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April, 2001
China's Banking System in Transition
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| Content provided
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| BUSINESS INTELLIGENCE --- China |
| No. 6 |
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| Executive Summary |
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| 1. |
Major accomplishments towards banking commercialization |
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A banking system with 104 commercial banks as the foundation has been established. |
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Regulatory regime has changed accordingly, with two important laws enacted aiming to make the commercial banks really "commercial" while the PBOC a genuine central bank. |
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While Top 4 of the 104 remain state-owned, all the other 100 commercial banks have adopted a shareholding ownership structure. |
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All the commercial banks, including the 4 state-owned, have become profit-oriented, being largely free of policy loans, though with different degrees. |
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A new credit management system has been introduced, which is largely in line with that used by international banks. |
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Various risk control functions have been established, to tackle different kinds of risk. |
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Business coverage has been considerably diversified, with a rapid development of new business and products as well as a large expansion of customers. |
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Service standard has been greatly enhanced, with sales culture emerging. |
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Progress has also been made in upgrading the banking system and developing banking products with technological innovations. |
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The state banks have seen their monopoly position weakening with a downsizing of branch offices and staff, while the shareholding banks have grown their market shares with a rapid expansion of network. |
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Meanwhile 177 foreign banks have established banking business in China with 155 branches and 429 Rep offices. |
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| 2. |
Many remain unaccomplished |
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New regulatory regime is weak on both independence and supervision effectiveness. |
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Banking environment is overall still restrictive and also is biased . |
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The state banks remain overwhelmingly dominant, with an over 70% market share. |
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Real corporate governance issues are yet to be addressed. |
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There is still swelling labor force as well as institutions for the state banks. |
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The banking system as a whole remains of poor profitability, while the shareholding banks performing much better. |
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The NPLs problem is far from solved. |
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Capital adequacy ratio is on the verge of minimum requirement. |
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Traditional business is still dominating. |
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Market opening-up remains limited, with a less than 2% market share for foreign banks. |
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Overseas expansion is far from the economies of scale. |
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| 3. |
The impact of WTO entry --- Challenges as well as opportunities |
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China's WTO entry is expected to lead to an overall opening-up of China's banking sector in 5 years, phased in two major steps. |
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But some restrictions would remain, which are however not in violation of WTO agreement. |
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Compared with international banks, Chinese banks exhibit weaknesses in the economies of scale, productivity and profitability, assets quality, international network, services, products, technologies, staff quality and incentives, and corporate governance, etc. |
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On the other hand they show strengths with their huge domestic network, long-established customer relationships, sound understanding of China markets, support from the government, and cultural recognition from domestic people, as well as high liquidity. |
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Thus negative impacts of WTO entry on Chinese banks would come from two basic effects: customer effect and talent effect, which would take customers, and in turn business, market shares and profits, away from Chinese banks to foreign banks, from demand and supply perspectives respectively. As a result, foreign banks' business in China is expected to achieve an unprecedented expansion in coming years. |
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The state banks are expected to be hit by both effects seriously. For the shareholding banks, the customer effect would be even greater, but the talent effect will be moderate. |
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By business, the most negatively affected would the international business, fee-based services, consumer credit, private banking, selective commercial lending, syndicated loans and project finance, and deposits via e-banking. |
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By customer, the most affected would include SOE-turned conglomerates, listed companies, large sized and highly profitable non-state enterprises, wealthy, young and educated people, and special consumer groups. |
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By geography, the first batch of the most affected would be Shanghai, Beijing, Shenzhen and Tianjin, and the second batch are likely to be Dalian, Qingdao, Guangzhou, Chongqing, Wuhan, Xian, Shengyang and Xiamen. |
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The main positive impact is a long term one, that is to force Chinese banks to accelerate banking reform, and hence help them grow up faster towards international standards. |
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The pace of foreign banks' penetration, and in turn the degree of the negative impacts, is controllable, given the possibility that some restrictions could be maintained without breaching the WTO agreements as well as the strengths of Chinese banks noted earlier. |
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In view of the above, a rough estimate goes that, foreign banks' market share in China will increase to 8-12% in 10 years time from the current less than 2%. |
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| 4. |
A new phase of banking reform over next 5 years |
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The PBOC is expected to play a balancing act --- pushing forward banking reform, with an array of new or upgraded reform programs, while controlling the degree of competition and containing financial risks, probably putting on hold some of the aggressive reform initiatives. |
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The reform initiatives that the state banks are expected to take would include, seeking shareholding restructuring, acquiring or merging shareholding or city banks, reforming the personnel and pay system, cutting redundant branch offices and staff, reducing NPL ratio (3% a year in coming 3 years) and increasing capital adequacy ratio (to 8% in two years), exploring new customers, improving credit and risk control systems, increasing input into technologies, and intensifying efforts in developing new business and products. |
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The reform initiatives expected for the shareholding bank would be to seek public listing, to merge with other shareholding banks or acquire city banks, to form JVs with overseas banks, to tackle genuine governance issues, to be more aggressive in business, products and technological innovations, to lobby the PBOC for equal treatment with the state banks, to reengineering the internal operating system, and to strive for international business and overseas expansion. |
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The expected initiatives for city banks would be to introduce individual shareholders, to lobby for the relaxation of the geographical restriction for them, to seek merger with larger banks, to strengthen staff training and recruit more university students, to cut the number of staff and business outlets, and to develop larger corporate customers. |
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| Contents |
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| 1. |
Banking system in China after 17 years of banking reform |
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| 1.1 |
Major accomplishments towards banking commercialization |
| 1) |
Establishment of a commercial bank system |
| 2) |
Ownership diversification |
| 3) |
From policy-driven to profit-oriented |
| 4) |
Regulatory rationalization |
| 5) |
Business diversification and division |
| 6) |
Governance structure |
| 7) |
Downsizing and organizational rationalization |
| 8) |
A new credit management system |
| 9) |
Risk control functions |
| 10) |
New accounting principles |
| 11) |
New businesses, customers and products |
| 12) |
Technological innovations |
| 13) |
Sales culture |
| 14) |
A nationwide money market and bond market |
| 15) |
Market opening-up |
| 16) |
Overseas expansion |
| 17) |
An encouraging improvement in profit performance in 2000 |
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| 1.2 |
Many remain unaccomplished |
| 1) |
New regulatory regime weak on both independence and supervision |
| 2) |
Banking environment still restrictive and also biased |
| 3) |
State banks remain overwhelmingly dominant |
| 4) |
Real corporate governance issues yet to be addressed |
| 5) |
Still swelling labor force and institutions for state banks |
| 6) |
The banking system as a whole remains of poor profitability, while shareholding banks performing much better |
| 7) |
NPLs problem far from solved |
| 8) |
Capital adequacy ratio on the verge of minimum requirement |
| 9) |
Traditional business still dominating |
| 10) |
Inter-bank and bond markets inactive |
| 11) |
Foreign banks' market share still too small |
| 12) |
Overseas expansion far from the economies of scale |
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| 2. |
Greater challenges as well as opportunities, and a new phase of banking reform ahead |
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| 2.1 |
The impact of WTO entry on China's banking sector --- Challenges as well as opportunities |
| 1) |
An overall opening-up of China's banking sector in 5 years |
| 2) |
Some restrictions would remain |
| 3) |
Competitiveness of Chinese banks --- International comparison
a) Weaknesses
b) Strengths |
| 4) |
Negative impacts at large |
| 5) |
Positive impacts at large |
| 6) |
Negative impacts by business, customer and location |
| 7) |
Negative impacts by banking group |
| 8) |
Negative impacts by time span |
| 9) |
A key issue and future market share of foreign banks |
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| 2.2 |
A new phase of banking reform over next 5 years |
| 1) |
A balancing act for the PBOC --- Pushing forward reforms while controlling the extent of competition and containing financial risks |
| 2) |
Expected reform initiatives by state banks |
| 3) |
Expected reform initiatives by shareholding banks |
| 4) |
Expected reform initiatives by city banks |
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| China's Banking System in Transition |
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| 1. |
Banking system in China after 17 years of banking reform |
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| 1.1 |
Major accomplishments towards banking commercialization |
| 1) |
Establishment of a commercial bank system |
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A banking system with commercial banks as the foundation has been established in China, which consists of the central bank --- The People's Bank of China (PBOC), 3 policy banks, 104 commercial banks, and a large number of city and rural credit cooperatives, as well as 155 branches and 429 Rep offices of 177 foreign banks. |
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The 104 commercial banks currently account for over 80% of China's total banking assets. |
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This compares to the pre-reform banking system in which the former PBOC was both a central bank and a unique business bank, with rural credit cooperatives providing supplement financial services in rural area. |
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While the 4 state commercial banks are transformed from the 4 former state specialized banks, which in turn had been the 4 major business divisions of the former PBOC, respectively, and the 90 city shareholding commercial banks are restructured from the 90 former city credit cooperatives, the 10 nation-wide or regional shareholding commercial banks are born commercial banks, established in late 1980s or early 1990s. |
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| 2) |
Ownership diversification |
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The 4 state commercial banks, as well as the 3 policy banks, remain wholly state-owned (state banks hereafter). But other 100 commercial banks have all adopted a shareholding ownership structure, though the state still has a controlling stake in most of them, while the credit cooperatives are of cooperative nature as self-explained. |
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Among the 100 shareholding commercial banks, the 10 nation-wide or regional shareholding commercial banks (shareholding banks hereafter) have the central government or the respective provincial or municipal governments holding a controlling stake, while the 90 city shareholding commercial banks (city banks hereafter) have the respective city governments as the largest shareholders. |
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3 of the shareholding banks --- SZDB, SPDB and Mingshen have been listing on China's A-share market since 1991, 1999 and 2000, with 69%, 17% and 70% of public shares respectively, while the Mingshen is a private bank, the only private bank in China, with all the shareholders including the holders of non-traded shares being private investors. |
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| 3) |
From policy-driven to profit-oriented |
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The 3 policy banks, which were established in 1994 and currently account for 9% of the total banking assets, are intended to assume the policy lending role of the formal state specialized banks, in the areas of agricultural development, infrastructure construction and international trade respectively. |
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With such an establishment, all the commercial banks, including the 4 state banks, while still being wholly or partially state-owned and having to take some quasi-policy loans, have shifted toward profit orientation, and are now supposed to have profit maximization as the objective, thus truly embodying the meaning of "commercial". The state-ownership is now supposed to represent the requirement for the banks to maintain and grow state assets, rather than to pursue policy loans. |
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Currently still having to take some quasi-policy loans is a transitory arrangement, and the quasi-policy loans are directed to the banks by informal persuasion of government officials rather than by official instruction of government departments. In terms of the degree to which commercial banks to hold quasi-policy loans, the 10 shareholding banks have the lowest burden; the 90 city banks comes in next, with some influences from city governments; the credit cooperatives then follow, influenced by low-level local governments; and the state banks fall last, still partly guided by the central government's industrial policies. |
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Importantly, the influences of provincial governments on banks, which was a major source of NPLs, have been largely removed, thanks to 1) the establishment of the Central Financial Work Committee, which has taken over the power to appoint banks' heads, and the establishment of a new intra-province regional branch system of the PBOC. |
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| 4) |
Regulatory rationalization |
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The PBOC has singled out its central bank role and become the specialized regulator of the banking sector in China, and no longer plays a dual role as both the central bank and unique business bank as it did during the pre-reform period. |
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Two major laws governing China's banking sector --- The Central Bank Law and The Commercial Bank Law, were enacted in 1995. |
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The Central Bank Law aims to make the PBOC a genuine central bank with both supervision power and independence, while the Commercial Bank Law is intended to enable the commercial banks become really "commercial". |
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| 5) |
Business diversification and division |
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The 4 state banks --- ICBC, BOC, ABC and CCB, have been transformed from the former 4 state specialized banks that were regulated to specialize in industrial and commercial business, foreign currency business, agricultural business and infrastructure development business respectively, into the commercial banks that are doing diversified commercial banking businesses depending on market conditions. |
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The shareholding banks, as well as the city banks, being born as commercial banks, have been market-oriented in determining business coverage since their inceptions. |
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But there is division of business and customers formed from market competition with every bank exploring their edges while walking away from weaknesses. |
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There are also different degrees of geographical coverage for different banks. |
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| 6) |
Governance structure |
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Even the 4 state banks are now enterprises with an independent legal status. Their presidents and vice presidents, though appointed by the government, have the full autonomy to make decisions for the business other than a small number of quasi-policy loans. |
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The governance structure for the 10 shareholding banks is close, while largely nominally at this stage, to that of international banks, with the shareholders' meeting and the board of directors as the decision-makers and the board of supervisors as the supervisor. The board of directors is elected by the shareholders' meeting, while it appoints the president and vice presidents of the bank. The supervisors comprise both those appointed by the government and those elected by shareholders as well as some externally invited ones. |
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The structure for the 90 city banks is similar to the shareholding banks, but with a more nominal nature. |
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| 7) |
Downsizing and organizational rationalization |
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To eliminate the influences of provincial governments on banks, the PBOC has abolished its 30 provincial branches and replaced it with a new regional branch system with 9 intra-province regional branches and two city offices in 1998. |
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Meanwhile the head office of the PBOC was restructured with the number of divisions reduced from 141 to 112, and staff number cut by about half. |
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As a major step of reforms to enhance efficiency and profitability, the state banks have merged their provincial branches and provincial capital city branches, eliminated a number of inefficient branch offices, and begun to cut staff redundancies. |
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City and rural credit cooperatives have also made progress in downsizing business outlets and staff. |
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On the other side, the 10 shareholding banks have grown their branches, branch offices and staff number rapidly. |
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Some insolvent banks have been closed or forced to merge with other banks, and acquisitions & mergers among banks have also begun. |
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A new credit management system |
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The loan lending function and loan approving function have been clearly separated in all the commercial banks, with the establishments of the Credit Examination & Approval Committees or Units at different levels that consist of those independent from relationship managers including external experts. |
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The previous top-down credit quota system has been abolished in 1997. Replacing it first is the establishment of a level-specific lending limit, and region, industry and enterprise-specific borrowing quota system. Under the system, on lending side the branch offices at different levels --- Tier-1 branches, Tier-2 branches, sub-branches, etc. are granted different degrees of loan-approving power with different single loan lending limits, while on borrowing side every region, industry and enterprise is given a borrowing quota. |
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Importantly, the internationally applied 5-category loan classification system has been introduced, and is currently being run on an experimental basis in all the major banks. It is different from the 4-category loan classification system currently used in China in many respects, including the definition of NPLs (Non-Performing Loans). |
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The first difference between the two systems seems to be that more subjective judgment is involved in the internationally applied 5-category system than in China's 4-category system, which points to a more prudent and forward-looking approach for international banks than for Chinese banks. |
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The difference as to the definition of NPLs between the two systems lies in that in the 4-category system the loans overdue on principal payment for 1 day are classified as non-performing, while in the 5-category system the non-performing relates to the interest payment, but with an allowance for 90 days. The latter also involves credit officer's judgement of borrower's financial position. |
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So the two definitions do not seem to match with each other, and thus it is difficult to compare the sizes of the NPLs measured under the two systems. While it seems to be a common belief that the NPL size with China's definition is less than that with international definition, how much it is less is difficult to estimate. It is advised from time to time by Chinese banks that the difference is not large. |
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| 9) |
Risk control functions |
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Credit risk control has been introduced, with the establishment of a credit risk unit under the credit department in most banks. |
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For overall liquidity risk control, assets & liabilities management has been in operation since 1994 when the assets management plan was abolished. All the state banks and shareholding banks have established an assets/liabilities management (or assets risk) department or committee, to control liquidity risk, as well as interest rate risk, foreign exchange risk, capital risk, credit risk and so on. |
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The assets & liabilities management comprises total balance control, term structure control, and liabilities & assets ratio control based on various internationally applied ratios such as capital adequacy ratio, loans/deposits ratio, medium & long-term loans/total loans ratio, cash assets/total assets ratio, reserves ratio, single loan ratio, inter-bank lending ratio, and loans to shareholders ratio as well as loan quality indices. |
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As a major effort to contain risks, 4 Assets Management Companies (AMCs) have been established in 1999, with RMB10 bn of paid in capital for each provided by the Ministry of Finance. These AMCs have bought a total of RMB1400 bn loans (most being NPLs) from the 4 state banks, at book costs, and they financed the purchase by issuing 10-year bonds to the banks with a guarantee from the Ministry of Finance. |
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Most of the RMB1400 bn are NPLs, two years overdue on average, but they also include a certain amount of performing loans with the intention to help their sales. |
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According to the PBOC, this has reduced the NPL ratio for the state banks by about 10 percentage points. |
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The AMCs intend to manage and dispose of these loans through debt/equity swaps, debt collection, debt exchange, debt transfer and sale, debt restructuring, stock listing and the underwriting of bonds, direct investment, and bond issues. RMB395 bn of them have already been disposed of with a debt-equity program for 569 SOEs. |
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The above risk control efforts have been paid off, and the NPL ratio for new loans extended within one year is reported to have fallen to less than 1%, e.g. to 0.3% for the ICBC in 2000. |
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| 10) |
New accounting principles |
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China's accounting principles for banks as well as for companies are already fairly consistent with the basic ideas of the International Accounting Standards since the July 1993 modifications of the country's accounting approach, though the application of these principles is far from satisfactory at this stage. |
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Some shareholding banks such as the Everbright, SPDB and CITICIB, are using both a domestic accounting firm and an international accounting firm as auditors. |
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| 11) |
New business, customers and products |
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On assets side: mortgage loans have grown by about 100%; credit cards have more than doubled; portfolio investment increased over 40%; and corporate loans to non-state enterprises risen by over 40%, a year over the 1990s, respectively, as compared to a 16% growth in total loans. Meanwhile it is estimated that consumer credit and mortgage loans currently account for 35% and 30% of total new loans, and 6% and 4% of total loans outstanding, respectively. Also more and more loans are secured with collateral. |
 
 
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On liabilities side: new deposit instruments such as CDs, notice deposits, agreement deposits and so on have been introduced; many cash management products have been developed, private banking has kicked off in some banks with a private banking department set up in the BOC and the CITICIB, and stock-trading via banking accounts have been recently approved. A result of these is a large decline in the M0/M2 ratio (M0 refers to cash in circulation, and M2 to M0 plus all kinds of deposits, in China). |
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Fee-based business: both international and domestic settlement business have grown rapidly in recent years, with strong economic and trade growth in the country on demand side, and fast development of the country's clearing system on supply side. The proportion of fee-based income in total revenue has increased from 0.5% and 2% in 1994 to 3% and 15% in 1999, while that of interest income declined from 98% and 91% to 89% and 70%, for the state banks and shareholding banks respectively. Meanwhile 62% of the OBS (off-balance-sheet) products transacted in international markets have also been put on transaction in China. |
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Towards universal banking: though universal banking is not allowed by the Commercial Bank Law, some forms of the integration of banking business with securities and insurance businesses have emerged in past two years. Selected brokers, fund management companies and insurance funds have been allowed to borrow from inter-bank market; selected brokerage houses have been allowed to borrow from commercial banks with stocks as guarantees; commercial banks are now able to buy and sell open funds while open funds can borrow short-term loans form banks; and residents will be able to trade stocks via their banking accounts as recently approved. Meanwhile many banks own a securities firm or/and insurance company with a controlling stake, e.g. the CCB owns the China International Investment Company, the BOC owns the BOC International, the ICBC owns the ICBC Asia, the Everbright Holdings owns the Everbright Securities, China Merchants the Guotong Securities, the Guangdong Development Bank the Guangfa Securities, and the Communications the Hong Kong-based China Communications Insurance, etc., though the banking business and securities business of them are still separated restricted by the segregation principle. |
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| 12) |
Technological innovations |
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ATMs and POSs have grown by 39% and 40% a year over past 5 years reaching 26424 and 223508 units by end-1999 respectively; electronics remittance is becoming increasingly common; the innovative products such as "all-in-card". "all-in-net", "all-in-mobile" and "all-in-counter" as well as phone banking have been launched and received heated welcome; and Internet banking is emerging. |
 
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For Internet banking business, almost all the major banks are providing the first and second services, while part of them providing the third one. The Merchants, CCB and BOC are able to provide payment and fund transfer services, with the Merchants being the best with its "all-in-one-net" product and a nation-wide on-line payment system covering both corporate banking and consumer banking businesses. |
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The PBOC has established a national clearing system providing RMB payment and settlement services for all the banks. It has approximately 1000 clearing centres and covers over 600 cities and towns. Payments between member banks typically take a day. Meanwhile the 4 state banks have their own internal clearing systems that provide the services for remittances between cities below RMB500,000. These clearing systems are all in large capacity and under-utilized, especially the one of the ICBC. Thus the 4 state banks, particularly the ICBC, have become agency banks for RMB payments and settlements for many smaller banks. Meanwhile a unified clearing company for the country's stock trading has been announced recently. |
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| 13) |
Sales culture |
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The notion of loan sales has been promoted in all the banks with an establishment of the relationship manger system. It signifies a remarkable improvement in the services of Chinese banks, while being in line with the emergence of a seller's market from a buyer's market in China's banking sector. E.g. Mingshen Bank spent RMB50 million to organize the "Sales Conference on Financial Products for Small & Medium Sized Customers" in Beijing last year. This is posing threat to foreign banks for which services are one of their key edges against Chinese banks. |
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Market differentiation has been emphasized, and differentiated banking products are emerging, e.g. the women-oriented banking services in Shenzhen. |
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Band recognition has been developed and brand competition is intensifying. E.g the "Happy Home" product for mortgage loans by the CBC, and the Poney Lady Card by the ICBC have become popular banking brand names, and the "all-in-card" by the Merchants ranked the 3rd in a survey of the best brand names for consumer goods elected by consumers in 34 cities. |
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| 14) |
A nationwide money market and bond market |
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A nationwide money market with free inter-bank rates has been established, through which funds can flow freely nationwide among banks upon demand, with the costs of the funds determined by market demand-supply conditions. |
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A bond market has also been formed, in which the interest rates for government bonds and financial bonds are fully determined by markets. |
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| 15) |
Market opening-up |
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177 foreign banks, including all the top 50 banks in the world, have established banking business in China, with 155 branches and 429 representative offices. |
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Foreign banks currently have a 1.5% market share in China' banking sector in terms of assets and loans. But they account for 40% of China's international settlement business, and 23% of China's foreign currency lendings, while the later is as high as 60% in Shanghai. |
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Geographically foreign banks' assets are concentrated in developed coastal cities, particularly in Shanghai, Beijing and Shenzhen. |
 
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Currently foreign banks' main business is foreign currency business with foreign-funded enterprises and a limited number of Chinese enterprises. But 32 foreign banks located in Shanghai and Shenzhen have been granted the license to conduct RMB business. |
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The PBOC's circular issued in mid-1999 represents a breakthrough progress in China's banking opening-up, which allows for a large expansion of foreign banks' RMB business in China. |
 
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| 16) |
Overseas expansion |
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Especially the BOC has made encouraging progress in overseas expansion. |
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| 17) |
An encouraging improvement in profit performance in 2000 |
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3 of the 4 state banks --- ICBC, BOC and CCB reported encouraging profit performance in 2000, with pre-tax profits growing by 28%, 167% and 15.3% respectively. |
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Though statistics is not available yet, most shareholding banks are expected to have also achieved an improvement in profit performance. |
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While this is partly attributed to the improvement in macroeconomic environment, the reform progress discussed above are certainly also an important contributor. |
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| 1.2 |
Many remain unaccomplished |
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| 1) |
New regulatory regime weak on both independence and supervision effectiveness |
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As a central bank, the PBOC still suffers a lack of sufficient independence. It is not an independent body, but a ministry under the State Council of China, by construction. While it is responsible for making the country's monetary policy, the policy remains largely subject to the macroeconomic policies formulated by other ministries such as the State Development and Planning Commission, the State Economic and Trade Commission and the Ministry of Finance. Meanwhile it still has to tolerate a certain amount of quasi-policy loans from different levels of governments. |
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In the meantime, its supervision effectiveness is constrained by a lack of comprehensive and clearly defined regulations and laws, independent institutional framework, qualified staff and policy enforcement efficiency, as well as by a poor status for the collection and analysis of regulatory data. The weakness in the supervision effectiveness is also reflected on the other side: still many regulatory restrictions against market operation, as will be touched on below. |
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| 2) |
Banking environment still restrictive and also biased |
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The Commercial Bank Law enacted in 1995 sets the business segregation among banks, securities firms and insurance companies as well as other financial institutions as a principle, prohibiting universal banking business. In line with this principle, China Securities Regulatory Commission and China Insurance Regulatory Commission have been established to assume the roles of regulators of China's securities industry and insurance industry respectively. |
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While this principle has played a positive role in containing financial risks, particularly during the period of Asian financial crisis, it has become a major obstacle to business expansion and the development of new products for commercial banks, especially for those newly established and ambitious banks. |
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Another major constraint is the still rigid interest rate environment with major rates being regulated. This not only limits the extent of competition but also hinders the development of treasury products. |
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The PBOC is also strict on approving new banking products, with tight standards as well as complicated approval procedures. |
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Also importantly, the PBOC's policies are biased towards the state banks. E.g. all the budget funds are deposited in the state banks; the bulk of state banks' NPLs have been transferred to the AMCs; pilot projects on new products are given to the state banks; the state banks are given the rights to issue subordinate bonds; and the government's propaganda is in favor of the state banks, etc. These have invited widespread complaint and criticism from the shareholding banks. |
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| 3) |
The 4 state banks remain overwhelmingly dominant |
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Despite a rapid expansion of the shareholding banks, the 4 state banks still hold a overwhelmingly dominant market share in China's banking sector, accounting for over 70% of the sector's total assets and loans and over 80% of its total deposits. The market share of the shareholding banks is about 10%. |
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This first reflects the fact that the strength of the state banks with a huge capital size and strong business network established in the past is not an easy thing to beat. |
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But it is also attributed to the restrictive banking environment and the biased policies of the government towards the state banks. The restrictive banking environment is particularly damaging to the shareholding banks as their development is more dependent on business innovations being new banks with a relatively weak position in capital size and network compared with the state banks. The biased policies by the government are of course more hurting with a direct adverse impact. |
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| 4) |
Real corporate governance issues yet to be addressed |
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The 10 shareholding banks have made great progress in adopting international standards to run the banks and develop business, being born as commercial banks with a shareholding structure. But as for most of the shareholding companies in other industries, corporate governance issues such as shareholder rights, accountability, transparency, risk management, incentives and operational efficiency, etc., have not yet been really addressed. |
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The key issue is the shareholder structure and shareholder rights. Except for the Mingshen Bank, the government still has a controlling stake in these shareholding banks including the other two listed banks, though indirectly via one or several conglomerate or investment company owned by the central government or a provincial government, while the rest of the shareholders being mostly other smaller state institutions. There are very few private investors. Thus the representatives from the governments always have a final say, and other SOE shareholders have small voices and also do not really have the incentives to exercise their shareholder rights. These shareholding banks are not yet operating like a genuine shareholding company. |
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The up-class city banks, such as the Bank of Shanghai, Beijing Commercial Bank and Shenzhen Commercial Bank, have a similar problem, while with the respective city governments having the final say. For most of other city banks as well as urban and rural cooperatives, corporate governance seems to be a more remote issue because of their backwardness in management, personnel, technology and mindset. |
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Meanwhile the state banks, being wholly state-owned, have not yet had the incentives as well as the mechanism to tackle the issue. |
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| 5) |
Accounting practices still inadequate |
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The state banks are audited by internal personnel, while the shareholding banks mainly use local auditors. Even for those using both a local auditor and an international auditor, their released financial statements are still audited by the local auditors. |
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While accounting principles are already fairly consistent with the basic ideas of the International Accounting Standards, accounting practices in China remain inadequate, with a lack of sufficient transparency, prudent concept, consistency in the applications of standards, timely public disclosure and accuracy of basic data, a failure in disclosing the exact information on NPLs, loss reserves and OBS activities, and liberal loan loss recognition and provisioning policies. |
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The 5-category loan classification system is still experimental, and has not been actually implemented. |
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There are also some specific inadequate accounting practices as compared to internationally accepted accounting practices. |
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| 6) |
Still swelling labor force and institutions for state banks |
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The number of staff for the 4 state banks still totaled 1.6 million at end-1999, which is believed to be record high in the world, while the PBOC is probably the world's large central bank with near 180,000 staff. |
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The problem of swelling institutions for the state banks is also far from solved. |
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As a result, the state banks have much lower per capita deposits and profits, than the shareholding banks. |
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| 7) |
The banking system as a whole remains of poor profitability, while the shareholding banks performing much better |
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Therefore the state banks have very poor ROE and ROA. |
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In comparison, the shareholding banks are much more profitable, with about 5 times higher ROE and ROA than the state banks on average. |
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While the up-class city banks have a performance close to the shareholding banks, most city banks are also of poor efficiency and profitability, with additional problems arising from the backwardness as well as the difficulties of many city economies. The urban and rural credit cooperatives suffer more from these problems and thus are even more inefficient. |
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| 8) |
NPLs problem far from solved |
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Though the NPL ratio for new loans has been reduced significantly, the ratio for outstanding loans remains high, and also has actually risen in recent years as the NPLs arising from the old loans that had been borrowed before but have matured recently increased. |
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For the 10 shareholding banks that were born with zero NPLs, the NPLs accumulated over 1997-99, with the weakening of the country's economic growth and worsening of enterprises' profits, some which have risen to a very high level. |
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The 39% ratio for the Everbright is largely due to its purchase of China Investment Bank in 1999, which included an acquisition of a large amount of NPLs. However, these NPLs were later taken over by the Ministry of Finance. |
 
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The state banks do not officially release the figures for the NPLs. According to the PBOC, the NPLs as percentage of total outstanding loans for the state banks as a whole still stood at 25%, with bad loans at 3%, as of end-2000. |
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Noting the difference in the definition of the NPLs between the two loan classification systems as noted earlier, the real NPL ratio would be higher if the international 5-category classification system were applied. |
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Meanwhile the loan loss reserves/overdue loans ratio is less than 10% on average, even for the shareholding banks, which is very low. |
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| 9) |
Capital adequacy ratio (CAR) on the verge of minimum requirement |
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Chinese banks do not officially release the information on the BIS risk weighted CAR, though it is internally available on an experimental basis for most banks. But it is reported that the CAR has dropped to below 8%, while slightly, again for the state banks since the government issued RMB 270 bn in bonds and injected the money into these banks to raise the ratio to 8% in 1998. |
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The non-BIS risk weighted CAR (shareholders' equity/total assets) is available from banks' annual report. This ratio ranges between 5-7% for most Chinese banks. |
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Three points are worth noting regarding the relationship between this non-BIS risk weighted CAR and the BIS risk weighted CAR. First, the shareholders' equity is Tier 1 capital, so that the shareholders' equity/total assets ratio is the Tier 1 CAR, for which the BIS minimum requirement is 4%. It means that all the Chinese banks except the GDB and ADBC have met this requirement. |
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Second, the size of the BIS risk weighted assets must be smaller than that of total assets, and hence the BIS risk weighted CAR with assets weighted by risks should be higher than the non-BIS risk weighted one with the assets non-weighted, by definition. This means that the BIS risk weighted Tier 1 CAR for Chinese bank should not be far from the minimum requirement of 8%. |
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Third, the size of Tier 2 capital is small, so that the Tier 1 CAR is close to total CAR, for Chinese banks. |
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Given the above, for Chinese banks, capital adequacy is not yet a very serious problem as some analysts claimed. But it is really on the verge of the minimum requirement, and a further decline would represent a real risk. According to the BIS, the BIS risk weighted CAR was 8.2%, 9.8%, 17.1% and 8.96% at end-99, for the ICBC, BOC, Merchants and Huaxia respectively. |
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The capital adequacy ratio, as well as the NPL ratio, is believed to be also poor for most city banks and urban cooperatives, and ever poorer for rural credit cooperatives. |
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| 10) |
Traditional business still dominating |
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Loans still account for about 75%, with 85% for state banks, while portfolio investment being 10%, of total assets. |
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Over 80% of revenue, with about 90% for the state banks, remain to rely on interest income, while the contribution from fee-based income being below 10%. |
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Consumer credit account for only 5% of total outstanding loans, though it has seen a rapid increase in recent years and accounts for about 30% of new loans. |
 
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The OBS business are in small scale, and are mainly guarantee services with limited treasury products. |
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Almost all the credit cards are debit cards with very few real credit cards. |
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Private banking, agency banking, consulting and custody businesses have just started and are in very small scale and traditional mode. The business and products related to universal banking are virtually absent, restricted by the business segregation principle, though progress is being made in this regard with the relaxation of the principle. |
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Settlement tools are limited, and the clearing systems are still far from international standards. |
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Internet banking is just a start, which is currently mainly used for information inquiries. For on-line payments, only Merchants's system is nationwide, while the BOC and CCBs' are only used in a few large cities such as Shanghai and Beijing. |
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| 11) |
Inter-bank and bond markets inactive |
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The transaction volumes of the inter-bank market and bond market are very small. |
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For the inter-bank market, only certain maturities are quite liquid, and hence the interest rates for most maturities are volatile. Thus many banks, including foreign banks, tend to use bilateral lines to raise funds for on-lending, though it is more expensive. |
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This is partly attributed to the high liquidity on short-term funds for Chinese banks in recent years, but it also reflects the backwardness of the money market. |
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As a result the role of the money market rates as leading indicators of the whole financial markets is limited. |
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| 12) |
Foreign banks' market share still too small |
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Foreign banks still face both heavy entry barriers and hefty business restrictions in China. As a result, the market share of foreign banks in China in terms of assets is below 2% despite 2 decades of banking opening-up, which is lower than in most other countries. |
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The market share in deposits market is even lower, being below 0.5%, owing to stricter restrictions on deposit business than on loan business for foreign banks, indicating a net creditor role that foreign banks play in China. |
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Major entry barriers are geographic restrictions and entry requirements, while main business restrictions include customer restrictions (to foreign investment companies and residents largely) and currency restrictions (to foreign currency business largely). |
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On the other hand, foreign banks enjoy a 15% income tax rate as compared to 33% for Chinese banks. The later is also subject to an 8% business tax. |
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| 13) |
Overseas expansion far from the economies of scale |
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No Chinese bank can be said an international bank, with a too small international network and weak international reputation. This also explains why 40% of China's international settlements are being done by foreign banks. |
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| 2. |
Greater challenges as well as opportunities, and a new phase of banking reform ahead |
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| 2.1 |
The impact of WTO entry on China's banking sector --- Challenges as well as opportunities |
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| 1) |
An overall opening-up of China's banking sector in 5 years |
 
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The Sino-US WTO agreement stipulates that foreign banks will be allowed to conduct all the banking businesses in China, in both RMB and foreign currencies, with both corporate and residents, for both Chinese entities and foreign entities, and in any place of the country, 5 years after China's WTO entry. |
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This will be phased in by two major steps: the opening-up of corporate banking business in RMB with Chinese enterprises in 2 years, and the opening-up of consumer banking business with Chinese residents in both RMB and foreign currencies in 5 years. |
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It is reported that the PBOC is drafting new laws to allow foreign banks to expand FX business with Chinese enterprises, suggesting that the opening-up would begin to accelerate immediately after WTO entry or even before the entry. |
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| 2) |
Some restrictions would remain |
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It should be noted that this does not mean foreign banks will be able to do business in China without restrictions. As in any other economies including the freest economies like the US, Hong Kong and Singapore, there are always some kind of restrictions on foreign penetration, which are however considered reasonable in the sense that they are not in violation of the WTO agreement and other international agreements signed in the spirit of market economies. |
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One of the key restrictions would be the number of branches that foreign banks are allowed to establish, for which currently the "one city, one branch" principle applies in China. This restriction is critical, but it is even not mentioned in the Sino-US WTO agreement, and perhaps even never touched on in the WTO negotiations. |
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The Chinese government may also follow the practices of other WTO member and even free economy countries to control the country distribution, size distribution or business distribution for foreign banks' business in China. |
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There are many other invisible ways for the government to affect the pace of foreign banks' penetration, including encouraging large SOEs to use domestic banks, setting obstacles to the use of domestic networks by foreign banks, complicating and prolonging the procedures for approving specific business of specific foreign banks, etc. These are not decent things in the eyes of foreign investors, but would be the real life. |
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| 3) |
Competitiveness of Chinese banks --- International comparison |
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Weaknesses |
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The economies of scale: The 4 state banks all enter top 100 with the ICBC ranking the 10th, ABC the 20th, BOC the 21th and CCB the 32th in terms of capital. But all the shareholding banks are out of top 100 and only 4 of them enter top 1000, suggesting that these more profitable banks in China are at disadvantages for the economies of scale. |
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Productivity and profitability: Productivity is over 5 times lower for the state banks and over 2 times lower for shareholding banks, than for international banking giants. In turn profitability is lower by about 10 times for the state banks, and 2 times for the shareholding banks. |
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Assets quality: The NPLs ratio (25-30%) put the state banks on a risky position as compared with international banks (below 5% normally). The ratio for the shareholding banks is lower (15% on average), but it is also much higher than their international counterparts. Meanwhile, while verging the minimum requirement, the CAR ratio points to a weaker capita position than international banks (over 10% normally). |
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International network: Weak international network is a major weakness of Chinese banks in comparison with international banks. This is clearly demonstrated in the fact that foreign banks have already taken 40% market share for the international settlement business in China. |
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Services: Though many Chinese banks have made a remarkable progress in improving services, the services for China's banking sector as a whole are still much poorer than foreign banks. |
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Banking products: Fee-based income is just 6% of total banking revenue as compared to as high as 40-50% for international banks; 38% of the OBS products have not been introduced into China, while even for those introduced, the transaction volume is very thin; universal banking is virtually absent, while it is growing fast and increasingly important for international banks. |
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Technologies: Chinese banks are still much behind the world in the application of the IT and Internet technologies. |
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Staff quality and incentives: With less than 5 years of commercial banking experiences, banking staff in China are generally less efficient and experienced than those in foreign banks, particularly for smaller banks. Work incentives are also much weaker with a much poorer pay package, especially for the state banks. |
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Corporate governance: Chinese banks still have a long way to go to be comparable with foreign banks in this regard. |
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| b) |
Strengths |
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Huge domestic network: This is the largest edge in competitiveness of Chinese banks, especially the state banks, over foreign banks, which is expected to be a critical factor for Chinese banks to resist foreign banks' penetration. |
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Long-established customer relationships: This is the second largest edge of local banks. |
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Understanding of China markets: It is also a major, and important, strength for domestic banks. |
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Government support: While direct financial support from the government is getting less and less, indirect government support will continue, and even strengthen to help guard domestic banks against foreign banks in the upcoming WTO competition, especially to the state banks. |
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Cultural recognition: This is one of the reasons why many middle and low class people prefer local banks to foreign banks. It would be turned into a bigger advantage if it could lead to a development of differentiated and specified banking products oriented towards Chinese residents and enterprises. |
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Liquidity: Liquidity for Chinese banks is better than most foreign banks in terms of the liquid assets/total assets ratio as well as the loans/deposits ratio. This is one of the important arguments for the belief that financial risks are manageable in China despite the high NPLs ratio. |
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| 4) |
Negative impacts at large |
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| At large, there would be two basic negative effects of WTO entry on Chinese banks: |
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Customer effect: taking good customers away from Chinese banks to foreign banks due to stronger competitiveness of the latter in the above mentioned areas, and |
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Talent effect: taking good staff away from Chinese banks to foreign banks owing to better pay package and brighter job prospects offered by the latter. |
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The customer effect would accordingly take business away from Chinese banks to foreign banks, and in turn to worsen their business volume, market shares, profits, liquidity and risks, from a demand point of view. |
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The talent effect would have similar impacts, while from a supplier viewpoint. |
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In response, Chinese banks would have to manage to survive, and then there will be intense competition between Chinese banks and foreign banks emerging in China's banking market. |
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| 5) |
Positive impacts at large |
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The main positive impact would be that, the intensified competition would help Chinese banks to grow up faster towards international standards, by pressuring them to accelerate banking reform and to learn about international banking practices, and also facilitating such reform and learning process. |
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Such an effect will not be immediate, and it would emerge after the negative impacts. But it is of far-reaching significance, and is really what WTO entry is meant for China. |
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Other positive impacts would include an improvement in international environment for overseas business of Chinese banks with expected reciprocal treatment from other WTO member countries for Chinese banks, the opportunities for Chinese banks to cooperate with foreign banks, an unification of the income tax rates for Chinese banks and foreign banks in favor of Chinese banks, and so on. |
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| 6) |
Negative impacts by business, customer and geography |
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| Despite an overall opening-up of China's banking sector, foreign banks are expected to put their resources on the areas of their strength. These areas would be the battlefronts between Chinese banks and foreign banks. |
| a) |
By business. The most affected would be highly profi | | |
