Friday, November 19, 2004

Dear readers, just as a matter of policy, I will not respond to comments unless I know the identity of the writer.

Back to business. So, the FT recently published an article outlining the changes in the banking sector in the past year. I have to say that the usual "beginning of the term boost" is at work again. That is, Wen Jiabao, as the new Premier, has enacted a series of pretty bold changes.

It is true that we have not seen this many changes since 1998, and many of these changes are toward a positive direction. However, Liu Mingkang and others also exaggerate the importance of some of the changes.

The most important change is the move to liberalize interest rates "in principle." Explicit interest rate regulations still apply to rural and urban credit cooperatives, but the Big Four banks and the joint-stock banks can now adjust lending interest rates as they please, while deposit rates can fluctuate downward. This is a good time for liberalization since China reduced its bond issuance this year as the economy recovered. With less need to sell bonds to the state banks, the government feels ready to allow banks to engage in more profitable business. Nonetheless, the CBRC and the PBOC will continue to monitor lending interest rates to ensure that they do not go against state interests. Meanwhile, depositors are still stuck with low yield bank accounts, which depress bond prices in the primary market at an artificially low level.

The move to emphasize adjusted capital adequacy ratio (CAR) is nothing new and has been in the works for a few years. Much of the improvement is due to the massive injection from the foreign exchange reserve.

Finally, the move to reform pay scale in the BOC is also not as dramatic as Zhu Min would like us to think. Since 1998, the pay (including bonuses) of bank branch managers have been tied to profitability and non-performing loans of the branches. The Big Four banks have also aggressively reduced branches and retired older bankers in the past few years. The new change presumably will allow BOC to bid for top talent with big bonuses, which hopefully will reduce the incentive forcorruption. However, all the top managers in the banks are still appointed by the Central Organization Department and the CBRC, and I don't think this will change for some time to come.

The FT piece,

Banking sees transformation from Chinese economy's weakest link to tower of strength
By James Kynge Published: November 18 2004 02:00 Last updated: November 18 2004 02:00

The start of 2004 did not look promising for the causeof Chinese banking reform. State banks, many wallowing in bad debts, were engaged in a lending frenzy that even the pro-growth Communist party worried might result in a meltdown.
But after an inauspicious start, the credit splurge has been tempered and so many long-awaited reforms launched that 2004 could yet be regarded as a watershed for the overhaul of one of the Chinese economy's weakest links.
"We have never seen such a rapid change in Chinese banking history," says Liu Mingkang, chairman of the China Banking Regulatory Commission (CBRC). At the same time, he says much hard work remains to be done.
Landmark changes this year have been manifold. Lending rates were liberalised in October, one large state bank is in the midst of a groundbreaking governance overhaul, authorities have recently approved banks to enter the fund management business and new private banks have been set up.
But Mr Liu uses the improvement in banks' capital adequacy ratios (CAR) as a general indicator on the growing strength of the financial sector.
He says by the end of this year the number of banks able to reach the international standard of 8 per cent CAR will have risen by 11 to a total of 19.
CAR is regarded as crucial because all Chinese banks have been ordered to comply with the 8 per cent standard required by the Bank of International Settlements in Basle, Switzerland, by 2007. It is also important because under rules announced earlier this year, banks with sub-standard CARs have to put more funds on reserve at the central bank - thereby hobbling their growth.
The focus on CAR has also been powerful in reining in banks' lending activities this year because the ratio of capital to assets declines as lending increases and Chinese banks need regulatory approval to issue subordinated debt to top up their CAR.
Mr Liu says lending has been brought under control following last year's frenzy. "Credit expansion since the second quarter [of this year] has been steadily keeping a level of 13.3 to 13.9 per cent," he says.
"One thing I can guarantee: Chinese banks will never be crazy," he adds. "In the next three to four years with CAR and risk management we can see the credit expansion speed will be 13 to 16 per cent. I am quite comfortable with that."
Ensuring the quality of these new loans is a separate task, the importance of which is emphasised by banks' historical legacy. Mr Liu says investment into "redundant projects" - those that fall foul of land, environmental and other regulations - is estimated at Rmb800bn ($97bn, €75bn, £52bn), some Rmb300bn of which comes from bank lending.
As the economy cools, banks will have to increase provisioning against such loans turning bad, an imperative that will further impel them to focus on profitable activities, Mr Liu says.
The regulatory squeeze on banks ordered since the CBRC was established in early 2003 has prompted some lenders to overhaul their management and staffing policies.
Bank of China (BOC), one of two large state lenders that hopes to list on the Hong Kong stockmarket, is engaged in far-reaching changes that will see each of its 230,000 staff reapply for their positions.
Following the reform, the current civil service-style pay scale will be replaced by a performance-based system that will reward staff for prudent lending over those whose decisions result in bad loans, says Zhu Min, Bank of China's executive assistant president.
Reinforcing the pressure for better governance is CBRC's decisions to approve the entry of several foreign competitors to take stakes in domestic banks. Mr Liu says nine more foreign banks are in line for permission to team up with domestic counterparts, in addition to the nine already approved.
Private banks too are starting to gain a foothold. Bohai Bank, a private lender based in the northern city of Tianjin, recently won regulatory approval, Mr Liu says. In addition, several former Rural Credit Co-operatives have transformed themselves into private banks serving mainly rural clients.
Private equity companies such as Zhongrui Caituan, a fund based in the east coast boomtown of Wenzhou, are also being given the green light, says Mr Liu, as long as they desist from public placement and use private placement to raise funds.
The last breakthrough reform was the shift in October to allow banks full freedom in setting their lending rates, abolishing the central bank's remit to set a fixed lending rate. A similar reform will eventually be applied to banks' deposit rates but the upper limit on deposits will be maintained for some time, officials say.
Given flexible lending rates, Chinese banks will for the first time be able to price their loans to reflect the risk profile of the borrower. This, it is hoped, will convince loan officers long accustomed to the mores of socialist banking to analyse the risk inherent in each project and lend accordingly.

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