Foreign Capital
Pours Into
Chinas Banks
By John Chan
08 October 2005
World
Socialist Web
When
China joined the World Trade Organisation (WTO) in 2001, Beijing agreed
to open up its banking system to foreign investors by the end of 2006.
A flood of foreign investment into Chinas largest state-owned
commercial banks (SCBs) since last year has signalled the start of a
process that will have major economic ramifications.
At the end of 2003,
foreign equity stakes in Chinese banking institutions were just $500
million or 0.3 percent of total banking capital. Foreign banks held
only about 1 percent of total banking assets. By contrast, Chinas
five largest SCBsthe Industrial & Commercial Bank of China,
the Agricultural Bank of China, the China Construction Bank, the Bank
of China and the Bank of Communicationscontrol over 60 percent
of the countrys loans and deposits.
International investors
are rapidly changing this landscape. Last year, the British-based Hong
Kong and Shanghai Banking Corporation (HSBC) bought 19.9 percent of
the Bank of Communications for $2.25 billion. In June, the Bank of America
invested $3 billion for a 10 percent stake in the Bank of China (BOC).
In July, the Royal Bank of Scotland bought another 10 percent of the
BOC for $3.1 billion, while Singapores Temasek committed $2.5
billion to the China Construction Bank. In August, the US-investment
house Goldman Sachs paid out $3 billion for a 10 percent stake in the
Industrial & Commercial Bank of China.
The Chinese government
has listed or is preparing to list major SCBs on overseas stock markets.
When the Bank of Communications made an initial public offering (IPO)
in Hong Kong in June, it was oversubscribed 200-fold by retail investors
and 20-fold by financial institutions. The IPOs planned for another
three major state banks next year will be worth a total of $20 billion.
By 2007, it is estimated that foreign financial groups will control
one sixth of Chinas banking system.
Paradoxically, the
major Chinese SCBs are weighed down by huge bad debts and are technically
insolvent. The capital adequacy ratio of the four largest SCBs was only
4.6 percent in 2003, compared to the 8 percent international standard.
However, international financial institutions are pouring money into
the SCBs in a bid to capture a key strategic sector of the Chinese economy
and exploit the financial opportunities opening up.
Transnational corporations
have invested tens of billions of dollars into the workshop of
the world over the past two decades, spawning a rapid growth of
private enterprises needing credit and financial support. Currently,
private business accounts for only 40 of some 1,600 Chinese companies
listed on home and overseas stock exchanges and receives less than 10
percent of total banking credit.
In addition, Chinas
high domestic saving rate holds out the prospect of new sources of capital
for the international financial markets. At the end of 2004, Chinas
total bank deposits stood at 185.5 percent of GDPfar higher than
most countries. The major Chinese SCBs, however, are not presently engaged
in profitable activities such as investment banking, securities and
insurance. Last year, the average rate of return for banking institutions
internationally was 1.2 percent, three times higher than the 0.4 percent
in China.
By partnering with
the China Construction Bank, for example, which has 136 million deposit
accounts and 14,500 branches across the country, the Bank of America
will be able to engage in corporate lending as well as consumer banking
activities such as mortgages and credit cards. Until now, foreign banks
have had limited access to Chinas domestic banking business.
Opening up Chinas
banks is bound up with broader economic reforms. As Jonathan
Anderson, chief Asian economist of the Swiss bank UBS, commented in
the Far Eastern Economic Review: The government has done everything
it can for banksexcept to privatise them. And as long as senior
management is made up of civil servants with a mandate to support official
policy, banks will never be fully market-oriented institutions. What
China needs to make financial system reform and restructuring stick
is to get the state out of the business of running banks.
This restructuring
involves a vast transformation in the role of the banking system. Under
the new regime, banks will operate for the benefit of shareholders and
foreign financial institutions. Their previous unprofitable functions
of financing social services, pensions, the public sector, state-owned
enterprises and rural subsidies, on which the lives of tens of millions
of people depend, will be ended.
Banking reform
Before 1978, one
institutionthe Peoples Bank of Chinacontrolled all
financial resources within a closed, nationally-regulated economy based
on state-owned industry and collective agriculture.
Chinas SCBs
were created during the first wave of market reform in 1980s.
Although these banks were commercial, they continued to
finance state-owned enterprises, social infrastructure and subsidies
for the rural peasantry in the form of loans. As a consequence, the
SCBs incurred huge bad debts, mostly unrecoverable.
While the Chinese
government gave large tax breaks to foreign investors, state-owned enterprises
were saddled with high tax rates and provided significant social benefits
to tens of millions of employees. At the same time, the state banks
started to look for profitable returns, entering the speculative real
estate market and accumulating even more bad debts.
Non-performing loans
(NPLs) rose sharply after the speculative investment bubbles burst in
the mid-1990s. In 1994, Beijing intervened to stabilise the real estate
and stock markets by tightening money supply and devalued the yuan from
5 to 8.3 to the US dollar to boost exports. As a result, yuan-denominate
assets depreciated and deepened the crisis in state-owned economic sectors.
By 1998, the ratio of NPLs to GDP ($960 billion) reached a staggering
20 percent.
Beijing reacted
by slashing state spending. In 1995, the government formally established
the Peoples Bank of China as the countrys central bank,
along the lines of the capitalist West. Its main objective was to prevent
banks from providing direct subsidies to the state or making loans to
government that did not meet commercial standards. Any subsidies had
to come from a far smaller government budget.
Fears of financial
instability effectively halted banking reform during the 1997-98 Asian
economic crisis. Four asset management companies (AMCs) were established
to liquidate tens of billions of yuan in bad debts owed by state-owned
enterprises. Privatisation and closures took place on an unprecedented
scale. According to official statistics, from 1998 to 2005, 60 percent
of the workforce of state-owned enterprises, or 30 million workers,
was thrown onto the unemployment queues.
The governments
financial crisis continued, however, as it was forced to borrow to meet
interest payments and pay off overdue debts. In 1998, Beijing issued
270 billion yuan ($33 billion) in bondsequivalent to 3 percent
of GDPto shore up the capital bases of the four largest SCBs.
The four AMCs issued 1.4 trillion yuan ($170 billion) in bonds in 1999
and 2000.
After joining the
WTO in 2001, Beijings policy has been that the state banks would
grow their way out of the problem. Their financial position,
however, remains precarious. Pressure from the US and European powers
to revalue the yuan has led to a wave of speculative lending to yuan-based
real estate and industrial projects. Investors hoped to make a killing
if the value of the yuan increased.
According to the
September issue of the IMFs Finance & Development magazine,
high saving rates and cheap credit has contributed to speculative investment
in China amounting to 40-45 percent of GDP. The resultant excess capacity
is likely to become a new source of bad debt, especially among less
competitive state-owned enterprises.
In short,
one basic problem in China is that the high degree of thrift that fuels
such rapid investment growth has a low payoff because of the fragile
threads holding the economic picture together. Providing cheap capital
to enterprises, especially state-owned firms, requires low interests
rates. Sustaining bank profits then requires correspondingly lower rates
of return on deposits. Thus, maintaining economically unviable state
enterprises and supporting them through the banking system results in
large implicit costs, the IMF magazine warned.
According to official
statistics, for the first quarter of this year, non-performing loans
(NPLs) in the four largest SCBs were 1,567.1 billion yuan ($193 billion)
or 15 percent of total loans. Unofficial estimates, however, put the
percentage much higher. The official ratio is down from 20 percent in
2003, but largely due to massive government bailouts.
In 2004, for example,
Beijing injected $45 billion from foreign currency reservesmostly
dollar-based assetsinto the Bank of China and the China Construction
Bank. In April this year, the Industrial & Commercial Bank of China
received $15 billion from the same source. Over the past 18 months,
Chinas central bank had spent more than $100 billion to recapitalise
or write off bad loans. None of these cleansing operations
has changed the fact that the Chinese government is the ultimate debtor.
The more the Chinese
economy is opened up to foreign investors and limited government controls
are loosened, the greater the danger of severe financial instability.
In July, Beijing announced a 2 percent appreciation of the yuan against
the US dollar and changed the basis for the currencys peg from
the dollar to a basket of international currencies. But the decision
has not ended the inflow of speculative capital, or ended the risk of
capital flight if the investment bubble collapses.
At present, Chinese
authorities maintain tight restrictions on Chinese citizens investing
abroad. Over the past two years, Beijing has used its control of state-owned
banks to try to slow speculation by halting lending in some over-invested
sectors such as steel. But as foreign capital flows into Chinas
banks, the governments ability to use these financial institutions
to control investment will end.
A financial crisis
would have immediate consequences for the global economy, which increasingly
relies on China as its main cheap labour platform. Last year, China
received $61 billion in foreign direct investment. Chinas banks
are now the second largest sources of finance, after Japan, to prop
up the huge US budget and trade deficits. It is the worlds third
largest exporter after the US and Germany, and one of the biggest consumers
of raw materials and energy. All this rests on increasingly unstable
foundations.