Thursday, August 18, 2005
My new piece for the Jamestown Foundation on Huijin came out yesterday; here is the full text. I don't really like their title, so I put my original title in parenthesis:
(Progress in Reform or More Beijing Power Politics: Central Huijin Company Acquires More Financial Institutions)
BEIJING’S BAILOUT OF JOINT-STOCK AND STATE-OWNED BANKS
By Victor Shih
In the spring and summer of 2005, the Chinese government successively announced that Central Huijin Company (China State Administration of Foreign Exchange Investments) will recapitalize Galaxy Securities (Yinhe Zhengquan), Southern Securities (Nanfang Zhengquan), Huaxia Securities, Shenyin Wanguo Securities, and Guotai Jun’an Securities. [1] Besides brokerages, Huijin is likely to recapitalize other joint-stock and state-owned banks in the future as they prepare for listing. It provided Bank of Communication with additional liquidity before its Hong Kong listing, and China Everbright Bank is currently negotiating with the State Council for a Huijin bailout. [2] Quite simply, Huijin has become the “savior” of the troubled financial sector in China. Bailouts in general create a moral hazard and encourage risky behavior, but given that the Chinese government is prone to bailing out financial institutions anyway, the formation of Huijin is a step forward toward greater discipline in the financial sector. Moreover, Huijin’s takeover of an increasing number of financial institutions allows the People’s Bank of China (PBOC) to regain some of the authority it lost when the China Banking Regulatory Commission (CBRC) split off from the PBOC.
The People’s Bank of China traditionally bailed out troubled financial institutions through the re-lending (zaidaikuan) process whereby the central bank lends money either directly to distressed financial institutions or indirectly through a major state bank. In the reform period, trillions of RMB in re-lending were provided to distressed financial institutions, constituting a major source of monetary expansion and inflation. The ready availability of central bank funds also encouraged local governments to pressure banks into financing wasteful regional developmental projects, causing more financial institutions to lapse into illiquidity.
With the formation of Huijin, the government found a less costly and arguably more market efficient way of bailing out financial institutions. Huijin was formed at the end of 2003 when the foreign exchange reserve injected $45 billion into the newly formed Central Huijin Company, which promptly “invested” the money into the China Construction Bank and the Bank of China respectively. [3] On that basis, Huijin became a state-owned investment company that held roughly 85% of China Construction Bank and 100% of Bank of China shares. [4]
Due to this bailout, Huijin became the claimant of healthy returns from the two giant state banks and stands to profit handsomely from the initial public offerings of these two banks in the near future. In 2004, Huijin was entitled to roughly 50 billion RMB in after-tax profit from the two banks and from other financial institutions it owns. [5] Although it did not take full advantage of this income stream in 2004, future dividend income and sale of shares will provide enough to bail out smaller financial institutions, which usually require recapitalization of a few billion to a few tens of billions RMB. Thus, the initial capital injection from the foreign exchange reserve created a “multiplier effect,” in which dividend income from the initial investment can be used to bail out other distressed institutions which can in turn generate further dividend income.
How is this bailout instrument better than the traditional re-lending method? First, the recipients of Huijin recapitalization do not have to pay back any loans or interest payments, as recipients of re-lending were nominally required to. Recipients of Huijin “investment” benefit from heightened capital ratios rather than more liabilities from re-lending, which at times pulled distressed banks further into trouble. The central bank also does not have to worry about defaults by distressed institutions. Recapitalization thus maintains the balance-sheets of all the involved parties much better than re-lending does.
More importantly, Huijin officials are nominally not government officials and are paid by Huijin, which almost certainly means that their salaries are substantially higher than that of civil servants. The State Council can potentially increase Huijin officials’ market incentive by giving them extra bonuses for improving the performance of financial institutions under Huijin’s charge. Thus, unlike government officials, Huijin officials have an incentive to maximize returns in hopes of increasing their personal income and, more importantly, to prevent re-assignment back to low-paying government positions. This of course would not work on officials who have political ambitions, but they would want to improve performance to fulfill their political mission as well.
Reformers within the government are also using Huijin as a means to lessen administrative intervention in the financial sector. Foremost in the reformers’ agenda is the movement toward appointing senior bankers and financial executives through market mechanisms rather than through party channels. Indeed, the CEO of Huijin, Xie Ping, stated recently that “the banks in this country have long been under the sway of various ‘leadership groups,’ which report false information, act without internal constraints, use funds for various exchanges, which result in many (corruption) cases and high non-performing loan ratio.” [6] He wants to change the current system through giving shareholders more power to appoint.
While Xie Ping, a long-time reformer within the PBOC, wants shareholders to take control of banks, this also happens to coincide with the corporate interest of the PBOC. With the formation of Huijin and its acquisition of a healthy portfolio of financial institutions, the PBOC shifted appointment of senior financial managers away from the party organization system and from the Central Banking Regulatory Commission to the People’s Bank of China via its subsidiary, the Central Huijin Company. After the abolition of the Central Finance Work Committee (CFWC), which had controlled appointment for most major financial institutions, the Central Organization Department and the CBRC took over appointment power for most major financial institutions, leaving the PBOC with only limited power to appoint regional governors of the PBOC itself. [7]
With the formation of Huijin, however, the PBOC stands to regain substantial clout in the appointment arena. Huijin itself is directly answerable to the Central Leading Group on Reforming State-Owned Commercial Bank, and the person running the daily affairs of the Leading Group is none other than Zhou Xiaochuan, the governor of the PBOC. Moreover, most of Huijin’s management comes from the PBOC/SAFE bureaucracy and dares not anger Zhou Xiaochuan. As Huijin becomes a majority shareholder of an increasing number of financial institutions, it can weaken if not deprive altogether the appointment power of rival agencies.
For example, after the abolition of the CFWC, the Central Organization Department held sole appointment power of the senior management in the Big Four banks. [8] However, in March 2005, after the sudden removal of Zhang Enzhao from the posts of chairman of the board and the party secretary of the China Construction Bank (CCB), Huijin sent its own chairman Guo Shuqing to serve as chairman of the board at CCB. While the Central Organization Department doubtless needed to approve Guo’s appointment since he also serves as party secretary, the PBOC, through Huijin, gained a direct voice in the selection process and most likely recommended Guo directly to the State Council. If Huijin injects capital into China Everbright Bank, it will likely obtain similar power with respect to the appointment of senior Everbright managers. With the recent bailout of a series of securities companies, the PBOC has even obtained appointment power over securities companies, an area traditionally controlled by the China Securities Regulatory Commission (CSRC). For example, Huijin subsidiary Construction Investment (Jianyin Touzi) successfully installed its favorite candidate as the CEO of the newly constituted Southern Securities over the CSRC’s favorite candidate. [9]
Clearly, Huijin has greatly upset the distribution of appointment power worked out in 2003, and various rival agencies, including the CBRC, the Ministry of Finance, and the Central Organization Department, are putting up a fierce fight against the PBOC’s empire-building efforts. For example, in March 2005, Huijin injected only 15 billion USD into the Industrial and Commerce Bank of China (ICBC), far short of the 22.5 billion that BOC and CCB had received despite being a much larger bank. It is likely that the MOF, which traditionally “owned” the major financial institutions in China, balked at the prospect of the PBOC gaining control over another major state bank through Huijin. Thus, with only a limited Huijin injection, the MOF retained control over 50% of ICBC shares. The CSRC, however, seems less able to fight back because it does not control its own source of funding.
Should foreign investors be weary of the Huijin’s emerging clout in the financial sector? On the one hand, if reformers like Xie Ping have their way, Huijin is merely a way-station to a fully commercialized financial sector in China. In this scenario, Huijin would first “acquire” distressed financial institutions. Then, it would do what other leverage-buyout firms do—repackage the firms and sell them off to private investors over time. However, given that financial institutions, especially the major banks, are vital elements of the national economy and the source of an endless supply of funds, the government is extremely reluctant to cede control. The recent acquisition of major securities companies, for example, might set the stage for a coordinated government effort to keep share prices up while non-tradable shares are released into the market. If the managers of banks and brokerages expect government interventions, however, they will continue to make decisions according to political rather than to market signals. If things go wrong, guess what, the Chinese state will be there with yet another bailout scheme.
Notes:
1. In the case of Southern Securities and Huaxia Securities, Huijin recapitalized these entities through its wholly owned subsidiary Construction Investment (Jianyin Touzi). See Ming Liu, "Chongzheng Quanshang, Huijin Jianyin Zai Xingdong (Huijin and Construction Investment Are Acting to Restructure Brokerages)," Jingji Ribao (Economics Daily), 8/11/2005 2005.
2. Haiyan Hu, "Zhongyang Huijin Gongsi Jinrong Bantu Qiemi (Unveiling the Secret Design of the Central Huijing Company)," Zhongguo Qiyejia (Chinese Entrepreneur), 7/7 2005.
3. China Economic Quarterly, "Understanding China's Bank Bailout," china Economic Bulletin 2004, no. 1 (2004).
4. Hu, "Zhongyang Huijin Gongsi Jinrong Bantu Qiemi (Unveiling the Secret Design of the Central Huijing Company)."
5. Author’s calculation based on Huijin’s share ownership of the two banks and widely available net profit figures for the two banks.
6. Caijing Magazine, "Xie Ping, Zhu Min, Wang Jun, Li Chuguang Siren Tan (a Chat with Xie Ping, Zhu Min, Wang Jun, Li Chuguang)," Caijing (Finance and Economics) 2005.
7. Sebastian Heilmann, "Regulatory Innovation by Leninist Means: Communist Party Supervision in China's Financial Industry," China Quarterly, no. 181 (2005).
8. Ibid.
9. Qing Li, "Quanshang Chongzuzhong Panzhan: Quanshang Wenze Yiding Yao Zhuijiu Zerenren (the Strategy in Restructuring Brokerages: In Order to Hold Brokerages Responsible, One Must Hold the Responsible Person to Account)," Caijing (Finance and Economics), 8/7/2005 2005.
(Progress in Reform or More Beijing Power Politics: Central Huijin Company Acquires More Financial Institutions)
BEIJING’S BAILOUT OF JOINT-STOCK AND STATE-OWNED BANKS
By Victor Shih
In the spring and summer of 2005, the Chinese government successively announced that Central Huijin Company (China State Administration of Foreign Exchange Investments) will recapitalize Galaxy Securities (Yinhe Zhengquan), Southern Securities (Nanfang Zhengquan), Huaxia Securities, Shenyin Wanguo Securities, and Guotai Jun’an Securities. [1] Besides brokerages, Huijin is likely to recapitalize other joint-stock and state-owned banks in the future as they prepare for listing. It provided Bank of Communication with additional liquidity before its Hong Kong listing, and China Everbright Bank is currently negotiating with the State Council for a Huijin bailout. [2] Quite simply, Huijin has become the “savior” of the troubled financial sector in China. Bailouts in general create a moral hazard and encourage risky behavior, but given that the Chinese government is prone to bailing out financial institutions anyway, the formation of Huijin is a step forward toward greater discipline in the financial sector. Moreover, Huijin’s takeover of an increasing number of financial institutions allows the People’s Bank of China (PBOC) to regain some of the authority it lost when the China Banking Regulatory Commission (CBRC) split off from the PBOC.
The People’s Bank of China traditionally bailed out troubled financial institutions through the re-lending (zaidaikuan) process whereby the central bank lends money either directly to distressed financial institutions or indirectly through a major state bank. In the reform period, trillions of RMB in re-lending were provided to distressed financial institutions, constituting a major source of monetary expansion and inflation. The ready availability of central bank funds also encouraged local governments to pressure banks into financing wasteful regional developmental projects, causing more financial institutions to lapse into illiquidity.
With the formation of Huijin, the government found a less costly and arguably more market efficient way of bailing out financial institutions. Huijin was formed at the end of 2003 when the foreign exchange reserve injected $45 billion into the newly formed Central Huijin Company, which promptly “invested” the money into the China Construction Bank and the Bank of China respectively. [3] On that basis, Huijin became a state-owned investment company that held roughly 85% of China Construction Bank and 100% of Bank of China shares. [4]
Due to this bailout, Huijin became the claimant of healthy returns from the two giant state banks and stands to profit handsomely from the initial public offerings of these two banks in the near future. In 2004, Huijin was entitled to roughly 50 billion RMB in after-tax profit from the two banks and from other financial institutions it owns. [5] Although it did not take full advantage of this income stream in 2004, future dividend income and sale of shares will provide enough to bail out smaller financial institutions, which usually require recapitalization of a few billion to a few tens of billions RMB. Thus, the initial capital injection from the foreign exchange reserve created a “multiplier effect,” in which dividend income from the initial investment can be used to bail out other distressed institutions which can in turn generate further dividend income.
How is this bailout instrument better than the traditional re-lending method? First, the recipients of Huijin recapitalization do not have to pay back any loans or interest payments, as recipients of re-lending were nominally required to. Recipients of Huijin “investment” benefit from heightened capital ratios rather than more liabilities from re-lending, which at times pulled distressed banks further into trouble. The central bank also does not have to worry about defaults by distressed institutions. Recapitalization thus maintains the balance-sheets of all the involved parties much better than re-lending does.
More importantly, Huijin officials are nominally not government officials and are paid by Huijin, which almost certainly means that their salaries are substantially higher than that of civil servants. The State Council can potentially increase Huijin officials’ market incentive by giving them extra bonuses for improving the performance of financial institutions under Huijin’s charge. Thus, unlike government officials, Huijin officials have an incentive to maximize returns in hopes of increasing their personal income and, more importantly, to prevent re-assignment back to low-paying government positions. This of course would not work on officials who have political ambitions, but they would want to improve performance to fulfill their political mission as well.
Reformers within the government are also using Huijin as a means to lessen administrative intervention in the financial sector. Foremost in the reformers’ agenda is the movement toward appointing senior bankers and financial executives through market mechanisms rather than through party channels. Indeed, the CEO of Huijin, Xie Ping, stated recently that “the banks in this country have long been under the sway of various ‘leadership groups,’ which report false information, act without internal constraints, use funds for various exchanges, which result in many (corruption) cases and high non-performing loan ratio.” [6] He wants to change the current system through giving shareholders more power to appoint.
While Xie Ping, a long-time reformer within the PBOC, wants shareholders to take control of banks, this also happens to coincide with the corporate interest of the PBOC. With the formation of Huijin and its acquisition of a healthy portfolio of financial institutions, the PBOC shifted appointment of senior financial managers away from the party organization system and from the Central Banking Regulatory Commission to the People’s Bank of China via its subsidiary, the Central Huijin Company. After the abolition of the Central Finance Work Committee (CFWC), which had controlled appointment for most major financial institutions, the Central Organization Department and the CBRC took over appointment power for most major financial institutions, leaving the PBOC with only limited power to appoint regional governors of the PBOC itself. [7]
With the formation of Huijin, however, the PBOC stands to regain substantial clout in the appointment arena. Huijin itself is directly answerable to the Central Leading Group on Reforming State-Owned Commercial Bank, and the person running the daily affairs of the Leading Group is none other than Zhou Xiaochuan, the governor of the PBOC. Moreover, most of Huijin’s management comes from the PBOC/SAFE bureaucracy and dares not anger Zhou Xiaochuan. As Huijin becomes a majority shareholder of an increasing number of financial institutions, it can weaken if not deprive altogether the appointment power of rival agencies.
For example, after the abolition of the CFWC, the Central Organization Department held sole appointment power of the senior management in the Big Four banks. [8] However, in March 2005, after the sudden removal of Zhang Enzhao from the posts of chairman of the board and the party secretary of the China Construction Bank (CCB), Huijin sent its own chairman Guo Shuqing to serve as chairman of the board at CCB. While the Central Organization Department doubtless needed to approve Guo’s appointment since he also serves as party secretary, the PBOC, through Huijin, gained a direct voice in the selection process and most likely recommended Guo directly to the State Council. If Huijin injects capital into China Everbright Bank, it will likely obtain similar power with respect to the appointment of senior Everbright managers. With the recent bailout of a series of securities companies, the PBOC has even obtained appointment power over securities companies, an area traditionally controlled by the China Securities Regulatory Commission (CSRC). For example, Huijin subsidiary Construction Investment (Jianyin Touzi) successfully installed its favorite candidate as the CEO of the newly constituted Southern Securities over the CSRC’s favorite candidate. [9]
Clearly, Huijin has greatly upset the distribution of appointment power worked out in 2003, and various rival agencies, including the CBRC, the Ministry of Finance, and the Central Organization Department, are putting up a fierce fight against the PBOC’s empire-building efforts. For example, in March 2005, Huijin injected only 15 billion USD into the Industrial and Commerce Bank of China (ICBC), far short of the 22.5 billion that BOC and CCB had received despite being a much larger bank. It is likely that the MOF, which traditionally “owned” the major financial institutions in China, balked at the prospect of the PBOC gaining control over another major state bank through Huijin. Thus, with only a limited Huijin injection, the MOF retained control over 50% of ICBC shares. The CSRC, however, seems less able to fight back because it does not control its own source of funding.
Should foreign investors be weary of the Huijin’s emerging clout in the financial sector? On the one hand, if reformers like Xie Ping have their way, Huijin is merely a way-station to a fully commercialized financial sector in China. In this scenario, Huijin would first “acquire” distressed financial institutions. Then, it would do what other leverage-buyout firms do—repackage the firms and sell them off to private investors over time. However, given that financial institutions, especially the major banks, are vital elements of the national economy and the source of an endless supply of funds, the government is extremely reluctant to cede control. The recent acquisition of major securities companies, for example, might set the stage for a coordinated government effort to keep share prices up while non-tradable shares are released into the market. If the managers of banks and brokerages expect government interventions, however, they will continue to make decisions according to political rather than to market signals. If things go wrong, guess what, the Chinese state will be there with yet another bailout scheme.
Notes:
1. In the case of Southern Securities and Huaxia Securities, Huijin recapitalized these entities through its wholly owned subsidiary Construction Investment (Jianyin Touzi). See Ming Liu, "Chongzheng Quanshang, Huijin Jianyin Zai Xingdong (Huijin and Construction Investment Are Acting to Restructure Brokerages)," Jingji Ribao (Economics Daily), 8/11/2005 2005.
2. Haiyan Hu, "Zhongyang Huijin Gongsi Jinrong Bantu Qiemi (Unveiling the Secret Design of the Central Huijing Company)," Zhongguo Qiyejia (Chinese Entrepreneur), 7/7 2005.
3. China Economic Quarterly, "Understanding China's Bank Bailout," china Economic Bulletin 2004, no. 1 (2004).
4. Hu, "Zhongyang Huijin Gongsi Jinrong Bantu Qiemi (Unveiling the Secret Design of the Central Huijing Company)."
5. Author’s calculation based on Huijin’s share ownership of the two banks and widely available net profit figures for the two banks.
6. Caijing Magazine, "Xie Ping, Zhu Min, Wang Jun, Li Chuguang Siren Tan (a Chat with Xie Ping, Zhu Min, Wang Jun, Li Chuguang)," Caijing (Finance and Economics) 2005.
7. Sebastian Heilmann, "Regulatory Innovation by Leninist Means: Communist Party Supervision in China's Financial Industry," China Quarterly, no. 181 (2005).
8. Ibid.
9. Qing Li, "Quanshang Chongzuzhong Panzhan: Quanshang Wenze Yiding Yao Zhuijiu Zerenren (the Strategy in Restructuring Brokerages: In Order to Hold Brokerages Responsible, One Must Hold the Responsible Person to Account)," Caijing (Finance and Economics), 8/7/2005 2005.
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