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Financial Sector Reform
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1980s not really considered as part of economic reform
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Banks were seen as the state’s “cashier” for its chosen economic programs—
as a result there was build-up of NPLs
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By mid-1990s, need recognized and necessity to clean up bad debts
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Zhu Rongji recognized that the problems were not cyclical but structural and
rooted in the financial system
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Extra urgency from
◦ Asian Financial Crisis
◦ WTO entry
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Financial Sector Reform
Main role of state banks--feed the SOE sector
 Led to huge portfolio of non-performing loans, perhaps 25% of
GDP (Naughton)
 True net equity value of large state commercial banks almost
certainly negative
 Requires internal restructuring and $200 billion in fresh capital
according to Bottelier (former head of the World Bank in
China)
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Financial Sector Reform
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Zhu Rongji’s policy—three main elements
◦ Restructure the banking system to allow more
commercialization and free state banks from local politics
◦ allow Central Bank to play increased regulatory role
◦ get non-performing loans off the books of banking system
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Financial Sector Reform
People’s Bank as a Central Bank
 1994 division into a three tier banking system: commercial banks (four
former State banks—Industrial and Commercial Bank, Bank of China,
China Construction Bank, and Agricultural Bank of China), policy banks
(China Development Bank, Agricultural Development Bank and
Export-Import Bank), and smaller regional and main banks of the SOEs
(Pudong Development Bank, Shenzhen Development Bank, Huaxia and
Bank of Communications) and non-bank financial institutions such as
the rural and urban credit cooperatives (more profit oriented and with
more flexible loan rates)
 Four major banks still under state authority but greater capacity to
make loans on a commercial basis
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◦ Account for 70% of the domestic banking business
◦ Most important source of capital for enterprises
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Financial Sector Reforms
1998 Reform--reorganize 31 provincial branches of PBOC into
9 regional centers to reduce political interference from
provincial leaders
 But state banks still often seen as funders of state’s severe fiscal
shortfalls
 1998 and 1999, PBOC did move to close the Guangdong
International Trust and Investment Corporation
 Major measure--move non-performing loans off books of four
commercial banks
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Financial Sector Reform
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AMC set up for each commercial bank
First = Cinda for the China Construction Bank
Capital for AMC provided by Ministry of Finance and owned by
Central Government not the bank. But many employees were
shifted over from the relevant bank
SOE debt solution--AMCs acquire at face value loans from
banks to SOEs
In 1998-99, $170 billion was transferred with a further $50
billion in 2004
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Financial Sector Reform
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Official expectation is to recoup 30 to 40% of the 1.1 trillion yuan in
NPLs—acquire at face value loans from banks to SOEs
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Unofficial expectations--lucky to get 10%
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By end 2004, the 4 AMCs had written off or sold assets worth around
$80 billion but had recovered only about 20 percent of face value of
the loans

SETC recognized 600 SOEs for help to rise to 1000
◦ Can be solvent once debt was cleared
◦ Future market niche existed
◦ Well managed
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Financial Sector Reform
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AMCs have had trouble meeting their mandate in part because of a
triple mandate
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1) Maximizing asset recovery
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2) Lessening the financial risks facing the big four banks
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3) Restructuring SOEs BUT (Steinfeld)—little capacity or power to do
this. Now resides with SASAC.
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Problem for State banks is that their customer base has not changed
significantly—SOEs are still the main clients, still occasional pressure
from government to expand social stability loans
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Financial Sector Reforms
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Despite reforms further bank recapitalization is necessary
Pressure comes from the requirements dictated by WTO entry
As of 2007, foreign banks are able to open free-standing branches
Measures to improve the banking system
◦ Formation of the China Banking Regulatory Commission (2003) to improve
supervision and regulation
◦ Capital injection into 3 of the major banks to improve balance sheets and bring CARs
in line with international norms
◦ January 2004, $45 billion injected from foreign exchange reserves
◦ October 2005, the China Construction Bank IPO raised $9.23 billion with stock rising
8.5%
◦ Newbridge purchase of controlling stake in Shenzhen Development Bank, faield
experiment
◦ End October ’05, 18 financial institutions committed $18 billion to 16 Chinese banks
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Financial Sector Reforms
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Criticism of the recent reforms has been a part of the “leftist” backlash
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Claim that finance is a strategic sector that should not be allowed to
fall into foreign hands
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Intense criticism has had a limited impact on policy
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Mid-December 2005, State Council met to consider whether state
banks are being sold too cheaply
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Main policy adjustment is to bring in domestic stakeholders—National
Social Security Fund can take a 10 billion Rmb stake in two state banks
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Financial Sector Reform
To make banks attractive further recapitalization may be necessary but
is it worthwhile
 Yes, but other requirements must be met
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Corporate governance will have to improve
Loan criteria will need to be tightened and risk management improved
Political lending to state firms will need to be reduced if not cut off
China will need to keep with liberalizing domestic interest rates
Seek fuller integration between domestic and international capital markets
Eventually move to a more realistic valuation of the currency
Ending preferential policies and lending practices will help direct
valuable resources to the non-state sector
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