Bank of China

OECD throws book on governance at mainland lenders

PUBLISHED : Saturday, 10 September, 2005, 12:00am
UPDATED : Saturday, 10 September, 2005, 12:00am

Ordinary investors wondering whether to buy shares in either the Bank of China or China Construction Bank when they float their stock on the Hong Kong market over the coming months might want to take a look at the Governance in China report published by the Organisation for Economic Co-operation and Development. It makes uncomfortable reading.

That does not mean investors should read the whole thing. The full report published on Wednesday weighs in at a massive 577 pages, and covers topics like 'the institutional organisation of statistical data compilation' and 'expenditure decentralisation in comparative perspective' in minute detail.

But the OECD - a Paris-based research body comprising the governments of 30 wealthy democracies - reckons the governance of China's banks is sufficiently important to rate a chapter all to itself. Its assessment is an important wake-up call for investors ahead of the pending flotations.

For the OECD does not mince its words. It lays bare a 'governance vacuum' within China's big state-owned commercial banks (SOCBs), and questions whether the reforms now being implemented will be enough to fill the void.

The report does praise China's programme of reform as 'very bold in its aspirations', but its authors are still doubtful. The big problem remains the relationship between the state and the banks. Despite the reforms, China's big state banks are still required to allocate credit in support of policy objectives, rather than in pursuit of commercial gain.

'Even on the simplest organisational level, the SOCBs lack the basic attributes of profit-making banks,' warns the report.

At the local level the banks are managed largely by government officials concerned with supporting otherwise insolvent state enterprises so they can sustain employment levels and pay pensions to retirees. The more credit the banks extend, the more they have to, to prevent the bankruptcy of weak borrowers, which would raise their levels of non-performing loans.

High costs, low lending margins and the banks' lack of non-interest income have resulted in poor asset quality, low earnings, inadequate capital and shaky balance sheets, says the report. Returns on assets are just 15 per cent of what is seen internationally as okay. Non-performing loan ratios are too high, and provisions against losses are a fraction of what they should be.

Worse: 'There is a clear suspicion that reported data give a misleadingly positive picture of the financial state of the SOCBs.'

Of course, the whole idea of recruiting foreign strategic investors and of listing the banks on international markets is to address the governance problems that have led to these weaknesses. But it is here that the OECD is most pessimistic.

Noting that 'the state has no intention of relinquishing its controlling interest in the SOCBs', the report says: 'One of the basic uncertainties overhanging the reform is whether the SOCBs can be transformed into profit-oriented entities while a commanding share of bank capital remains under the control of the state.'

Enlisting foreign banks as strategic directors like Bank of America, which earlier this year bought a 9 per cent stake in CCB, and Royal Bank of Scotland, which is leading a consortium of investors in BOC, may not be much help.

The OECD argues that foreign institutions have taken minority stakes largely to promote lucrative joint ventures in specific areas, like credit cards, or to further their own entry into the Chinese market with influential officials.

That could make them reluctant to kick up a fuss over bad governance, lest it jeopardise their other interests.

On BOC and CCB specifically, the OECD report concludes: 'It is not obvious that the planned change in ownership structure, in which the state will retain its controlling share indefinitely, represents a viable form of governance.' We have been warned.