The high-flown self-congratulation that characterised the opening sessions of this week's Fortune Global Forum in Beijing came to a juddering halt yesterday when delegates began to examine China's capital markets and corporate governance standards. Optimistic rhetoric about the 'Asian century' and China's nascent consumer markets gave way to sober realism when Goldman Sachs chairman and chief executive Henry Paulson warned that China's growth trajectory had not freed it from the economic law of gravity. 'There are going to be bumps along the road,' said Mr Paulson, adding that to continue its economic development, China must eliminate its US$500 billion structural overhang of non-tradable state-held shares, strengthen domestic securities firms, encourage the development of institutional investors, improve the quality of listed companies and introduce more effective regulation. China's bad debt-riddled banks are a big worry for delegates. 'We all question the ability of the banks to keep up with the economy,' said Jack Rodman, Beijing-based partner at accountant Ernst & Young, who warned that a fragile financial system could scupper mainland growth prospects just as weak banks destroyed the 1980s dream of Japanese economic dominance. 'You have to wean state-owned enterprises and other businesses away from the state banking system and on to other forms of capital,' he said. 'China's reform philosophy is gradualism,' said People's Bank of China governor Zhou Xiaochuan, insisting the government was working hard to develop a functioning debt capital market and to clean up the banking system. After successive rescues in 1999 and 2003, Mr Zhou claimed, between 70 per cent and 80 per cent of banks had reached 'a relatively good standard' of capitalisation and non-performing loan ratios. However, even he was forced to admit that recent restructuring efforts remained untested. 'The test of reform will happen in the downside of the business cycle,' he said. Meanwhile, developing alternatives to bank loans for companies in search of financing is proving a tough proposition. Many delegates mused on the paradox of an economy growing at annual rates of 9 per cent to 10 per cent and a domestic equity market trading near six-year lows. 'The stock market does not reflect the business cycle of the economy at all,' said Stuart Gulliver, chief executive of HSBC's corporate and investment banking unit. Mr Gulliver warned of the danger of developing a two-tier equity market in which China's best companies listed abroad. Kevan Watts, chairman of Merrill Lynch International, emphasised the importance to China of developing a solid institutional investor base to drive price discovery in the domestic market and called for local investment quotas for qualified foreign institutional investors to be raised. Mr Watts argued that the size of the overhang of state-held shares was perhaps less of a problem than the poor quality of China's corporations and market participants. 'If the companies were better, the brokers better and the investors better, I have a feeling that they would be able to cope with the overhang,' he said. Here Mr Watts touched on the delegates' other big concern: the weakness of corporate governance standards in China. Fang Xinghai, deputy chief executive of the Shanghai Stock Exchange, called on the authorities to provide leadership, saying the government needed to declare exactly what corporate governance was and who needed to do what to meet set standards. Meanwhile, he suggested, senior executives should be forced to buy shares in the companies they managed to ensure their interests matched those of small investors. David Eldon, chairman of Hongkong and Shanghai Banking Corp, questioned whether a rules-based system could solve China's endemic corporate governance problems and called for a better ethical education for directors. 'You cannot legislate people's behaviour,' he said. 'Ethics are ethics; end of story.' Jiang Jianqing, chairman and president of Industrial and Commercial Bank of China, argued that things were moving in the right direction but conceded: 'There is lots of room for improvement to realise better shareholder value.' One problem, he said, was China's profusion of regulators. 'We need to solve the conflicts between them,' he said. Amid all the hyperbole about the Asian century, Mr Watts warned: 'We have to be realistic here. Against the backdrop of a bank-driven credit system, these changes are not going to create a US-style equity market in the next five years.'