Tough tasks await next PBOC head
The first job for the new governor of the mainland central bank may be to liberalise interest rates, allowing banks to compete
The next governor of the People's Bank of China is likely to have got there by first becoming the head of one of the country's big state-owned lenders. His initial task? To curb the power of those very banks.
Among the hot candidates are Xiao Gang, 54, the chairman of Bank of China; Guo Shuqing, 56, the chief securities regulator chief and former chairman of China Construction Bank; and Shang Fulin, 61, the top banking regulator and former president of Agricultural Bank of China. All are newly elected members of the Communist Party Central Committee, which is a prerequisite for becoming a central bank chief.
Zhou Xiaochuan, who has headed the central bank for a decade and is fluent in English, has arguably been its most popular chief yet in international circles. He has earned high marks at home and abroad for engineering monetary policies to support the world's second-largest economy while combating inflation. He also won plaudits for his efforts to ease control of the interest-rate and exchange-rate systems, as well as for progress in further opening the capital account and boosting the yuan's global role.
Now approaching 65, the typical retirement age for officials, Zhou is expected to step aside early next year. He will leave a number of key reforms yet to be implemented.
At the top of his successor's to-do list will be the further liberalisation of the interest-rate regime. China took a step in this direction in June when it granted banks more flexibility to set rates. But the next person to sit in Zhou's chair is expected to go much further by removing the ceiling for deposit rates and the floor for lending rates, creating an environment to allow banks to compete with each other by setting rates based on their own risk assessments.
"Interest-rate liberalisation lies at the heart of China's financial reforms," say economists at HSBC, who predict it may take the country three years to complete the process.
Indeed, a consensus is growing among observers and government leaders that furthering the financial reform and cutting corporate reliance on banks for funding are crucial to sustaining economic growth.
Also, there is the need to deepen the country's capital markets so mainland companies have more options to raise funds, including further development of the bond market.
Yuan bond issuance, including treasury bonds and financial bonds issued by policy banks, is relatively low in China. In 2008, bonds accounted for 57 per cent of total lending. That figure fell to 46 per cent last year, and has averaged 38 per cent in the first nine months of this year. The equivalent figure for South Korea last year was more than 85 per cent, according to HSBC.
The country also needs to fast-track the legalisation of private lending, a grey area that often has gone underground to escape supervision. Beijing has approved a pilot programme for Wenzhou, known as the mainland's entrepreneurial hub and a haven for grey-market loans, to legalise underground credit. But progress has been slow.
In the late 1990s, Beijing disposed of 1.4 trillion yuan of non-performing loans - a legacy of government-directed lending at the country's biggest state banks. That led to the restructuring of the banks into stock-holding companies and paved the way for the banks to be listed on the mainland and Hong Kong stock markets.
However, more needs to be done.
Thanks to the government-controlled interest-rate regime, the state's largest banks, led by Industrial and Commercial Bank of China, Bank of China, China Construction Bank and Agricultural Bank of China, have enjoyed huge profits from the spread between deposit and lending interest rates. Their vast nationwide networks feed them with deposits, and they easily secure big loan deals through close ties with state-owned firms. Moreover, the banks face little competition from private players because of official entry barriers, and there is little incentive for innovation.
The big Chinese financial conglomerates remained "pretty simple entities", said Jing Ulrich, the chairman of global markets for China at JPMorgan. "They just take deposits and make loans. And the margins are very, very sizeable."
The state banks, whose heads enjoy ministerial-level rank in the central government, also tend to base their business decisions on political rather than commercial reasons.
Take, for example, Beijing's response to the global financial crisis in 2008-09. To combat the downturn, Beijing undertook an urgent 4 trillion yuan stimulus plan, with about 1.3 trillion yuan coming from the central government and the rest provided by local governments.
Then in 2009, banks pumped out nearly 10 trillion yuan in loans, underpinning economic growth but ignoring potential future credit risks.
Speaking at a recent summit in Beijing held by Caixin Media, Zhou acknowledged that while the lending spree supported the economy during the global downturn, it exposed the nation to threats, including inflation.
"Since the global crisis, China has been caught in a trap of investment-driven growth funded by massive credit," said Fitch Ratings in a recent report.
At current growth rates, by next year, the mainland's banking sector assets would have risen by nearly US$14 trillion since 2008, the global rating agency said. "This is equal to replicating the entire US commercial banking sector in five years," it said. "Such massive balance-sheet expansion is unsustainable."
"I think this is a very good time to reform the bank sector because [non-performing loan] ratios are low, the economy is in reasonably good shape, and banks have very healthy balance sheets," said Ulrich, who argues that liberalising interest rates will encourage banks to introduce more consumer credit services, insurance products and mutual funds.
She also called on the authorities to develop private lending, including micro-financing, to support funding of small and medium-sized enterprises, which are major drivers of employment.