Banking Reform in China

Following up on this post describing advice the U.S. is giving China, Weijian Shan of Newbridge Capital analyses the Chinese banking system, the banking reforms in progress, and the need for further widespread reform in this commentary from the Wall Street Journal:

Will China's Banking Reform Succeed? By Weijian Shan, Wall Street Journal: ...more than two years ago, China's newly appointed governor of the central bank, Zhou Xiaochuan, told a business audience that China would take a "gradualist" approach to reforming its banking system. Many thought the governor meant China was in no hurry to fix its banks. Since then, however, China has injected more than $60 billion to recapitalize four of its five largest banks and has transferred some $200 billion worth of nonperforming loans out of these banks ... almost twice as much as Korea spent to restructure its banks during the 1997-98 financial crisis. ... A healthy banking system ... is necessary for China to sustain its economic growth. ... In spite of its rapid growth ... the Chinese economy remains inefficient and wasteful. ... These inefficiencies have not yet slowed down the economic expansion because the growth fueled by the country's extraordinarily high savings rate ... As the savings are channeled into investments by banks, the inefficiencies and wastefulness simply turn into bad loans. ... To continue to grow, China needs to clean up its banking system and force its banks to kick the habit of underwriting bad loans. A strong banking system will ensure more efficient allocation and use of scarce resources, allowing the economy to grow on the basis of improved productivity, as opposed to increased input. Chinese leaders' resolve to reform the nation's banking system shows that they understand what it takes to sustain economic growth. They are wise and far-sighted enough to take painful measures without waiting until the going gets tough. Whereas many other countries regard foreign capital as the last resort or a necessary devil in solving a banking crisis, China is in the enviable position of having sufficient [foreign-exchange reserves] to clean up its banks without foreign help. ...

China wants foreign investors not so much for their capital, but for the expertise they bring in. As such, China is prepared to be generous. ... Foreign investors may be only minority shareholders. But it is whether they are treated as necessary devils or welcome angels that will make the difference between the success and failure of China's banking reform. Chinese banking officials do not wish foreign investors to simply take a ride. They want them to contribute to changing how banking business is conducted in China. Chinese banking reform does not just redress the balance sheet, it involves systemic change. ... the most significant step is China's effort to push its banks to adopt good corporate governance. Almost all the national banks have been, or are in the process of being, transformed into joint stock companies with boards whose independent directors must represent a third of the total. ... This subjects them to greater transparency, tighter supervision and close scrutiny by overseas regulators and public shareholders. While what China has accomplished thus far in its banking reform is impressive, Chinese banking still has a long way to go to meet international best practices. ... More broadly, it will take time for Chinese banks to build a real credit culture in which lending decisions are made on the basis of the credit worthiness of the borrower and risk analysis, regardless of relationships and government policies. In hindsight, a "gradualist" approach means one step at a time, although the pace of change is anything but slow. ... The rest of the journey will be very tough. Still, there is good reason to believe that China will get there eventually, given the vision and resolve its leadership has shown in banking reform so far.