Is Chinese banking reform meeting its deadlines

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Is Chinese banking reform meeting its deadlines ?

• Olena Havrylchyk
• CEPII
• July 19, 2005

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Domestic Credit / GDP in
3
Share of loans by type of financial institution
4
Structure of assets of SOCBs
5
Structure of liabilities of SOCBs
6
Sources of investments for state and private
enterprises
7
Sources of fixed investments in 2003
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Finance growth literature for China (1)

• Aziz Duenwald, 2002
• Bank loan-to-GDP ratio is higher in provinces
  that grow slower
• Provinces with higher concentration of SOEs had
  higher loan-to-GDP ratios
• The level of financial intermediation is not
  significant in explaining provincial GDP growth
  rates, FDI and non-state credit are significant

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Finance growth literature for China (2)

• Boyreau-Debray Wei (2005)
• Local investments are constrained by local
  savings/deposits Feldstein-Horioka test 0.53
• Test of Consumption Risk Sharing relative
  consumption correlation 0.78-0.83
• Self-raised funds flow to regions with high
  productivity of capital
• State budget funds and bank loans flow to
  regions with low GDP per capital and low
  productivity of capital

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Finance growth literature for China (3)

• Allen et al. (2005)
• Private and quasi-state-owned companies grew at
  the rate of 19 per year, whereas SOEs grew at
  4.
• Private firms have limited access to formal
  financial sector
• Informal finance sector (relationship and
  reputation-based financing channels) plays a
  crucial role loans from other entrepreneurs,
  business partners, such as retailers, suppliers,
  family and friends

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Targets of the Chinese Banking Reform

• End of 2005
• reduction of NPLs at the SOCBs to 15
• complying with the new five-tier classification
  of loans and sufficient provisions for NPL
• public listing of the BOC and CCB with strategic
  investor
• End of 2006
• capital adequacy ratio of at least 8
• lifting all geographical restrictions for foreign
  banks

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Recapitalization/NPL transfer measures undertaken
by the Chinese Government

• 1998 Injection of RMB 270 billion (33 billion,
  3.5 of GDP) of capital into the four SOCBs.
• 1999 Transfer of RMB 1.4 trillion (170 billion,
  14 of GDP) NPLs from four SOCBs to AMCs.
• 2003 Injection of RMB 370 billion (45 billion,
  3.2 of GDP) of capital into CCB and BOC.
• 2004 Transfer of RMB 278.7 billion (34 billion,
  2 of GDP) NPLs from BOC and CCB
• 2005 Injection of RMB 124 billion (15 billion)
  of capital into ICBC.
• 2005 Transfer of 246 billion RMB (29.6 billion)
  NPLs from the ICBC

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Fiscal costs of banking crisis
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Foreign Exchange Reserves in 100 million USD
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Non-performing loans in RMB bn and in of total
loans
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Financial ratios for three large SOCBs
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Progress in public listing of BOC and CCB

• Both banks have announced their decision to list
  till the end of the year
• Bank of America invested US 32.5 bl in CCB and
  will purchase US 500ml of CCB securities during
  IPO (9 of capital) . It has an option to
  increase ins stake to 19.9.
• Bank of Communication, 5th largest bank, was
  listed on the Honk Kong Stock Exchange in June
  2005 and raised US 1.88 bl.

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Literature relevant for listing of Chinese banks
on Hong Kong stock exchange

• Benefits from listing abroad
• commitment to disclosure and corporate governance
  standards
• higher liquidity
• Karolyi, 1998
• positive stock price reaction to cross-listing
  announcements
• Chen et al., 2005
• analyses stock market reaction to listing of
  BOCHK on the Hong Kong stock exchange in July
  2002
• some Honk Kong financial institutions reacted
  negatively
• financial institutions in Mainland China reacted
  positively

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What are the concerns for the future? (1)

• Moral hazard problems of unlimited public support
  and implicit blanket deposit guarantee scheme
• Fast loan growth in the last few years
• Liberalization of interest rates

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What are the concerns for the future?(2) Loan
growth
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What are the concerns for the future?(3)
Interest rate liberalization

• 1997 liberalization of interbank market interest
  rates
• 2002-2004 liberalization of foreign currency
  interest rates
• 1996 bank lending rate can fluctuate ?10 of the
  benchmark rate
• 1999 -10 30
• January 2004 -10 70
• October 2004 -10 ?
• October 2004 deposit interest rate can be
  adjusted downward

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What are the concerns for the future?(4) Real
lending and deposit interest rates
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The role of foreign bank ownership in China

• 13 banks with foreign capital and 156 foreign
  branches
• 3 of total assets in 2004
• but in Shanghai 12 of total assets
• Geographical restrictions should be lifted in
  2007
• but the restriction of 20 equity share limit for
  a single foreign investor will remain

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Conclusions

• The quantitative targets of banking reforms are
  usually met
• But there are still problems
• moral hazard due to repetitive bailouts
• lack of credit and interest rate risk management
  skills
• The foreign investments are a good signal