Banking: Where now? China's banks have come a long way in the past 10 years. Today, China Construction Bank (CCB) is on the cusp of an initial public offering that could raise as much as $60 billion. That is an astonishing achievement for a bank which just two years ago laboured under a non-performing loan ratio of 12 per cent and which lost its two most recent chairmen to corruption scandals. Approaching its listing, CCB boasts a bad-loan level of just 3.9 per cent and a respected former senior central banker as its boss. It has cut costs by slashing branches and reducing bloated staffing levels. It claims a respectable return on equity and an adequate amount of capital. To bolster confidence, the bank has recruited two high-profile foreign strategic investors - Bank of America and Singapore's Temasek Holdings - which have bought 15 per cent between them. Bank of China, next up for flotation, has done even better - enlisting Royal Bank of Scotland, the Li Ka Shing Foundation and Switzerland's UBS as investors. Yet, despite the good news, all is not well within the mainland's banks. The reduction in non-performing loans has been achieved largely by expanding the overall size of loan books. Lending grew more than 20 per cent in 2003 and has continued to swell at double-digit rates since. Because borrowers usually manage to service their loans for the first two or three years, the proportion of bad loans has fallen even as the absolute amount threatens to rise. Worse, there are doubts about the quality of the companies to which the new loans have been made. Strenuous efforts to inculcate a risk management culture have met with limited success. The interest rates banks can charge on their loans are still capped by central government decree. With restricted freedom to set rates on loans to private-sector companies, for the most part bankers have continued to lend to corporations with strong state ties at rates that bear little relation to their risk of loss. New loans to companies in the inflated property sector are turning bad at an alarming rate. At CCB, 'special mention' loans - those considered highly likely to turn bad - amount to almost 17 per cent of the loan book. Bank of China is even worse off, with a non-performing loan ratio of 5 per cent and a special-mention level of 20 per cent. Even after listing, Beijing will retain a controlling share in the big banks, a situation that has led the Organisation for Economic Co-operation and Development to question their standards of governance. Despite all the improvements introduced by recent reforms, the big problem remains that bankers are unable to set their own prices on credit risk. Until interest rates are deregulated, allowing banks to make returns commensurate with their risks, mainland banks will remain little better than policy arms of the central government. While rates continue to be centrally mandated, irrespective of credit risk, China's banks will remain a dubious investment.