Bank bailout will fail without deeper reform

PUBLISHED : Tuesday, 26 August, 2003, 12:00am
UPDATED : Tuesday, 26 August, 2003, 12:00am

Reform at the Big Four - China's largest state-owned banks - has been tipped by financial industry insiders since the start of the year, and it now appears that a plan from the country's regulators is imminent. The case for immediate and radical action is substantial. For one thing, the industry will have to compete with foreign banks once the market is fully opened to competition in 2006. Yet even without the imposition of this deadline, there is the simple fact that the four banks, which account for 70 per cent of the country's loans, are technically bankrupt. The official estimate of a 22.2 per cent bad loan ratio at these banks, out of nine trillion yuan in outstanding loans, has some observers speculating about a possible collapse of the entire system before 2006.

The plan under consideration aims to bring bad loans down to 15 per cent of all loans and raise capital reserve requirements. The problem is that this much-anticipated bailout, while taking some of the most hopeless debt off the banks' balance sheets and therefore making them look healthier, will only make matters worse if a more fundamental issue is not resolved. That issue is the misguided lending policies that have created the problem loans in the first place.

In fact, repeated bailouts - this one will be the third since 1998 - have created a classic moral hazard. They signal to the banks and their borrowers that there are no negative consequences to be faced from liberal credit policies and an absence of quality control at banks. Regrettably, such continued support encourages irresponsible behaviour as there is nothing to keep these institutions from continuing with their risky lending practices once this bailout is complete. Any plan that does not address this question will already have failed before it begins.

The bailouts of years past are still being worked out and absorbed by the financial system. The 1.4 trillion yuan worth of bad debts transferred from the four banks to asset management companies in 1999 are still in the process of being sold off, and it is not clear how much money will be recovered and how much will need to be written off. The financial burden of that bailout may in the end be shifted to the central government, which is running deficits and which also needs to fund other pressing social, public health and educational programmes.

The state-enterprise sector has arguably been the primary beneficiary of the Big Four's loose lending policies, but private businesses such as the companies connected with Shanghai tycoon Chau Ching-ngai are recent and vivid reminders that the problem extends throughout the banking system. The fact that the Hong Kong branch of the Bank of China, thought to be the mainland's best-regulated bank, was exposed to the Chau companies' troubles, is yet another sign.

Already this week, we have seen regulators tighten reserve requirements for banks across the country and warn sternly against continued lending to overheated sectors such as property development. Following on this news, and given the widely acknowledged need to address the non-performing loans sitting on the books at Chinese banks, a recapitalisation plan makes sense. However, the most dangerous outcome of all would be to send the message to banks that the bailout is permission to continue with business as usual. The notion the banks will 'grow out of' their troubles because of the country's booming economy is wishful thinking if underlying policies and lack of oversight mean a new pile of bad debt is created each time the old one is taken away. The most important goal should be to make sure there is no need to repeat these bailout exercises every two years. Such a scenario would amount to a financial drain that China can ill afford.


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