The Reform and Development of China’s Financial System
Pieter Bottelier
Abstract
Fudan-HSBC Economics Forum
Fudan University
May 13, 2002
The author teaches graduate courses on China’s economy at Johns Hopkins University (SAIS) and at Harvard (KSG). During his World Bank career he served in several senior positions, including Chief of the Bank’s Resident Mission in China (1993-97).
China’s great external financial strength masks potentially dangerous internal financial weaknesses. For political and other reasons, financial sector reforms have consistently lagged behind real economy reforms and development since 1978. Awareness of domestic financial sector weaknesses and the risks they entail, increased sharply as a result of the Asian financial crisis of 1997/8.
WTO membership dramatically changes the environment within which China’s financial institutions will operate and sets timetables for internal adjustment. Among the many challenges faced by China in the financial sector, the re-capitalization of state-owned commercial banks and the promotion of a healthy credit culture are the most daunting. With or without WTO, failure to address the NPL- and related problems in a decisive manner is likely to worsen the condition of banks and may jeopardize future growth. The problems will not correct themselves; deliberate state intervention is needed.
Several partial attempts at state bank re-capitalization have been undertaken in recent years. However, a general “roadmap” showing how to reach the goal of a healthy financial sector, and linking financial sector reforms to fiscal policy, public debt management and capital market development in a systematic way, appears to be lacking.
Illustrations of critical linkages are: (1) underdevelopment of domestic capital markets contributes to overdependence on bank loans, (2) the need to find non-budgetary solutions for at least part of the Government’s large implicit pension debt may involve creating new financial instruments that will enhance domestic capital market development, (3) restrictions on the rate at which state banks were allowed provision against expected losses were driven by short-term budget needs, not by banking reform.
The Government should develop strategic partnerships with private foreign and domestic financial institutions to accelerate domestic capital market development and at the same time find solutions for the Government’s large unofficial internal debt, most of which is related to economic transition. Managing the large “transition debt” (including state bank NPLs, implicit pension debt, AMC losses, and other components) is much more challenging than managing the Government’s relatively modest official internal and external debt.
Ultimately, successful macroeconomic and institutional reforms depend on appropriate behavioral change and increased efficiency at the micro level. This applies to both state and non-state enterprises, including banks. China has not yet succeeded in making firm level incentives (and penalties) fully consistent with the requirements of a modern, open market economy. The respective functions, rights and responsibilities of the Government (as government and as shareholder), the Party and SOEs needs to be more clearly defined and separated.
Key regulatory and policy agencies such as PBoC and CSRC have to be given greater independence. Ongoing efforts to update and amend the Company Law of 1994 deserve high priority. Private firms, which in China are largely self-financed, need greater access to bank credit and equity markets. A Venture Capital Investment Law and a NASDAQ-like, second Board stock market for VC and technology start-ups are both needed. A corporate bond market needs to be developed. More local small and medium sized private banks should be allowed to enter the market. A larger share of total bank resources needs to be channeled to non-state enterprises.
In the massive NPL clean-up task that lies ahead and in the management of other domestic “transition debt”, state assets will have to play a central role. A key dimension of this challenge is to make full and effective use of the huge (and growing) pool of currently non-tradable government-owned shares in listed SOEs. An effort should be made to draw up a balance sheet of the present value of transition-related public debt (contingent and implicit) and public assets that could be used in the unwinding of such debt (e.g. govern-owned shares, SOEs to be sold or listed, real estate).
Although implementation had to be suspended, the State Council’s decision of last year to sell part of the government-owned shares on the A-share markets to help fund the NSSF, was in principle correct. The tactics may have to be modified, however. To facilitate government share sales, the government should accelerate the opening of both A-share markets to QFIs. It could also use some of the shares for direct re-capitalization and/or securitization purposes.
Bond securitization with state assets instead of MOF guarantees could help to diversify and deepen capital markets, while reducing share price volatility. The accelerated licensing of experienced fund management companies and the gradual liberalization of investment restrictions applicable to pension and insurance funds, would similarly help to stabilize equity markets and strengthen the forces for improved corporate governance.
Foreign capital will also have to play an important role in the unwinding of NPLs and other “transition debt”. Foreign asset sales (though IPOs, negotiated share sales, auctions, etc.) facilitate the financing of China’s transition, because they add to the country’s pool of financial resources, whereas domestic sales tend to substitute one financial asset (e.g. state bank deposits) for another (e.g. SOE shares).
China should make an effort to leverage the country’s considerable external financial strength for domestic re-capitalization. This can be done e.g. though additional external borrowing. In this connection, it seems advisable to flexibilize management of the exchange rate and to allow a modest appreciation of the RMB to reflect continuing current- and capital account surpluses. International reserves are more than adequate; the rate of reserve build-up could be relaxed.
To facilitate and accelerate the commercialization and re-capitalization of the four large state-owned commercial banks, it may be advisable to break some of them up into smaller, regional units. Ownership of the units could initially be centralized in government holding companies. This would permit the pace of banking reform to be adjusted to regional needs, available resources and opportunities.
Achievement of the government’s apparent objective to make state banks responsible for a larger share of their own re-capitalization needs will in some cases be easier when the units are smaller and more competitive. Interest rate liberalization, necessary among other measures to permit a widening of bank margins, may be accelerated.
Smaller state banks in China’s more developed regions could be privatized more easily and more quickly than the large four with their huge national branch networks. The (partial) privatization of some or all of the state commercial banks is likely to be necessary to achieve the Government’s overall development goals.
Foreign banks wishing to enter the Chinese market under WTO, or expand operations through equity participation in existing state banks are unlikely to be interested in unwieldy national branch networks. Regional branch networks on the other hand, may be attractive to foreign banks and have franchise value that national networks lack. Foreign and domestic investment banks and asset management companies should be encouraged to participate more actively in the NPL clean-up process.
题 目 中国金融系统的改革与发展
（Reform and Development of China's Financial System）
时 间 2002年5月13日下午1:30-4:00
地 点 复旦大学逸夫科技楼报告厅
