Remaining Problems and Future Prospects

The SOCBs were basically held hostage for much of the post-reform era by the demands of the credit plan. This credit plan dictated the banks’ distribution of loans according to preset quotas, and government initiatives often ran counter to commercial forces.

Reform measures have attempted to correct some of the problems through policy and bank structure changes. Many early policy changes had only limited effects, however, reflecting little initial provision for enforcing such innovations as the new bankruptcy law. More meaningful structural changes have been seen recently, prompted in significant part by the open­ing up to foreign competition required under the terms of China’s WTO entry. Public listings of CCB, BOC, and ICBC in Hong Kong during 2005­2006 were preceded by substantial balance sheet improvements. Reduced loan-to-deposit ratios and a downward trend in SOE lending after 2000 also suggest progress toward more commercially oriented bank policies. However, the repeated need for government bailouts raises the question of whether the commercialization of the banks is, in fact, going fast enough. Foreign ownership appears to have delivered at least some visible benefits to other Chinese banks, however, and may help the SOCBs as well going forward.

Looking ahead, the authorities must not only pursue further liberaliza­tion of interest rates and other aspects of bank lending practices but also find a way to finally lay to rest lingering concerns about the NPL problem. There is a stark contrast between the relatively benign official estimates and the much higher outside estimates (cf. Ernst & Young, 2006; Setser, 2006). There may well be substantial additional bad loans on the banks’ balance sheets that have not yet been formally acknowledged - as well as the risk that renewed increased lending rates could generate new NPL problems in the future. The lending increase itself is connected to the exchange rate dilemma discussed in Chapter 1 - with the role of foreign capital inflows in adding to the run-up in real estate prices, for example, drawing the atten­tion of China’s National Statistical Bureau in April 2006 (see also Chap­ter 8).^[127] The AMCs are another potential source of concern. Although they provided a much needed vehicle for removing NPLs from SOCB balance sheets, the built-in loss associated with purchasing the debt at between 50% and 100% of its nominal value suggests that the AMCs may eventually need a substantial bailout themselves.

Although the popularity of the recent major Chinese bank IPOs suggests that investors believe these banks have evolved away from their old habit of extending loans to bad-risk borrowers, the rapid growth in fixed asset investment in 2006-2007 did not exactly seem consistent with conservative lending practices. Future progress may depend just as much upon the sta­bility of China’s macroeconomy as upon the banks’ own efforts to measure up to the standards expected by their new foreign investors. Progress toward more market-driven lending practices will also require a willingness on the part of the Chinese government to cede meaningful market share to foreign entrants. Even the legislation implemented at the end of the five-year “buffer period” in December 2006 seemed to embody excessive amounts of pro­tection for domestic banks. It is to be hoped that predictions of intensified competition between domestic and foreign banks (cf. Qian, 2006) come to pass and that a better allocation of credit to China’s rapidly growing pri­vate sector can be achieved in the future. On a positive note, some foreign banks, such as Standard Chartered Bank and Citibank, had already launched special services for small and medium-sized companies by 2007. Foreign banks also began providing meaningful competition in the home loan mar­ket in Shanghai, offering rates as low as 5.5 to 5.75% compared to 7.85% from Chinese lenders.^[128]