Analysts are divided over the impact foreign competition unleashed by World Trade Organisation concessions will have on China's under-capitalised and over-regulated banks. In the view of Deutsche Bank senior economist Jun Ma, mainland banks stand to lose market share to sounder and technically more proficient foreign banks. But Nomura International economist Pu Yonghao believes retail banking will remain largely the domain of China's existing banking giants. In a research note to clients, Mr Ma said the mainland's banking sector had enjoyed impressive asset growth over the past two decades but behind that expansion lay an array of problems. 'Banks are burdened with large amounts of non-performing loans, lower than required capital, inadequate risk-management capacity, and many underemployed workers,' he said. The restructuring of the banking sector had already cost the Government 'a fortune' - 1.66 trillion yuan (about HK$1.5 trillion), or 19 per cent of gross domestic product at last year's prices, in bonds issued to finance bank recapitalisation and the operation of asset-management companies. To prevent financial crises, the Government had taken several additional steps over the past few years to reform the ailing banking system. The People's Bank of China last year also began to liberalise interest rates with the lifting of the control on foreign-currency rates for deposits larger than US$3 million. It also announced a plan to deregulate all foreign-currency and yuan interest rates over the next three years. Mr Ma noted: 'Recently, however, the timetable became less certain on concerns that full-fledged interest-rate liberalisation may lead to over-competition, that domestic banks are not yet prepared to manage interest rate risks and [state-owned enterprises] will have to pay higher interest. 'In our view, while this reform . . . may lead to more volatility in interest rates, it should improve the overall efficiency of financial resource allocation . . . furthermore, banks will learn how to manage interest-rate risks only if they are given the opportunity to price loans and deposits,' he said. Meanwhile, Mr Pu noted that many analysts had come to dire conclusions about the negative impact on China's banks of foreign competition. This ignored the impact of WTO accession on sub-sectors and the role of government in monitoring and regulating the banking sector. Mr Pu said competition for corporate clients between domestic and foreign banks might become intense, but foreign banks were unlikely to present a significant competitive challenge in retail banking. Foreign banks were also at present restricted by domestic regulation. Recent signals from banking regulators on the mainland have raised concern among foreign banks that these restrictions may be tightened. Mr Ma said the focus of policymakers in the next few years would remain on interest-rate liberalisation, the opening of yuan business to foreign banks, and listing state-owned banks on the stock markets. Meanwhile, the urgent need to improve inferior capital-adequacy ratios and operating efficiency required the simultaneous implementation of various reforms, Mr Ma said. These included: Rapid improvement in banks internal risk-management systems to achieve a reduction in the level of non-performing loans; A sharp cut in staff and consolidation of branch networks; Interest-rate liberalisation to allow an increased interest spread to reflect lending risk premiums; A further cut in the banking business tax from 5 per cent and a reduction of the 33 per cent corporate income tax; Recapitalisation, including another round of government-bond-financed capital injections or more buying of non-performing loans by asset managers; and Issuance of long-term subordinated debt by banks, which will be included in the calculation of Tier Two capital. Mr Ma said the reforms should aim to achieve partial privatisation through listings within five years of all main state-owned banks.