Regulators are shaking up a system burdened by bad debt and a mindset at odds with international practice The mainland's big four state banks have undergone some radical changes over the past decade, many of them sparked by the 1997-98 Asian financial crisis. But with the appointment of the mainland's first banking regulator this year, the big four are facing their biggest challenges. Despite being in better shape than they were 10 years ago, it is clear the banks have a long way to go before they can match the operating level of their Western counterparts. Embracing change has not been an easy task for the banks, which have operated for decades behind the protective shield of rigid state control. It was an environment in which officials were not responsible for loan defaults, much less checking the creditworthiness of customers. In the past, the credit approval process was a collective exercise. In other words, nobody was blamed for loans that went bad. '[But] today, individuals are held responsible for the credit they approve. Managers' interests and career paths are also tied more closely with their performance,'' said Yen Wei, banking analyst at Moody's Investors Service. These steps, indeed, are gigantic for the Industrial and Commercial Bank of China, Bank of China, China Construction Bank, and the Agricultural Bank of China. The big four rank among the world's largest banks in terms of assets, but they lag well behind foreign banks when it comes to performance and credit quality measures. Nearly half their loans are considered bad by foreign analysts, while their average capital adequacy ratio is still far from meeting the 8 per cent international best practice under the Basel Accord. The mainland's banking chief, Liu Mingkang, admits that more needs to be done. In just five months in the driving seat, the chairman of the China Banking Regulatory Commission has spared no time in cleaning up the country's banking mess. Regulations have been rolled out, tighter supervision is on the cards and, starting this week, on-the-spot inspections will be carried out. The central government hopes the tighter scrutiny will ensure banks adhere to stricter requirements in loan classification and credit-risk management. The biggest challenge lies in changing the 'credit culture' of banks to focus on cash flow as opposed to collateral, relationships or policy guidance. 'This is a lot harder to do than adopting risk-control procedures of best international banks as it requires training and proper incentive systems,' Shan Weijian, a partner of private equity firm Newbridge Capital, wrote recently in the Asian Wall Street Journal. According to Fitch banking analyst Arthur Lau, the human factor is impeding the reform process. Despite the new standards and requirements, the system continues to be overridden arbitrarily. In the past, bank officers were recruited directly from school, lacking financial experience. But, according to China Minsheng Bank executive He Qun, the old mindset is changing. More specialists and professionals have been recruited over the past two years in a bid to ensure risks are contained from the outset. Meanwhile, the big four have been taking a more proactive approach to expand business given the rather tardy reforms at state-owned enterprises. Without good customers to lend to, the banks will continue to be swamped by bad debts. Today, personal lending accounts for about 8 to 9 per cent of the loan books of mainland banks, albeit dwarfed by international levels of 40 per cent in Hong Kong and 50 per cent in the United States, according to Mr Yen. Foreign competition will test the big four. Will this see a flurry of government bailouts, stockmarket listings or break-ups? The answer will be out in about three years, when foreign banks are given full access to the mainland market under China's World Trade Organisation accession agreement.