In the middle of the first decade of this century, Chinese officials led by then-Prime Minister Zhu Rongji set out to clean up one of the world’s biggest financial messes, the state-run banking system. It is estimated that just the amount poured into the four biggest banks alone was RMB2.4 trillion (US$348.7 billion at current exchange rates), 17 percent of China’s gross domestic product in 2003.
That followed the earlier collapse of two of China’s giant state-backed investment trusts, Guangdong International Trust and Investment Corporation (GITIC) and the Hainan Development Bank, as well as several other trust companies and financial institutions in 1998. For GITIC alone, the collapse amounted to US$5.6 billion including US$4.7 from foreign investors. It was estimated that investors recovered 12.5 percent on the dollar.
In the intervening years, there have been additional concerns about China’s so-called shadow-banking industry, which exists outside of the state and is largely unregulated. As late as 2014, the government moved to shore up an investment product distributed by ICBC, China’s largest bank, to keep it from defaulting.
Given regular occurrences like these, it seems like it would take a brave individual indeed to say China’s banking system has been transformed into one that can and does compete on a global level. But James Stent, a veteran banker who has served on the boards of banks in the Philippines, Hong Kong and particularly in Thailand and who spent 12 years as an independent director of China Minsheng Bank and China Everbright Bank, has written China’s Banking Transformation: The Untold Story, in which he argues that “Lessons have been learned from the 1990s within China, from 1997 in Southeast Asia, and from the Wall Street problems of 2008,” that “the right people were put in the banks at all levels from board through management to general staff, and they went to work. The result was a ‘night and day’ transformation.’”
If Stent is right, this is quite a Herculean achievement. China’s commercial banks, he says, are hybrid creatures, which of course they are, built on what may be one of the biggest oxymorons of all time – market socialism. Socialism by definition is state ownership of the engines of the economy. A market economy is one in which the market dominates the economy. But under the economic reforms introduced by Deng Xiaoping, the market has to adopt capitalist techniques to survive. Socialism will come later.
The paradox is that in a socialist economy, there inevitably comes a time when banks are asked to do their patriotic duty – to lend to companies owned by the state, which may not deserve to exist at all. Banking after all is predicated on the ability to recognize risk – to train bank officers to recognize risk in lending. In market economies, the banks refuse to lend.
China, Stent says, has solved that problem. And if he is right, it is a rather astonishing transformation. After all, when Mao Zedong came to power, he decreed that the country didn’t need a banking system. For the first three decades of the country’s existence, the People’s Bank of China – essentially an accounting and cashier unit – served until Deng Xiaoping launched reform and opening, seeking to create a rational economic system.
The modern banking system only came into existence in about 1992, when Zhu Rongji became governor of the PBOC. Zhu was a giant in more ways than one. Modern China almost owes its existence to him. In the mid-1990s China’s triangular debt problem was so overwhelming that it could have sunk the country’s financial system. In fact, China has Deng’s reforms seen an astonishing series of gigantic debt crises that might have wrecked the financial system.
Systemic reform was obviously crucial. Zhu and his team first focused on the four giant state banks, ICBC, CCB, BOC and ABC. If they could be put on the right track, the smaller banks would follow. He broke the command economy culture, clean up balance sheets in which as much as 50 percent of loans to state-owned entities were nonperforming, issue government-backed bonds to pay for the mess and finally to list the banks on international stock exchanges to force them to submit to market discipline.
The regulatory function had to be spun out of the PBOC and placed with an independent bank regulatory commission. That, Stent argues, has succeeded and the building blocks of modern banking have now put in place, including proper corporate governance, bank accounting, profit-oriented management, risk control (risk control!) and retail branch service standards. Foreigners, he says, find supervision to be on a par with professional capabilities in global central banks.
Since 2010, Stent writes, the wrenching change that characterized the previous decades has slowed, and is now more evolutionary than transformational. The reform process is continuing.
One hopes he’s right. But there is an estimated US$600 billion in railway debt out there somewhere, left over from the country’s headlong rush into continental high-speed rail that one suspicions might not be paying for itself. In the earlier part of this decade, China's State Council was forced to act to bail out to local governments from at least U$1.7 trillion steered through covert “financing vehicles” to finance a wave of spending on development spending on empty housing complexes and over-developed infrastructure. The wave of development spending from 2009 that saved the global economy created huge overcapacity in a long list of industries.
“I have made the case that banks in recent years performed their intermediation function reasonably effectively, but the system works differently from the way it works in modern capitalist economies,” Stent writes. “The development of the system is still going on, so it is at least premature, and possible impossible, to reach a judgement about whether or not the Chinese hybrid system functions as effectively as do systems in market capitalist or cooperative capitalist economies.”
The system, he argues fits into China’s collectivist market socialist economy and reflects an inherited Confucian way of thinking about how the polity and society should work and relate to each other.”
Indeed. But we have to wait to see if interventionist state leaders lean on the banking system to lend to meet national goals that are untenable or hubristic. Stent is an optimist. The railway system debt and the local government financing vehicles tend to produce pessimism.