Analytic Views on Chinese Banking System

Chinese banking system has made progress over the past 30 years, and has a vital part to contribute for China’s future prosperity.  A banking system that can allocate capital more efficiently, and earn an attractive return on investment, is a goal worth pursuing even in face of setbacks.  It should be acknowledged that Chinese banks and their regulators still have a long way to go before they will become real world-class players, a destination hopefully expected to come in a not-too-distant future.

 Part1.         Profile of Chinese Banking System

 When talking about the Chinese banking system, people will be first impressed by its sheer size. For instance, the Agricultural Bank of China (ABC) pocketed in total proceeds of $22.1 billion from its recent IPO in Shanghai and Hong Kong, after exercising over-allotment option, making the world’s biggest IPO ever. The ABC has over a working force of more than 440 thousand, with 23 thousand offices across China and 320 million individual accounts, the biggest bank by business outlets and account holders. According to the Banker, China has 84 banks in the 2010 Top 1000 (in terms of tier 1 capital), up from 52 in the 2000 Top 1000, while US has 169 banks and Japan has 100 banks. Of the Top 20, China has three banks, including the ICBC, CCB and BOC, and the number is just after US (five), UK (four) and France (four), but ahead of Japan (one). With IPO of the ABC, the number of Top 20 in 2010 will definitely be four. China contributes some 8% of total tier-1 capital of top 1000 banks, roughly the same portion of its GDP. Chinese banks do weigh a lot more than a decade ago.

 Second, Chinese banks have developed at fast pace for past three decades. Ever since 1978 when China shifted policies toward market economy, Chinese nominal GDP grew from 364.5 billion yuan to 30 trillion yuan, up 15.9 percent on an annualized basis. The banking industry’s total assets have increased 388 fold, or a 21.2% compound annual growth rate. The outstanding balance of RMB loans increased from 189.0 billion yuan to 30.3 trillion yuan, up 18.5 percent on an annualized basis. The growth of real GDP is closely connected with that of loans over the corresponding periods. It is banks- dominated Chinese financial system s that has effectively transformed the high saving rate into high investment rate and has sustained China’s rapid economic growth. It is expected that Chinese economy will maintain its growth momentum and Chinese banks will continue to expand.

Third, the majority state-owned banks still dominate the Chinese Banking sector, though the dominance is fading with fierce competition from joint-stock banks and other banks. With over 3000 banking institutions at the end of 2009, over half of the assets are still concentrated in four banks (the Big Four), whose shares are majority-owned by the Chinese Central Government. However, the dominance is in steady decline with faster growth and competition from other sector players. In 2003, Big Four controlled over 60% of the banking industry’s total assets.

1.1       Development Stage of Chinese Banks

 China’s banking sector is flying high today and it seems that the current global financial crisis had a very limited effect on China. Does it mean that Chinese bankers do better jobs than their western counterparts? Not necessarily. Chinese banks tend to have a more traditional business model based on retail and corporate lending rather on financial market exposure. According to annual reports of Chinese banks, over 85% of operating income is from net interest income. Chinese banks earn hefty profits on the guaranteed spread in regulated interest rates.

 Chinese banks also face insignificant external competition and foreign exposure. The isolation of the Chinese financial system is conducive to stop spillover effects from the world financial crises. Although China has worked up to open up its financial market since its entry into WTO, the process is gradual and cautious. Furthermore, Chinese government still imposes restrictions on capital accounts and banks’ shareholder structure.

The market share of all foreign banks in China at the end of 2009 was less than 3%. The majority of Chinese assets are domestically sourced, with overseas assets no more than 4%. It is no wonder that the success of Chinese banks should be mostly attributed to golden opportunity in China’s markets rather than their corporate governance.

 On the other hand, the Chinese financial markets are still underdeveloped. Chinese used to be burdened with piles of Non-Performing Loans (NPLs). With the help from state governments, booming economy and hard work from banks themselves, NPLs has been decreased consecutively. By end 2009, the average NPL ratio is around 1.6%. However, the shortlist of inventory from Chinese banks is becoming more and more obvious. The Chinese bankers can offer only corporate loans, household loans and savings. No much for wealth management. So far, financial products on the Chinese financial markets are quite limited. Derivatives traded on the market are traditional products, such as interest rate swap, options and warrants. No CDOs (collateralized debt obligations), or synthetic CDOs are ever traded. Securitization is not commonly traded. That helps to explain why China has not suffered from any indigenous problem.

 However, as China moves into a more open economy, such a situation cannot last long. Chinese banks must find new growth points; otherwise Chinese banks will live and die by their loans. With further development of securities markets and likely convertibility of RMB, Chinese people would like to diversify their portfolio and demand higher returns than paltry fixed savings income. Chinese banks should render more products and more services to their clients’ need. They should learn experiences from west banks.

 1.2       Political Structure, Corporate Governance and Risk Management

 The Chinese banking sector covers a wide variety of institutions, including policy banks, large and medium-sized commercial banks, a network of credit cooperatives in both rural and urban areas, as well as limited presence of foreign banks.

 Except for China Minsheng Bank and a few other banks, the majority banks are still controlled by governments directly or through their vehicle companies. So far, the Chinese Central Government, through the arm of Central Huijin Co., keeps controlling stakes in the Big four, all three policy banks and a few other medium-sized banks. Various provincial and municipal governments also possess majority shares in commercial banks within their jurisdiction.

 During past few years, Chinese banks have marked improvements on their corporate governance and risk culture. At least in theory, almost all banks have solid corporate governance mechanism in place, including general meetings of shareholders, board of directors and board committees, management and board of supervisors. Lines of responsibilities and reporting lines are clearly stipulated in policies. Strategic investors with a seat on the board also have voice.

 For Chinese banks, the purpose of risk management is to maintain a moderate risk preference and a balance between risk and return in a rational, stable and prudent manner. The stated primary objectives are to maximize value for banks’  shareholders, maintain risk within acceptable parameters and, most important of all, to satisfy the requirements of the regulatory authorities, depositors and other interest groups for the banks’ prudent and stable  development. Chinese banks have institutionzed their risk management functions, such as the Risk Policy Committee under the Board, Internal Control Committee, Anti-Money Laundering Committee and Assets Disposal Committee under senior management, Risk Management Department, Credit Administration Department, and etc. However, there are some problems. For instance, boards of directors are still stacked with people from the government. The functions that these risk institutions can play is still a question, especially under political pressures.

 Credit risk is definitely the most important amongst risks facing Chinese banks, and it is referred to situation when a customer or counterparty may be unable or unwilling to meet a debt obligation to the Bank when required. Usually, banks’ credit risks are mainly from loans, trade financing and treasury activities businesses. The credit approval process can be divided into three stages: 1) credit origination and assessment, 2) credit review and approval, and 3) loan disbursement and post-lending management. This process will be revised and updated by the Risk Management Department and related departments regularly. For corporate credit facilities, we continue to use the ‘three-in-one’ credit decision-making process. The three components of this process are an independent due diligence investigation, an independent credit review, a strict approval process by authorized approver and follow-up evaluation.

 Generally speaking, the credit risk assessment process is composed of a series of risk assessment modules such as customer credit rating module, and debt facility rating module. Since the start of the new century, Chinese banks have commenced using a 10-category customer credit rating system (from AAA to D in decreasing credit quality). Customer credit ratings have been centralised, any assignment of a “B”  or better credit rating under the ten-category customer rating system is required to be approved either at domestic tier one branches or the head office.

Banks manage their loan books on individual customer account basis as well as on portfolio basis. At the portfolio management level, banks carried out the overall monitoring of credit portfolios through regular monitoring of the risk and return; and circulated the quantitative guidelines of credit approval policies according industry and customer segments, product category and geographic region. This included revising customer and product policies and placing greater emphasis on reducing industry risk. Chinese banks install industry-based portfolio management of corporate credit assets, pushed forward limit supervision of different industries, controlled the scale of its credit exposure to high-risk industries and optimized the industry structure of its credit portfolio to avoid excessive industry concentration. In line with governments’ policies, Chinese banks encourage the growth of some sectors while discouraging the expansion of others. On one hand, the industry extends more credit support to SMEs and such projects as infrastructure construction, post-Sichuan-Earthquake reconstruction, enterprise merger and acquisitions and innovation of enterprises. On the other hand, credit extension is strictly controlled to industries of high energy consumption, high pollution and resource consumption and those suffering from overcapacity.

 Chinese banks establish personal loan centers in tier-one domestic branches, and centralized the approval of personal loans to these personal loan centers except for individual pledged loans and government-sponsored student loans. Since 2005, relationship managers are able to obtain the borrowers’ credit information through the PBC’s national credit information system. The daily monitoring of retail loans is similar to that of corporate loans. Collection teams is established within the personal banking departments at our domestic tier one branches to improve collections as well as implement more standard procedures and collection methods. The CBRC does not give clear specifications about LTV on corporate loans, but restrictions are imposed on mortgages. For first-home buyers, LTV could be as high as 80%, but for second-hand home or second-home purchase, the down payment will be at least 30% or more.

 Top executives of majority state-owned banks are still appointed by the State Council (Chinese Cabinet), although the appointment will undergo some procedural formalities from their respective boards of directors. To some extent, Chinese banks’ executives are more like government officials than professional managers. Chairmen of boards from the CCB, BOC, ABC, China Everbright and three policy banks, are all former deputy ministers of either the PBC or the CBRC. Chairmen of board of directors, presidents and chairmen of boards of supervisors are all regarded as cadres of deputy-minister level from the administrative hierarchy. According to the BOC’s annual reports 2009, the total payment for the chairman and the president is less than 200 thousand USD. The similar situation exists for the other Big Four. Their payment is only a fraction of that of their western peers. With their dual role as party bigwigs and executives, they are more compliant to a higher authority than the stock market. Furthermore, the Chinese government has the tradition of rotating top management among competing banks.

 The decision to use China’s state-controlled commercial banks as the main conduit for stimulus spending, undermined efforts and progress that was being made towards building a sound banking culture.  In the process, the banks on a large part acted as a cash dispenser, rather a responsible lender. The CBRC, along with the PBC, acted in according to orders by the State Council. Although somewhat unwillingly, the CBRC urged that commercial banks should play their parts to boost the faltering national economy.  Later on, the Chinese regulator warned commercial banks to lend prudentially, imposed loan quota restriction, and asked for higher loss provisioning and capital requirement. For Chinese banks, they believed that stimulus package was an opportunity and they would lend the projects from approved list from the National Development and Reform Commission (NDRC), provided those projects has guarantee from relevant governments. 

 The fact that banks appear to be doing well makes people all the less willing to rock the boat. During last two years, the Chinese banks stress more on size and market share at the cost of risk management and credit quality. In terms of corporate governance, Chinese banks were actually moving backward.

 1.3       Exposure to LGFPs and Real Estate

 Facing the grave situation caused by the world economic crisis, the Chinese government was determined to use an investment plan to boost the sagging Chinese economy, with a four-trillion-yuan economic stimulus plan as its core. Much of that stimulus plan asked Chinese banks to provide enormous amount of funds for new infrastructure projects and the like. The main goal of the lending was to build up the economy and keep unemployment low, rather than to earn a decent return. In the process, a big portion of the loans granted not on a commercial basis, but on policy motives.

 Now some data is emerging on the potential extent of problems, particularly potential losses from loans to development entities (known as LGFPs, or Local Government Funding Platforms) with explicit or implied guaranteed by local governments.  Earlier this year, the Chinese Central Government nullified those guarantees, stating that local authorities lacked the financial strength to support those guarantees and it is not legally allowed for local authorities to provide such guarantees.  In light with Guaranty Law of the People’s Republic of China, the 8th Article clearly stipulates that no state organ (including local governments) may act as a surety, except in the case of securing for onlending, from a foreign government or international economic organizations, as is approved by the State Council. However, in business practice, Chinese banks usually require that local governments should issue guarantees or letters of comfort.  The motive behind this practice is that banks will be in better position for further developments, when local government cannot perform those guarantees.

 According to the CBRC, at the end of June 2010, the total loans outstanding to LGFPs amounted to RMB 7.66 trillion or 9% of all assets in the banking system. Of these LGFP loans, 27% are performing with sufficient cash inflow, 50% must rely on alternative sources for loan repayment, and 23%  or  RMB 1.76 trillion are facing high credit risks.

 Although potentially severe, these bad debts will not necessarily bring the downfall of Chinese banks. According to a recent study by BOC International on Chinese listed banks, LGFP loans will pose a serious threat to their income statements, but without fatal threat to their wellbeing. With further recovering efforts (including loan restructuring, increased collateral and additional guarantor, among others), BOC International suggests the final  loss ratio will be  around 5% on those high credit risks, based on  previous banking experience.

 However, people may argue that the 5% figure is rather too optimistic or too conservative. Even suppose 50% loss ratio for those high risk LGFP loans, with a rough estimate of LGFP loans at 14% of total loan book, the corresponding NPL ratio increment from LGFPs will be 1.61%. In order to keep NPL ratio basically on par with that of 2009, the credit cost ratio will rise from 0.58% in 2009 to 1.82% in 2010, supposing 30% loan growth rate for 2010. Worse prospects are for non-listed banks, especially for city commercial banks, given closer relations with local governments and concentrated loan exposures. However they will also survive, as local government will inject new capital to save their lives. The exact capital to be injected is uncertain, because the CBRC set different CAR targets for different commercial banks. The Big Four’ CAR should be over 11.5%, given their systemic importance. For joint-stock banks, the CAR target is over 10%, and city commercial banks’ CAR should be over minimum CAR, i.e., 8%.

 People may say that LGFP loans aren’t the only risky or inappropriate loans that were made during last year’s lending boom.  There are plenty of other categories, such as loans to property developers, loans to industries with significant overcapacity, loans to overextended home buyers, and loans to businesses that diverted the funds to stock and real estate speculation. These loans may pose equal or greater risk of loss. LGFP figures could just be the beginning. If the pattern persists, and subsequent revelations indicate 20-25% NPL rates for all or most of last year’s lending, problems are hard to fix, and will be headaches for the CBRC and Chinese banks.

 However a large-scale rise in NPLs this year is remote, if not unlikely. Most of the loans aren’t due for another two to three years, and this will give Chinese banks time to fix problems. The risk functions within Chinese banks have played a positive role, and at least they asked for collateral and guarantee to cover risks. Besides, NPL ratio is at historic lows for Chinese banks, around 1.6% by end 2009, and this will also provide some space for Chinese bankers. Most importantly, China’s economy will still to grow at a rather high speed. China’s industrialization and urbanization continue to make it one of the top destinations for foreign investment. The growing economy and burgeoning wealth will further boost consumption and credit.

 So the obvious conclusion is that Chinese banks will suffer some losses (maybe huge), but won’t have systemic risk. At present, the Chinese banks are starting to improve their work and to clean their balance sheets. The CBRC also takes steps to prevent systemic risks, ordering banks to raise their capital base and up their provisioning.  Although the CBRC sounds the credit quality alarm recently, that does not mean that the regulator is  very worried about the deteriorating quality,  the agency jus wants banks to pay attention. If there is real trouble, the CBRC will not make much noise.

1.4       Competition among Chinese Banks

 Although top managers might be politically appointed, the competition between banks is real. Front line banking managers are fighting for market share, loan target and profit quotas, among other annual goals. Their emoluments are directly connected to their performance.

 How do Chinese banks compete with each other? There is a long list to be considered. Pricing, products, banking network, operations of software, market positions of individual bank and its customer, each bank’s prevailing lines of business, extant relationships, and supports from local governments are just a few important factors.

 Say, if Petro China will build a refinery complex in Xinjiang, the project will need huge amount of credits and loans. Definitely every bank would like to get a slice. Which bank(s) should be the winner? The usual practice is that Petro China will send invitation letters to potential bidders and ask each bank to provide its financing proposal. Petro China will select the sponsoring bank(s) based on the financing proposals.

 As Petro China is a listed SOE company, it has a national network and offices throughout the world.  So it will need services only from national banks, including the Big Four and joint-stock banks. City commercial banks and credit cooperatives will have no chance even to be considered.

 The financing proposal will likely cover the following topics, including capital structure of the project, loan and credit structure, proportion of RMB and FX, interest rate structure, drawdown arrangement, repayment schedule, grace period, protection arrangement against unfavourable FX movements, among other things. The more comprehensive the report is, the higher chances the bank wins the project.

 Every bank has its specific advantages. The ABC is well-known for its service for agricultural sector and low cost of deposits. The BOC is good at FX business and trade finance. The CCB is established in the fields of big construction projects and personal mortgage. The Industrial and Commercial Bank (ICBC) takes care of commercial entities of the PRC, boasting its branch network and easy operations of its banking software.

 The interest rate will not be an issue here. Petro China will no doubt enjoy the best quotations. As this is an enormous project, no individual bank alone can handle it, and it is likely to form syndication, likely to be comprised two tranches, RMB tranche and FX tranche. The CCB or the ICBC will be the likely lead manager for RMB tranche; BOC will lead the FX tranche, given their respective forte and good relationship.

Part2.         The Regulation Environment

At present, China adopts a traditional sectors-based regulatory model or functional regulation, with separate regulators for banking (the CBRC), securities (the CSRC) and insurance (the CIRC). Together with the PBC as the central bank, those three highly specialised and mutually independent regulatory commissions make up China’s financial regulatory framework, collectively referred to as one bank, three commissions. This sectors-based regulatory model corresponds to the segmentation of financial services and markets in China, a policy commonly known as separate operation, separate regulation.

As the central bank, the PBC assumes responsibility for monetary policy and the stability of the financial system as a whole. The CBRC is the competent authority responsible for regulating the banking industry. However, it should be noted that certain other government agencies also perform some regulatory functions. For instance, the Ministry of Finance (MOF) has the authority to make strategic and policy decisions on finance and taxation, to set accounting standards, and to issue treasury bonds. The National Development and Reform Commission (NDRC) is empowered to approve the issuance of corporate bonds and is involved in making financial and monetary policies.

  All these bodies, including the PBC, CBRC, CSRC, CIRC, MOF, and NDRC are ranked equally under the direct leadership of the State Council, and the head of each body has the administrative status as a minister.

 2.1       Mechanism of Interest Rates from the PBC

 In recent years, the PBC has made progress in interest rate liberalization. Chinese banks are allowed to determine the interest rate by market conditions for transactions between financial institutions and large FX transactions (in excess of 3 million equivalent USD).

For maturities less than 3 months, the SHIBOR is gradually developing into the market benchmark yield curve. For maturities over 3 months, no benchmark yield curve exists as the market is rarely traded beyond three months.

 However, the PBC still plays a significant role in regulating interest rates, laying down benchmark deposit and lending rates for commercial banks. The PBC abolished the ceilings on lending rates and floors on deposit rates, but still retains floors on lending rates and ceilings on deposit rates. This leaves a guaranteed spread of interest income and some space for banks to compete for loans and deposits.

 It is still unclear about the process and the factors considered by the PBC to determine changes in interest rates. The Monetary Policy Committee under the PBC is the organization that recommends changes in interest rate policy for the State Council’s final approval. A number of factors, such as inflation, employment, economic growth, monetary trends, and investment momentum are all factors considered. However, it is still unclear that which factor is the most important.

 Interest rates do have a rather limited role on Chinese economy. It is widely accepted that interest rate movements have limited effect on the investment behavior of SOEs. Many SOEs, with implicit support from government bodies, face no real threat of bankruptcy and don’t view profit-making as their sole goals. Higher financing costs from higher interest rates do not necessarily affect their investment decisions. Similarly interest rate fluctuation only plays a marginal role on personal consumption, given that Chinese low household debt level means consumption is mainly from savings instead of borrowing. Nonetheless, some sectors of the Chinese economy, such as non-state enterprises and the housing sector, are sensitive to interest rate movements.

 2.2       Regulations from the CBRC

 One thing is worth mentioning here. The CBRC regulates not only banks, but also a variety of specified non-banking institutions, including assets management companies, trust investment companies, financing companies, financial lease companies and other financial institutions established with the approval the CBRC.

 The CBRC is responsible for both market conduct regulation and prudential regulations in relation to the financial institutions it regulates. In practice, the CBRC exercises its supervisory function through prudential standards, such as asset-liability ratio management, capital adequacy ratio and risk management. In addition, the CBRC may seek administrative measures, like the imposition of loan quotas or degradation punishments.  The loan quota is an upper limit on annual loan increment for commercial banks. It is calculated on net basis. The loan quota is conducted through window guidance by the CBRC.

 Despite rapid progress, China’s banking regulatory system is facing challenges ahead. One problem is that China regulators lack regulatory independence. Both the PBC and the CBRC must listen to directions from the State Council. Another issue is the unbalanced structure of market players. State ownership is still pervasive in the financial markets, which may have the effect of inhibiting competition in the financial services and market. Moreover, state-owned banks traditionally favor SOEs and provide limited support to private enterprises. This represents inefficiency in banking system.  As said before, the State Council appoints presidents and other senior officers of the Big Four. Those persons have dual roles, business persons as well as government officials. Simply put, they are quasi-governmental officials, and may even rank equally with the top leaders from the CBRC in the hierarchy of the administrative system. This has affected the authority of the CBRC vis-à-vis the major state-owned banks.

 2.2.1    Conduit of Bank-Trust Issue

 Recently the CBRC has released guidelines regulating the cooperation over bank- trust products (also known as conduit of bank-trust cooperation), following calls in July to halt new launch of those products.

 Regulators are apparently worried that banks and trusts are forming partnerships and using products to finance loans without calling them loans. Regulators are suspecting that banks using these conduits to evade rules to rein credit growth.

 The basic model of bank-trust cooperation runs like this. Banks sell credit assets to trusts, and trusts in turn will sell those credit assets to bank clients as wealth management. At the same time, banks continue to manage loan assets as proxies to trusts. Banks enjoy several advantages. Loans disappear from balance sheets, thus obviating capital requirements and loan loss provisioning, and evading credit quotas imposed by the CBRC. Banks earn fairly decent fee income, and provide customers with credit otherwise unavailable due to credit controls, and customers get higher returns.

 It is estimated that by June 2010, the outstanding balance of bank-trust product amounts to some RMB 2 trillion, or 3% of total banks’ assets. Most of those products are short-term loans or trade finance, and some are near-to-term loans. As Chinese banks are asked to book those off-balance-sheet items into their loan book, they are facing higher capital requirements and lowered income at least in the short run.

 2.3       New Capital Accord

 The idea behind Basel II is, by acknowledging modern risk management techniques, to allow banks to calibrate capital in a more risk-sensitive manner based on the banks’ own measurements of different risks incurred. Moreover, Basel II also requires better risk management and governance, higher disclosure and transparency, and gives regulators more teeth. The key question here is, under such a framework, is it good to Chinese banks?

 The incentives for the CBRC to implement it are clear: deeper and better understanding of the risks incurred in banks, better risk management overall and increasing the industry’s risk withstanding ability and financial intermediation capacity, and responding to the fact that increasingly complex financial instruments have also found their way in China, thus rendering regulatory arbitrage possible and worthwhile. One thing cannot be omitted, to avoid putting Chinese banks at a disadvantage with their international competitors that would implement Basel II.

 In light of the CBRC’s requirements, those internationally active Chinese banks should implement the new accord by end 2010 (or 2013 at the latest) while other banks can choose between Basel II implementation by 2011 or remain on the current mixed framework adopted by the CBRC. All banks are encouraged to work towards the internal- ratings-based approach, but the decision over which approach to implement is theirs, and some of the largest Chinese banks have already started Basel II work. Capital adequacy can be calculated according to Basel II provided the bank has been recognised as compliant and that the coverage of internal ratings exceeds 80% of assets after three years.

 2.3.1    Capital Definition

 The creation in 2003 of the CBRC was intended to force Chinese banking system on a more commercial footing. The Law establishing the CBRC drew heavily on the Basel Core Principles for Effective Banking Supervision, incorporating the Capital Adequacy regime into a key part. In 2004, the CBRC issued Regulation Governing Capital Adequacy of Commercial Banks, combining most of the capital requirements of Basel I with the supervisory review and disclosure aspects (pillar two and three) of Basel II. This regulation is often referred to as Basel 1.5, and symbolized Chinese efforts to adapt Basel requirement with Chinese situations. The regulation was revised twice, in 2007 and 2009 respectively.

 According to the regulation, the capital adequacy ratio (CAR) is defined as the ratios of capitals held by the commercial banks to risk-weighted assets of commercial banks. CAR should be based on consolidated and solo basis. The calculation should be conducted after adequate provisions for various losses, including loan losses, and CAR should be disclosed on a quarterly basis.

 According to the CBRC, capital includes core capital plus supplementary capital minus deductions. Core capital includes paid-in capital or common stock, capital reserve, capital surplus, retained earning and minority interest. Supplementary capital refers to revaluation surplus, general provisions (specific provisions excluded), preference shares, convertible bonds, and long-term subordinated debts (longer than 5 years). Deductions should encompass good will, equity investment in unconsolidated investments, equity investments on commercial real estate and equity investments in business enterprises, and unrealized gains from MTM movements on certain HTM and AFS securities are also to be deducted.

 The initial regulation required that core capital should not be less than 50%, and long term subordinated debt should not be more than 50% of core capital. However, the CBRC raised this threshold in 2009, asking commercial banks to keep at least 75% of capital as core capital.  The CBRC has been working with the BCBS to new definitions of capital, and the general trend is to raise capital quality and have more core quality to withstand loans losses.

 2.3.2    Liquidity Rules

 In November 2009, the CBRC issued Guideline on Liquidity Risk Management of Commercial Banks.  The guideline defines liquidity risk as a failure for a solvent commercial bank to duly acquire fund or to do so at a reasonable cost to deal with the risk of asset increase or repayment of debts at maturity. The guideline stresses that without proper control, liquidity risk is likely to damage the solvency of commercial banks, and therefore liquidity risks management is very important.

 In light of the guideline, the term liquidity risk management refers to the whole process including identification, measurement, monitoring and control of liquid risks. Commercial banks shall follow the principle of prudentially in managing liquidity risk under the normal business conditions as well as under stress. The guideline requires commercial banks to set up a perfect governance structure, defining relevant roles for the board, senior management and relevant department, to measure and determine liquidity risk tolerance in light of the bank’s strategy and risk profile, and to install a good information system. The guideline also clarifies the role of the CBRC to supervise liquidity risk management of commercial banks, and will take timely measures to reduce liquidity risk’s effects.

 The guideline specifically asks commercial banks to cover liquidity risk limits, over-limit processing program, cash flow analysis, stress testing and situation analysis, and contingency plan. Stress test shall be conducted at least quarterly and shall be implemented in accordance with different currencies on consolidation and solo basis.

 Although China doesn’t have in place deposit insurance scheme, government provides implicit guarantee for the retail deposits. Bank run is a rare phenomenon in China. Chinese banks rely on deposit to provide capital to loans, not from the money market. This is a first time that CBRC gave a detailed guideline to banking industry, obvious taking into consideration of the fallout effects from Lehman Brother. The guideline is in broad line with requirement from the BCBS. Detailed requirement will follow after the final agreement from international community.

 2.4       Future International Roles of Chinese Banking Industry

 According to predictions by the Economist Intelligence Unit (EIU), by 2020 American, EU and Chinese economies will each account for just less than 20% percent of global GDP (using purchasing power parity). It predicts that by 2030, the Chinese economy will be the largest in the world, while the relative weight of the US and the EU will continue to fall. According to a recent study from Oliver Wyman, China’s banking sector is expected to grow some 10% on an annualized basis between 2009 and 2014, among the fastest of any other G20 country. Although much uncertainty surrounds such figures, the trend seems clear.

 It is true that China has traditionally taken a realistic view of international relations. It has taken a very cautious approach to most international institutions, seeing them as western-dominated. They have positive attitudes toward international cooperation or the democratization of international relations. China sees the main institutions of global governance as run by westerners for their own benefit. China often stays on the sidelines when international institutions are reformed. As China learns to define and pursue its interests across the globe, it will also take some the responsibilities of a major power.

 The current system of global economic governance largely fails to reflect the rise of China, India or other emerging powers.  The American or EU should be accepted to the view that the global economic institutions must choose between reform and irrelevance. China’s foreign policy is still predominantly hard-nosed and realist, focused on the pursuit of the national interest. Chinese begin to realize that China has an interest in strong international institutions. With the rise of emerging power as a group, the world configuration of major economic powers has undergone great change, which has also put forward the demand for simultaneously rising representativeness and voices for the emerging powers in major international institutions. Under the background of global financial crisis, the opportunity for China to join the reform of international financial looms large. With passing of the crisis, they will also diminish or even disappear.

 China’s major efforts still need to be put on domestic economic reform and development. China is also in desperate want of high-level financial, legal, management talent with experience in international markets. The current strategic focal point for China is to fully advance the institutionalization of the G20, enhancing its role and influence in the international financial system.   The US is the largest benefactor of the current financial system, and China is the largest independent variable in this system. Therefore, China and the US should construct mutual trust and coordinate mutual interest.

 China is going global. Go-out Policy is the Chinese Government’s current strategy to encourage its enterprises to invest overseas. The Chinese government actively seeks to employ its foreign reserves by acquiring assets overseas, as a way to deflate the demand to float RMB.  Lenovo’s purchase of IBM’s personal computer and Geely’s acquisition of Volvo are the most often cited example of this strategy. However, so far this strategy has mixed results. China’s heavy reliance on industrial exports, combined with an increasing reluctance to open its domestic markets, is exacerbating global imbalance. China, as the world’s second largest economy and biggest exporter, needs open market, clear rules on trade and strong dispute settlement mechanism. With the Corporate China going outside, the Chinese banks will follow suit.

 The Chinese government holds positive views towards the Basel framework, believing that the Basel accord still represents the best practices in terms of financial regulations and managerial knowhow from the advanced economies, and that Chinese banks should gain positive benefits from cautious acceptance of the Basel framework. The main momentums are from several key factors:

 v     Chinese banks now rank the world’s largest and most profitable, thus giving regulators and governments’ confidence to adopt the Basel framework.

v     Banking regulators, including the PBC and the CBRC, have strong bureaucratic interest in using global standards to leverage their limited autonomy in the domestic policy process.

v     The voluntary status of Basel standards is important factor, permitting Chinese banks to pick and choose what they needs, and adapt them to Chinese domestic circumstances.

v     The growing significance of international market for China’s own major banks has provided additional incentives for Chinese convergence.

 Part3.              Basic Facts with Chinese

 China has the oldest continuous civilization, with a verifiable history over 4000 years. Beijing is the capital of China and is the focal point for the country. The official language is standard Chinese, which is derived from the Mandarin dialect. Many dialects are spoken but only one written language. Most of international business people and college students speak English.

 A Communist form of government rules China. The Chinese government promotes atheism although the constitution guarantees freedom of religion. The Chinese practice a variety of religions. However, Confucianism, despite not being a formal religion, is widely observed throughout the country.

 China is the most populace county in the world, with an unofficial estimation of China’s population of over 1.4 billion by 2008. Almost 90% percent of the population is Han Chinese. There are strict rules regarding childbirth and each couple is limited to only one child.

 3.1       Facing Keeping and Indirectness

 The Chinese are very conscious of face. Face is called “mianzi” in mandarin, which can also be translated to mean “dignity, prestige and reputation.” Face is essentially some respect in a community and is a crucial underpinning of society. Loss of that respect threatens the relations of individuals with almost everyone in his or her world and is hard to get back once lost, and thus must be avoided at all costs. Chinese go out of their way to be polite and accommodating, to maintain dignity in a variety of situations and avoid disputes, conflicts and embarrassment in their pursuit to avoid losing face.

 Maintaining face and avoiding losing face are important concepts in the West. But the Chinese raise face to a high art. It’s a fragile commodity in China that can easily be lost. The trigger doesn’t have to be extreme. The simple action of contradiction with somebody in the presence of another who is lower ranking causes that person to lose face. Even the simple act of saying no to somebody can make that person lose face.  Chinese also value loyalty and stress the importance of keeping one’s word. Discretion is greatly valued. It is tied with humility and not causing others to lose face.

 Apologizing is important in China. The methods, manners and the ways it is carried out is affected by the rank and identity of the person doing the apologizing and the person being apologized to and is often conducted in a way that is difficult for Westerners to unravel and comprehend. Chinese find it difficult and humiliating to apologize to someone face to face. Sometimes they refuse to apologize even when they know they are wrong. Refusing to apologize causes great harm because of concerns about losing face.

 Chinese can also be very indirect, sometimes painfully so, especially when talking about something that bothers them or may cause them to look bad. Chinese, for example, consider it rude to ask for something directly and tend to avoid using questions that have a yes or no answer to avoid putting someone in the position where they might have to give an answer they don’t want to give or hurt someone’s feelings.

 3.2       Socializing and Privacy

 People like to hang out and socialize on the street, in courtyards or in open public spaces. Conversation is a major pastime and people enjoy joking around and teasing one another. Things are often done with the help of personal contacts or Guanxi in Chinese. Guanxi is omnipresent. If you can’t find someone with a service you need, you find someone who does know such a person.

 Homes are open to family and friends. Brothers, sisters, cousins, uncles and aunts are frequent visitors. Friends often don’t knock when they visit, they just walk in. It is not usual for guests to spend the night. There is not an emphasis on privacy and calling ahead to let people know you are coming like there is in the United States.  However, this habit is changing, especially in big cities.

 While Chinese can be shy and suspicious they can also be very outgoing, generous, curious and genuinely friendly. Many enjoy speaking English with strangers or going out drinking and having a good time. Chinese like to do things in groups. They feel comfortable doing things with their friends and get a certain sense of security and reassurance from being with people like themselves. They tend to be absorbed in the group and their activities and could care less about what people outside their group think of them.

 Chinese are not so comfortable with American-style cocktail parties. One executive with the Chinese computer company Lenovo told Time, “We stand there and talk to each their. That’s just not our style.” Chinese are also fond of having photographs taken of themselves with their friends and are particularly fond of having their picture taken in front of anything considered wacky, different or strange. Chinese on hiking trips seem to do more photo-taking than hiking. This is because Chinese treasure their friends and the memory of good times, and the value of an activity is often measured more in the bonding that takes place than with the activity itself, plus they get enjoyment from posing and looking at the photos later on. Photos without people in them are considered boring.

 3.3       Business Greetings and Meetings

 Address a person using his or her family name only, such as Mr. Chen or Ms. Hsu. The Chinese family name comes first and is usually one syllable. A one or a two-syllable given name follows a family name. For example, in the case of Teng Peinian, Teng is the family name and Peinian is the given name. In some instances, westernized Chinese might reverse their names when visiting and sending correspondence abroad. Therefore, it is always a good idea to ask a native speaker which name is the family name.

 For business purposes, it is traditionally acceptable to call a Chinese person by the surname, together with a title, such as “Director Wang” or “Chairman Li.” Avoid using someone’s given name unless you have known him or her for a long period of time. Formality is a sign of respect, and it is advisable to clarify how you will address someone very early in a relationship, generally during your first meeting.  Do not try to become too friendly too soon, and do not insist that your Chinese counterparts address you by your given name. The Western pattern of quick informality should be resisted.

 The Chinese way of greeting is a nod or slight bow. However, when interacting with Westerners, Chinese usually shake hands. Bear in mind that a soft handshake and a lack of eye contact do not necessarily indicate timidity. It only implies that the person is not accustomed to the firm handshakes commonly used in the West. Meetings begin with small talk. Resist the temptation to get down to business right away. Also, avoid telling Western-style jokes, because jokes sometimes do not translate across cultures and can cause confusion or hurt feelings. Avoid talking politics or religion. Good topics: Chinese food, sports or places one should visit.  If a Chinese person gives you a compliment, it is polite to deny it graciously. Modesty is highly valued in China.

 3.4       Rank and Status

 Chinese pay much attention to rank and status. The most important member of a company or group should lead important meting. In the presence of seniors, juniors will be inclined not to give opinions, especially different opinions. In China, it is assumed that the first person that enters the room is the head of the group. Westerners should observe this convention so as not to confuse the Chinese. Important guests are usually escorted to their seats. If the meeting room has a large central table, the principal guest is likely to be seated directly opposite the principal host.

 Special respects should be rendered to secretary to senior officials. Unlike their western counterparts, secretary is regarded as the right hand man beside the VIP. He or she can play important roles when arranging meetings and other social events.


About wilbertouyang

I am a Chinese, just moved from China to the States. I am now working for the banking compliance field, especially keen on new basel accord, liquidity risk, corporate governance, etc.
This entry was posted in Banks, Basel Accord, Regulations and tagged , . Bookmark the permalink.

2 Responses to Analytic Views on Chinese Banking System

  1. Christopher Roy says:


    Great post and very informational for someone like me, as I continue to pursue careers in China.

    There is much to discuss here, but first I’d would like to ask a few general questions:

    In aggregate, how big of a role has true credit analysis (cash flow, collateral, industry, etc…) played in the approval process for commercial loans in China over the last decade? Are approvals more dependent upon Guanxi? How do you foresee this changing going forward given the surge in lending last year?

    What is the average size of a commercial borrower (in terms of assets or revenues)?

    Is there currently a Chinese equivalent of the SBA guaranty program? If no, do you envision this becoming a part of the maturing Chinese banking system?

    Again, great post and I look forward to your response.

    • Hi, Christopher,

      Thanks for your interest in my article.
      I believe that true credit analysis plays a more and more important role in the credit approval process. Guanxi is essential to lure t the business, but in order to get it approved, the bank needs accurate credit analysis, to weigh the cons and pros of the deal.

      Well, I don’t believe that average size matters here. In China, we have very big SOEs, and a lot ordinary banking customers. If those two combined, it doesn’t make much sense. But to give you a sense, customers with assets less than 10 million RMB, will be classified as individual loans.

      I don’t understand SBA guaranty program.

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