans. In 1998, the government injected 270 billion yuan into the four major banks, through issuance of special Treasury bond, to raise their average capital adequacy ratio (CAR) from 4.6% to above 8%. By the end of 2001, however, the average CAR had come down to around 5% again. Banking problems represent one of the biggest risks for the post-WTO Chinese economy. Whether or not China can escape a financial meltdown depends on how quickly the government can eliminate, or at least contain, the banking problems and improve competitiveness. In this paper, I argue that banking crisis still is an unlikely scenario because the capital account control helps prevent external speculative attacks and the government also has sufficient fiscal and monetary means to settle any bank instability. Complete resolution of the banking problems, however, requires more coordinated efforts than the current reform program. In particular, we believe that breaking up of the giant SOCBs is a necessary step for effective transformation.
2. Meltdown unlikely While pessimists often compare China’s banking situation to those of pre-crisis countries like Thailand or Mexico, we believe that such comparison ignores some important institutional differences between China and those crisis-affected countries, especially capital account control and blanket guarantee of deposits. Capital account control is a second-best policy given the problems of the state-owned enterprises (SOEs) and the SOCBs. It reduces efficiency and welfare by restricting domestic enterprises and households directly accessing to the international capital market. But it also prevents external speculative attacks that triggered financial crises in some countries. Even if there are problems with some banks, depositors still need to put money into other banks in the country because of restrictions on capital mobility. This ensures that local problems do not lead to systemic disasters. In fact, capital account control was a key contributing factor to China’s successful riding out of the storm of the Asian financial crisis in 1998–1999 (Huang, 2001).
Y. Huang / China Economic Review 13 (2002) 382–387
384
The entry of foreign banks may change the situation.3 From late March 2002, several foreign bank branches already started to receive US dollar deposits from local residents. Of course, full competition by foreign banks is still 5 years away. In a way, the WTO commitments have served as a driving force to accelerate banking reforms. In the perceivable future, foreign competition will mainly in the form of taking away wealthy and profitable clients away from local banks (Bonin & Huang, in press). Foreign banks are not likely to build matching networks any time soon. Experiences of other emerging markets suggest that the problem often is not too much foreign competition but too difficult for foreign banks to expand their businesses. Despite the policy commitments, the Chinese authorities still have plenty of flexibility to restrict foreign competition if domestic banks are not yet ready. A recent example is the new rule introduced by the PBOC that foreign banks’ total borrowing from local interbank market cannot exceed 40% of their assets. This rule, while not in violation of the national treatment principle, severely limits foreign banks’ potential in local currency business in the near term and thus shelters the domestic banks from competition pressure. Another factor that helps keep the depositors with the banks is the blanket guarantee of deposits by the state. The guarantee causes a moral hazard problem because depositors do not discriminate against bad banks. But it maintains depositors’ faith in the shaky state banks. Does the government really have the ability to keep the guarantee? We believe that it has both the fiscal and monetary means to settle bank runs. China’s formal public debts only account for 16% of GDP at the end of 2001. If we take into account the estimated costs for restructuring banking system and the potential expenditure to finance the pension fund, 46% and 26% of GDP, respectively, the contingent liabilities are around 90% of GDP. This ratio is very high according to any international standards but still does not pose any immediate threat to fiscal sustainability. The Chinese economy has been growing at remarkable rates, even after discounting the overstatement of the official data. Fiscal revenues have been increasing at 15–20% per annum and fiscal deficits have been kept below 3% of GDP for the past years. But the share of fiscal revenue in GDP is still below 20% and has the potential to rise further. Thus, it should not be difficult for China to absorb the existing contingent liabilities over an extended period. Moreover, the government can also print more money should extra cashes are needed to restore confidence in the banking system. Printing money can have adverse macroeconomic impacts, but such impacts will likely be minimal given the current deflation/low inflation.
3. The reform program The pace of banking reforms accelerated in the wake of the East Asian financial crisis, especially during the past year as the WTO entry drew closer. From early 2001, policymakers 3
WTO agreements or entry of the foreign banks do not automatically require liberalization of the capital account. But significant participation of foreign banks in the market does make it more difficult to maintain the control.
385
Y. Huang / China Economic Review 13 (2002) 382–387
were divided up into eight groups exploring various reform options in different areas. The Central Financial Works Conference was held in early February 2002 to put together a blueprint for reform of the financial sector. Although the outcomes of the policy conference were less ambitious than we expected, the policy framework for banking reforms encompassing three key areas became clear. The first area is resolution of the existing NPLs. The four AMCs would continue to deal with 1.4 trillion yuan of bad loans already transferred from the parent banks. We estimate the overall recovery rate to be at 25% at best (Bonin & Huang, 2001). More worrying are the at least 3 trillion yuan of NPLs still in the banks. The PBOC’s current policy is that there would be no more transfer of NPLs to the AMCs and that the banks should aim at reducing the NPL ratios by 2–3 percentage points every year in the next 5 years in order to lower the average NPL ratio to below 15%. The second area is financial supervision. One of the main decisions at the February policy conference was the creation of a relatively independent body in charge of financial supervision within the PBOC. This body is expected to gradually introduce international standard bank supervision practices, replacing the traditional administrative measures, such as dispatch of investigation teams. And the third area is reform of the SOCBs through a three-step approach. Step 1 continues the on-going reforms improving internal management systems, including implementation of the accounting, auditing, and risk assessment systems. These will probably not bring about breakthrough changes, but are necessary for the success of the later steps. Step 2 includes both corporatization of the banks and introduction of strategic investors. The government intends to implement the share-holding system to the major banks within 2–3 years, initially with the Ministry of Finance (MOF) as the sole owner. Then, MOF will quickly sell some equities to domestic and foreign strategic investors. Currently, foreign interests are still capped at 25%. Finally, Step 3 aims at public listing of the large banks in about 5 years. The detailed forms of listing still need to be worked out in due course and case by case. It was the dynamism of the reform rather than the existing program itself that made us reasonably confident that banking problems can be resolved. Five years ago, privatization of the SOCBs would not be acceptable for most policymakers. But today it is already a policy that the SOCBs will either be listed or be sold to foreign strategic investors soon. China’s practical reform approach, popularly characterized as ‘crossing the river by groping the stones,’ suggests that necessary reform measures will be adopted in order to improve the competitiveness of the banks.
4. Breaking up the banks Some measures of the current reform program will likely be ineffective. The expectation that the SOCBs should absorb their own NPLs, for instance, will likely prove impractical. While it was true that these banks lowered their NPL ratios by 3–4 percentage points in 2001–2002, that is probably unsustainable, especially as competition is expected to rise rapidly. Banks wrote off some NPLs in recent years through increases in NPL provision,
Y. Huang / China Economic Review 13 (2002) 382–387
386
facilitated by tax reduction. They also kept NPLs of the newly extended loans at unusually low levels because a large proportion of the new loans were for state-guaranteed projects. From January 1998 to December 2001, the financial institutions’ total outstanding loans increased 3.7 trillion yuan, of which about 2 trillion yuan (or 54%) were for state-sponsored projects. NPLs are likely to rise, rather than falling, in the coming year before significant improvement in banking practice occur. The government should simply accept the responsibilities for the existing NPLs and free banks’ hands on more important institutional reforms. Otherwise, the burden for the fiscal system will probably end up bigger rather than smaller. While it is right to strengthen bank supervision by regulators, we believe that monitoring by the market (through investors of subordinated bond and stocks and depositors) is equally important. The planned issuance of bonds and public listing by the banks are useful steps forward. But significant improvement in market institutions is still needed before monitoring by investors can be effective. Depositor discrimination against inefficient/poor banks can only start after the interest rates are liberalized and the state deposit guarantee is replaced by a limited deposit insurance system.4 The decisions to allow strategic investors into the SOCBs and to list them in stock markets are policy breakthroughs. A number of foreign institutions such as the International Finance (IFC), Asian Development Bank (ADB), and Hong Kong and Shanghai Bank (HSBC) already bought equities in some second-tier joint-stock banks. But introducing foreign strategic investors into the SOCBs will not be an easy task. First, SOCBs need to substantially clean up their balance sheets before they can interest any potential buyers. Second, the foreign interests cap at 25% would discourage some potential investors because of limited influence on decision-making. And, third, not many companies would have the capital to buy even 10– 15% of any of the SOCBs because all four are among the world’s 50 largest banks. The option of public listing has similar problems. The domestic stock markets are still small, relative to the sizes of the SOCBs. More importantly, domestic stock markets still need to be improved significantly before they can become effective institutions transforming the behaviors of the listed companies or banks. Otherwise, listing companies or banks would just behaved like the old SOEs or SOCBs. We believe that breaking up of SOCBs is a necessary step to both foster competition and facilitate reform.5 All SOCBs are giant organizations. It is very difficult to send messages through the whole institution, with constraints by government at various levels. The sizes of the banks also mean that the China cannot afford to let any of them fail. This generates the moral hazard problem, which is very bad for the reforms. It is simply impractical to expect that all elements of all the four SOCBs will become competitive. This situation may change once the banks are split into several components, based on either geographical concentration or business lines. Market competition will pick winners. And if some smaller banks fail, there would be no devastating macroeconomic implications. More importantly, breaking up will
4
Extra cautions are needed when liberalizing interest rates and abandoning state deposit guarantee in order to avoid sudden shock to depositor confidence or banks’ excessive taste for risky projects. 5 Li (2000) made a similar argument in an earlier paper.
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Y. Huang / China Economic Review 13 (2002) 382–387
facilitate the processes of introducing foreign strategic investors and public listing for reasons discussed above. For the idea of breaking up to be an acceptable policy, Chinese policymakers will need to change the perception that ‘‘big is more competitive.’’ China needs healthy and competitive banks, not large banks. If scale efficiency becomes important, successful components can build up their size rapidly through merger and acquisition.
Acknowledgements The author would like to thank Don Hanna, Gao Jian, Kenneth Koo, John P. Bonin, Wing Thye Woo, Stanley Fischer, and Elliott Parker for helpful comments and discussion. Views expressed in this paper are those of the author and do not necessarily represent those of the Citigroup or its affiliated organizations.
References Bonin, J. P., & Huang, Y. (2001). Dealing with the bad loans of the Chinese banks. Journal of Asian Economics, 12, 197 – 214. Bonin, J. P., & Huang, Y. (in press). Foreign entry into Chinese banking: does WTO membership threaten domestic banks? The World Economy. Chang, G. (2001). The coming collapse of China. New York, NY: Random House. Huang, Y. (2001). China’s last steps across the river: enterprise and bank reforms. Canberra: Asia Pacific Press. Huang, Y., & Yang, Y. (1998). China’s financial fragility and policy responses. Asian – Pacific Economic Literature, 12, 1 – 9. Li, D. (2000). Beating the trap of financial repression in China. Cato Journal, 21, 77 – 90.
Is meltdown of the Chinese banks inevitable? Yiping HUANG* Citibank and Salomon Smith Barney, Hong Kong, China Received 20 August 2002; accepted 29 September 2002
Keywords: Chinese banking system; Meltdown; Foreign competiton
1. Big problems The health of the Chinese banking system has come under a spotlight since the beginning of the East Asian financial crisis in 1997. In early 1998, the People’s Bank of China (PBOC) estimated the average proportion of the nonperforming loans (NPLs) at 24% in the four major state-owned commercial banks (SOCBs)—the Bank of China (BOC), the Industrial and Commercial Bank of China (ICBC), the Construction Bank of China (CBC), and the Agricultural Bank of China (ABC).1 This was much bigger than those of the pre-crisis Thailand, South Korea, Indonesia, and Malaysia (Huang & Yang, 1998). But China maintained strong GDP growth in the following years without major financial instability.2 China’s entry into the WTO on December 11, 2002 revived the anxieties about sustainability of its banking system. China promised to grant, within 5 years after joining the WTO, foreign banks market access and to remove geographic and client restrictions. Two years after the WTO, foreign banks will be allowed to do local currency business for Chinese firms, whereas in 5 years, they can do local retail business. The WTO agreements became effective on February 1, 2002.
* Tel.: +852-2501-2735; fax: +852-2501-8235. E-mail address: [email protected] (Y. Huang). 1 ‘China central bank governor on financial situation,’ People’s Daily, March 7, 1998, Beijing. 2 There were several incidents of bank runs in southwestern and northeastern provinces in 1998 and 1999, but all of them were settled quickly. 1043-951X/02/$ – see front matter D 2002 Elsevier Science Inc. All rights reserved. PII: S 1 0 4 3 - 9 5 1 X ( 0 2 ) 0 0 0 9 5 - 0
383
Y. Huang / China Economic Review 13 (2002) 382–387
Can Chinese banks survive the foreign competition? For China watchers like Chang (2001), the answer is definitely negative. Some optimists, however, take comfort in domestic banks’ national branch networks that no foreign bank is likely to be able to build within a short period. This is true. What is also true is that the SOCBs generate 95% of their profits from about half dozen of the coastal cities, including Shenzhen, Guangzhou, Xiamen, Shanghai, Tianjin, and Beijing. Unfortunately, these are the battlefields where foreign banks will come and fight. There is concern that the banking problems grew bigger during the past years. Official data, which are based on the recently implemented international loan classification system, show the average NPL ratio at around 23% in mid-2002. Our estimate is 35%, considering the huge unrecognized bad assets, illustrated by recently revealed BOC scandals in both New York and Liping of Guangdong (Bonin & Huang, in press). These ratios, 23–35%, still exclude the 1.4 trillion yuan already transferred to the four asset management companies (AMCs) affiliated to the four SOCBs. Therefore, the NPLs of the whole banking system actually account for 40–50% of total outstanding loans. In 1998, the government injected 270 billion yuan into the four major banks, through issuance of special Treasury bond, to raise their average capital adequacy ratio (CAR) from 4.6% to above 8%. By the end of 2001, however, the average CAR had come down to around 5% again. Banking problems represent one of the biggest risks for the post-WTO Chinese economy. Whether or not China can escape a financial meltdown depends on how quickly the government can eliminate, or at least contain, the banking problems and improve competitiveness. In this paper, I argue that banking crisis still is an unlikely scenario because the capital account control helps prevent external speculative attacks and the government also has sufficient fiscal and monetary means to settle any bank instability. Complete resolution of the banking problems, however, requires more coordinated efforts than the current reform program. In particular, we believe that breaking up of the giant SOCBs is a necessary step for effective transformation.
2. Meltdown unlikely While pessimists often compare China’s banking situation to those of pre-crisis countries like Thailand or Mexico, we believe that such comparison ignores some important institutional differences between China and those crisis-affected countries, especially capital account control and blanket guarantee of deposits. Capital account control is a second-best policy given the problems of the state-owned enterprises (SOEs) and the SOCBs. It reduces efficiency and welfare by restricting domestic enterprises and households directly accessing to the international capital market. But it also prevents external speculative attacks that triggered financial crises in some countries. Even if there are problems with some banks, depositors still need to put money into other banks in the country because of restrictions on capital mobility. This ensures that local problems do not lead to systemic disasters. In fact, capital account control was a key contributing factor to China’s successful riding out of the storm of the Asian financial crisis in 1998–1999 (Huang, 2001).
Y. Huang / China Economic Review 13 (2002) 382–387
384
The entry of foreign banks may change the situation.3 From late March 2002, several foreign bank branches already started to receive US dollar deposits from local residents. Of course, full competition by foreign banks is still 5 years away. In a way, the WTO commitments have served as a driving force to accelerate banking reforms. In the perceivable future, foreign competition will mainly in the form of taking away wealthy and profitable clients away from local banks (Bonin & Huang, in press). Foreign banks are not likely to build matching networks any time soon. Experiences of other emerging markets suggest that the problem often is not too much foreign competition but too difficult for foreign banks to expand their businesses. Despite the policy commitments, the Chinese authorities still have plenty of flexibility to restrict foreign competition if domestic banks are not yet ready. A recent example is the new rule introduced by the PBOC that foreign banks’ total borrowing from local interbank market cannot exceed 40% of their assets. This rule, while not in violation of the national treatment principle, severely limits foreign banks’ potential in local currency business in the near term and thus shelters the domestic banks from competition pressure. Another factor that helps keep the depositors with the banks is the blanket guarantee of deposits by the state. The guarantee causes a moral hazard problem because depositors do not discriminate against bad banks. But it maintains depositors’ faith in the shaky state banks. Does the government really have the ability to keep the guarantee? We believe that it has both the fiscal and monetary means to settle bank runs. China’s formal public debts only account for 16% of GDP at the end of 2001. If we take into account the estimated costs for restructuring banking system and the potential expenditure to finance the pension fund, 46% and 26% of GDP, respectively, the contingent liabilities are around 90% of GDP. This ratio is very high according to any international standards but still does not pose any immediate threat to fiscal sustainability. The Chinese economy has been growing at remarkable rates, even after discounting the overstatement of the official data. Fiscal revenues have been increasing at 15–20% per annum and fiscal deficits have been kept below 3% of GDP for the past years. But the share of fiscal revenue in GDP is still below 20% and has the potential to rise further. Thus, it should not be difficult for China to absorb the existing contingent liabilities over an extended period. Moreover, the government can also print more money should extra cashes are needed to restore confidence in the banking system. Printing money can have adverse macroeconomic impacts, but such impacts will likely be minimal given the current deflation/low inflation.
3. The reform program The pace of banking reforms accelerated in the wake of the East Asian financial crisis, especially during the past year as the WTO entry drew closer. From early 2001, policymakers 3
WTO agreements or entry of the foreign banks do not automatically require liberalization of the capital account. But significant participation of foreign banks in the market does make it more difficult to maintain the control.
385
Y. Huang / China Economic Review 13 (2002) 382–387
were divided up into eight groups exploring various reform options in different areas. The Central Financial Works Conference was held in early February 2002 to put together a blueprint for reform of the financial sector. Although the outcomes of the policy conference were less ambitious than we expected, the policy framework for banking reforms encompassing three key areas became clear. The first area is resolution of the existing NPLs. The four AMCs would continue to deal with 1.4 trillion yuan of bad loans already transferred from the parent banks. We estimate the overall recovery rate to be at 25% at best (Bonin & Huang, 2001). More worrying are the at least 3 trillion yuan of NPLs still in the banks. The PBOC’s current policy is that there would be no more transfer of NPLs to the AMCs and that the banks should aim at reducing the NPL ratios by 2–3 percentage points every year in the next 5 years in order to lower the average NPL ratio to below 15%. The second area is financial supervision. One of the main decisions at the February policy conference was the creation of a relatively independent body in charge of financial supervision within the PBOC. This body is expected to gradually introduce international standard bank supervision practices, replacing the traditional administrative measures, such as dispatch of investigation teams. And the third area is reform of the SOCBs through a three-step approach. Step 1 continues the on-going reforms improving internal management systems, including implementation of the accounting, auditing, and risk assessment systems. These will probably not bring about breakthrough changes, but are necessary for the success of the later steps. Step 2 includes both corporatization of the banks and introduction of strategic investors. The government intends to implement the share-holding system to the major banks within 2–3 years, initially with the Ministry of Finance (MOF) as the sole owner. Then, MOF will quickly sell some equities to domestic and foreign strategic investors. Currently, foreign interests are still capped at 25%. Finally, Step 3 aims at public listing of the large banks in about 5 years. The detailed forms of listing still need to be worked out in due course and case by case. It was the dynamism of the reform rather than the existing program itself that made us reasonably confident that banking problems can be resolved. Five years ago, privatization of the SOCBs would not be acceptable for most policymakers. But today it is already a policy that the SOCBs will either be listed or be sold to foreign strategic investors soon. China’s practical reform approach, popularly characterized as ‘crossing the river by groping the stones,’ suggests that necessary reform measures will be adopted in order to improve the competitiveness of the banks.
4. Breaking up the banks Some measures of the current reform program will likely be ineffective. The expectation that the SOCBs should absorb their own NPLs, for instance, will likely prove impractical. While it was true that these banks lowered their NPL ratios by 3–4 percentage points in 2001–2002, that is probably unsustainable, especially as competition is expected to rise rapidly. Banks wrote off some NPLs in recent years through increases in NPL provision,
Y. Huang / China Economic Review 13 (2002) 382–387
386
facilitated by tax reduction. They also kept NPLs of the newly extended loans at unusually low levels because a large proportion of the new loans were for state-guaranteed projects. From January 1998 to December 2001, the financial institutions’ total outstanding loans increased 3.7 trillion yuan, of which about 2 trillion yuan (or 54%) were for state-sponsored projects. NPLs are likely to rise, rather than falling, in the coming year before significant improvement in banking practice occur. The government should simply accept the responsibilities for the existing NPLs and free banks’ hands on more important institutional reforms. Otherwise, the burden for the fiscal system will probably end up bigger rather than smaller. While it is right to strengthen bank supervision by regulators, we believe that monitoring by the market (through investors of subordinated bond and stocks and depositors) is equally important. The planned issuance of bonds and public listing by the banks are useful steps forward. But significant improvement in market institutions is still needed before monitoring by investors can be effective. Depositor discrimination against inefficient/poor banks can only start after the interest rates are liberalized and the state deposit guarantee is replaced by a limited deposit insurance system.4 The decisions to allow strategic investors into the SOCBs and to list them in stock markets are policy breakthroughs. A number of foreign institutions such as the International Finance (IFC), Asian Development Bank (ADB), and Hong Kong and Shanghai Bank (HSBC) already bought equities in some second-tier joint-stock banks. But introducing foreign strategic investors into the SOCBs will not be an easy task. First, SOCBs need to substantially clean up their balance sheets before they can interest any potential buyers. Second, the foreign interests cap at 25% would discourage some potential investors because of limited influence on decision-making. And, third, not many companies would have the capital to buy even 10– 15% of any of the SOCBs because all four are among the world’s 50 largest banks. The option of public listing has similar problems. The domestic stock markets are still small, relative to the sizes of the SOCBs. More importantly, domestic stock markets still need to be improved significantly before they can become effective institutions transforming the behaviors of the listed companies or banks. Otherwise, listing companies or banks would just behaved like the old SOEs or SOCBs. We believe that breaking up of SOCBs is a necessary step to both foster competition and facilitate reform.5 All SOCBs are giant organizations. It is very difficult to send messages through the whole institution, with constraints by government at various levels. The sizes of the banks also mean that the China cannot afford to let any of them fail. This generates the moral hazard problem, which is very bad for the reforms. It is simply impractical to expect that all elements of all the four SOCBs will become competitive. This situation may change once the banks are split into several components, based on either geographical concentration or business lines. Market competition will pick winners. And if some smaller banks fail, there would be no devastating macroeconomic implications. More importantly, breaking up will
4
Extra cautions are needed when liberalizing interest rates and abandoning state deposit guarantee in order to avoid sudden shock to depositor confidence or banks’ excessive taste for risky projects. 5 Li (2000) made a similar argument in an earlier paper.
387
Y. Huang / China Economic Review 13 (2002) 382–387
facilitate the processes of introducing foreign strategic investors and public listing for reasons discussed above. For the idea of breaking up to be an acceptable policy, Chinese policymakers will need to change the perception that ‘‘big is more competitive.’’ China needs healthy and competitive banks, not large banks. If scale efficiency becomes important, successful components can build up their size rapidly through merger and acquisition.
Acknowledgements The author would like to thank Don Hanna, Gao Jian, Kenneth Koo, John P. Bonin, Wing Thye Woo, Stanley Fischer, and Elliott Parker for helpful comments and discussion. Views expressed in this paper are those of the author and do not necessarily represent those of the Citigroup or its affiliated organizations.
References Bonin, J. P., & Huang, Y. (2001). Dealing with the bad loans of the Chinese banks. Journal of Asian Economics, 12, 197 – 214. Bonin, J. P., & Huang, Y. (in press). Foreign entry into Chinese banking: does WTO membership threaten domestic banks? The World Economy. Chang, G. (2001). The coming collapse of China. New York, NY: Random House. Huang, Y. (2001). China’s last steps across the river: enterprise and bank reforms. Canberra: Asia Pacific Press. Huang, Y., & Yang, Y. (1998). China’s financial fragility and policy responses. Asian – Pacific Economic Literature, 12, 1 – 9. Li, D. (2000). Beating the trap of financial repression in China. Cato Journal, 21, 77 – 90.