The revolution taking place in China's banks is all about risk management. The big changes under way - increasing centralisation, the installation of sophisticated new technology and the introduction of foreign investors - are all being driven by an overriding need to assess and manage financial risks more accurately. In the days of a centrally planned economy 20 years ago, risk simply did not matter to mainland banks. They acted more like welfare organisations or offices of a budget department than anything approaching the rest of the world's idea of commercial banks. Savers kept their money on deposit because there was little else for them to do with it. Provincial branches lent the cash to local state-owned companies in support of official policy. The money ensured the factories kept operating and wages were paid. With interest rates decreed by the central bank, there was no attempt to assess borrowers' ability to repay or price loans according to risk. Often, borrowers made little effort to service their debts. They suffered no penalties. When the loans fell due, the banks simply rolled them over to ensure the companies stayed in business. By the late 1990s, as many as half of the loans extended by the Big Four state-owned commercial banks were non-performing. The country's financial system was effectively insolvent and threatening to undermine the economy's growth trajectory. The need for action to clean up the banks had become urgent. In 1998, the central government injected fresh capital into the big state banks, and the following year took 1.4 trillion yuan of bad loans off their books. That was the easy part. Altogether more challenging was to establish credible risk management systems and procedures to ensure the creation of new bad loans be kept to a minimum. China's banks have made great strides since then. They have spent lavishly on computer systems, tightened their classification of bad loans, and in some cases they have even hired experienced outsiders as risk managers. 'There have been some obvious improvements,' said Ryan Tsang, a bank credit analyst at ratings agency Standard & Poor's, which last week raised its ratings on seven mainland banks. Quantifying those improvements is tricky, however. Over the past two or three years, China's banks have been aggressively expanding their loan books. With the economy growing strongly, few of these new loans have so far turned bad. The worry now is that the apparent fall in bad loans over the past two years is due more to the rapid growth of new lending rather than to superior risk management. Mr Tsang has tried to gauge the magnitude of this effect for China's second-tier, joint-stock banks. At the end of last year, the average bad-loan level was a relatively respectable 4.4 per cent. But when he adjusted for the growth of loan portfolios over the past three years, the proportion of non-performing loans transpired as 10 per cent. Even so, Mr Tsang is encouraged. 'Clearly, the NPL ratio is higher than reported. But the trend is downwards, which indicates some improvement in risk management.' That is good news for the five listed joint-stock banks. Assessing standards of risk management at the Big Four state banks, with their tens of thousands of branches and close political connections, is another matter. In a research report on China Construction Bank ahead of its planned flotation this month, investment bank Goldman Sachs has attempted to work out how many of the loans extended over the past few years to new customers have turned bad. The answer is disturbing. Last year, according to Goldman Sachs' estimate, 7.4 per cent of the loans granted to new corporate customers in 2002 became non-performing. That indicates there are still deep flaws in the quality of the bank's lending decisions. Even worse, 'special mention' loans, which borrowers are servicing but which are reckoned to have a high probability of turning bad, made up 14 per cent of CCB's loan book in the first half of this year. If economic growth slows, concludes the investment bank, 'corporate NPLs could rise sharply'. The problem, say observers, is that although senior executives and headquarters' staff at the country's biggest banks have bought thoroughly into the doctrine of risk management, there are doubts over how deeply their message has penetrated their vast branch networks. It is simple enough to buy sophisticated computer systems and employ risk managers. It is far more difficult to re-engineer a bank so that assessments of risk and judgments about how to manage it lie at the heart of every business decision taken each day, especially if there is resistance to the new methods from entrenched middle managers. 'It will take many years to get everyone on board; to break the old culture of relationship banking and policy lending; and to persuade managers to follow procedures and evaluate companies' credit-worthiness,' Fitch Ratings managing director David Marshall said. Nevertheless, China's most senior bankers are trying hard. They are building databanks of information on borrowers that rate them by credit risk, industrial sector and the quality of their collateral. Credit approval decisions are increasingly being taken out of the hands of local managers and centralised. The powers of audit committees are being strengthened. And for the past three years, bankers have even been granted some discretion over the interest rates they are allowed to charge private-sector borrowers. But such fundamental changes can only take effect slowly. 'How do you change the culture when the problem is down in the trenches at the credit approval level?' ABN Amro financial institutions head Sam Zavatti asked. 'Given the size and depth of China's financial services problems, they are not going to be solved overnight or even in the next couple of years.'