China's Banking Sector

The fundamental problems with China's banking system are the interdependence between banks and State-Owned Enterprises (SOEs), the way that banks are run as SOEs, and government's improper influences on the operations of SOEs and banks. Even though in current years when banks are partially owned by minority foreign banks or listed on the stock exchange, the rooted problems still have not been solved

The inefficiency of SOEs has had fiscal/financial consequences. Under a centrally planned system, the banking system plays little role in allocating capital, and state-owned banks extend loans as, and when, required to finance plan allocations. Even after the move towards a market-oriented economy, there was a continuing desire to enable many loss-making SOEs to continue in operation.

Current Reform

The central bank and CBRC may have realized the problem and started addressing this issue by encouraging micro-loans and small and medium loans (SMEs) recently.

Finally, but not least, we note that the management of SOEs and state-owned banks who violated lending policies and procedures, or even broke laws, were not always disciplined via legal procedures - many of them were disciplined via the government's internal political system instead. Those who got prosecuted or put in prison were usually connected with scandals involving foreign jurisdictions (e.g. in the U.S. and Hong Kong) and exposed by foreign media.

Suggested Reforms

 Environmental Pre-conditions

Improve the information infrastructure

There must be adequate information disclosure and enforcement of that by regulators. The quality of information disclosure is dependent on the professional infrastructure, notably the availability of clearly-defined accounting standards and the establishment of a financial professional system, within which professionals, such as well-trained accountants and security analysts, can adequately analyze the financial conditions of a company.

Improve managerial incentive structure

In order to establish an effective incentive structure to motivate the management to maximize the ROE, it is necessary to reward management for out-performance and hold the management accountable for underperformance and/or mismanagement

We note that the regulations by China's central bank and CBRC are moving along the right avenue. For example, in September 2005 CBRC released a provisional guideline on the operations of boards of directors of joint-stock commercial banks, and placed more pressure on independent directors of banks. Also, when the government made the capital injections into BOC and CCB early this year, it set several quantitative goals for these two banks to achieve, such as a minimum