MEASURED against its own standards, Beijing has been remarkably swift lately in acknowledging - and confronting - the problems of its fragile banking sector. The new resolve is seen not only in senior leaders' redoubled rhetoric about the need for tighter financial supervision, but in its most ambitious overhaul of the banking sector since 1949. Until Asia's financial crisis, which brought down several economies along with their insolvent banks, Beijing's efforts to reform the antiquated banking sector were, at best, half-hearted. The severity of the Asian financial turmoil has finally convinced Vice-premier Zhu Rongji - expected to be confirmed as premier this week - and People's Bank of China governor Dai Xianglong to tackle the long-running banking ills head on. Crucial to the reforms' success is the commercialisation of the state banks - the Agricultural Bank of China, Bank of China, China Construction Bank, and Industrial Bank of China. Woefully under-capitalised, the banks have for years acted as government cashiers, giving out unprofitable policy loans to state enterprises, which should have been financed out of the fiscal budget. Along the way, they have amassed mountains of bad debt which would have made them just as susceptible to the kind of bank failures seen in Japan and Thailand had the mainland economy been more open. Today, based on Mr Dai's figures, they account for 60 per cent of the total loans in the banking system. Now, Messrs Zhu and Dai have given themselves three years to sort out the banking mess through a package of reforms derived largely from a national meeting convened in November specifically to discuss - and draw lessons from - the region's financial crises. Among the key reforms are: Removal of credit quotas - a legacy of the centrally planned economy - from January so state banks can learn to lend on the basis of merit and asset-liability ratios; Issuance of 270 billion yuan (about HK$251.1 billion) in special treasury bonds by the Ministry of Finance to help the four banks meet the minimum capital-adequacy ratio of 8 per cent set by the Basle-based Bank for International Settlements; Adoption of a five-category loan classification system based on international standards to help banks spot and monitor bad loans more effectively; Setting up of a Federal Reserve Board-style of central banking system. On paper, the reform plans look laudable. 'They seriously represent the first big step taken by the authorities to improve the banking system,' Goldman Sachs China economist Fred Hu Zuliu said. Implementing all of them without lobby groups watering down the proposals is a difficult enough task, not to mention that some of the proposals calling for a change in the mindset of top bank managers is even more challenging. Some aspects of the reform programme, such as the 270 billion yuan capital injection, are easier to implement. Others, such as getting banks to lend on merit and to reclassify loans, rely more on selective judgment. 'If banks are to be responsible for their own bottom lines and lend on the basis of merit, they need to have hundreds of credit officers to assess the credit risks of borrowers,' Shanghai Economic Commission deputy director Hu Xiongfei said. 'Our banks have many competent tellers and computer analysts, but are woefully short of people who know how to assess the viability of projects.' Bank officers are so used to being told what to do and how to lend that asking them to judge whether borrowers are credit-worthy or loans risky will require a slow but long process of behavioural change. At present, mainland banks classify loans on the basis of a formula and the passage of time, whereas the new method of grouping loans as normal, special-mention, sub-standard, doubtful and loss will require judgment - an ability not required under the communist way of allocating bank funds. 'This [new loan method] is a system which requires a lot of judgment on what constitutes risk and is a more helpful way of tracking the trend and quality of a bank's portfolio,' said Thomas Macy, Price Waterhouse's Beijing-based chairman of financial services practice in China. Implementing the new system will not be easy, not just because old banking habits die hard, but because information required by the approach is unreliable or lacking. Some mainland companies are known to hold several sets of accounts, and the most favourable is presented when they borrow from banks. Because of the present antiquated way of classifying loans, mainland banks have been unable to truly reflect the size of non-performing loans and bad debts, and thus the magnitude of the country's banking ills. Mr Dai recently said 20-25 per cent of total loans were non-performing, of which 5-6 per cent were truly unrecoverable. Foreign rating agencies believed the figures were much higher and were more nervous about the country's banking woes. By the end of last year, outstanding loans were 7.49 trillion yuan. Based on Mr Dai's percentages, non-performing loans amounted to 1.5 trillion to 1.87 trillion yuan, and bad debts to 380 billion to 450 billion yuan. Banks will write off more than 50 billion yuan this year, and 60 billion to 70 billion yuan in the next two years. If things go smoothly, it means banks could write off the entire bad debts in five to six years. Will a healthy banking system emerge by then? It is too early to tell, and much depends on how fast banks are able to learn new lending habits to reduce poor loan decisions. Learning to control bad lending is not easy, as many banks in the region have already discovered.