Mainland banking reform still has a very long way to go

PUBLISHED : Friday, 20 January, 2006, 12:00am
UPDATED : Friday, 20 January, 2006, 12:00am

A rash of optimism has broken out over China's banking sector.

Yesterday, Jonathan Anderson, chief economist for Asia at UBS, released a research report proclaiming that 'China's bank clean-up is already mostly done'. On Wednesday, credit ratings agency Standard & Poor's published its own assessment of the sector, in which it declared 'the outlook on China's banking industry is positive'.

Figures released by two of the mainland's big four state banks seem to support this view. Yesterday, Industrial and Commercial Bank of China said pretax profits rose to 28 billion yuan last year from 3.3 billion yuan in 2004. The bank said it had got rid of 450 billion yuan-worth of bad loans last year, reducing its non-performing loan ratio to 4.4 per cent from 19 per cent.

The clean-up will do a lot to help ICBC on its way towards a stock market flotation, either later this year or next. Lagging behind, but also keen on a makeover, is Agricultural Bank of China which yesterday said its operating profit rose 32 per cent last year.

Revamping China's banks has been an enormous undertaking. According to Mr Anderson, more than four trillion yuan worth of bad loans have been shifted off the banks' balance sheets in the past few years. Most of the remaining 2.7 trillion yuan worth will be disposed of over the next two years, he says, completing 'one of the largest asset write-downs in history'.

There is no doubting the scale of the write-offs. What is open to question, however, is whether the central government's vast expenditure on reform has really succeeded in buying the country a new banking sector to go alongside its new economy.

Certainly, the banks look a great deal healthier today than they did a few years ago. Most of the big institutions are better capitalised and earn more of their revenues from fee-based sources, less from interest income. Senior executives are more commercially minded than before and risk management is improving.

But, despite the progress, China's banking system still has a long way to go before it can stand up to international comparison. According to S&P, 25 per cent of Chinese banks' credit portfolio consists of impaired assets. That is far worse than Indonesia, long considered Asia's banking basket case, where only 15 per cent of assets are impaired. Yet, while Indonesian banks have made provisions covering 92 per cent of their bad assets, at Chinese banks the figure is just 13 per cent.

Worse, Chinese banks are still creating bad loans. Last year, Agricultural Bank disposed of non-performing loans worth 46 billion yuan. Yet, figures released by the bank indicate the absolute amount of bad loans on its books still rose by 48 billion yuan. In other words, the bank racked up some 94 billion yuan worth of new bad loans, equivalent to 40 per cent of its net new lending.

Agricultural Bank may be among the worst but it is not alone. According to analysis from UBS, about 10 per cent of new loans extended by the sector last year can be expected to turn bad. The scale of the problem is big enough to worry Liu Minkang, China's top banking regulator who this week warned banks to guard against the formation of new non-performing loans.

That is more easily said than done. Last year, 799 Chinese bankers were disciplined for making 'improper loans', worth a massive 589 billion yuan. Shaking off the legacy of government-directed lending will prove hard too. On Monday, Vice-Premier Huang Ju told regulators that Beijing would retain control of the state banks to ensure the safety of the economy. In other words, banks will still be required to extend cash lifelines to ailing firms regardless of credit quality if it suits officials' policy objectives.

These warning signs do not negate the advances made over the past two years. But they do underline that the real test of banking reform will come only when China's economy enters a cyclical downturn.

Until then, unbridled optimism looks a little premature.