Reforms gain pace

The Chinese government looks set to allow more public share listings of banks as a means of accelerating reforms in the troubled banking sector.

At the Fortune Forum meeting held in Shanghai at the end of September, Mr. Gao Xiquing, vice chairman of the China Securities Regulatory Commission, said that Beijing hoped to use the stock market to benefit state-run banks. "We already have over 30 domestic banks in China. Quite a few are planning to go public," he was quoted as saying.

The first to list was Shenzhen Development Bank, on the Shenzhen stock exchange. It was followed recently by Shanghai Pudong Development Bank (SPDB), a regional bank set up in 1993 to help finance major government projects in Shanghai and neighbouring provinces. Its initial public offering was much larger than that of Shenzhen Development raising a total of US$480m-worth of capital in A-shares. These shares are denominated in the local currency and available only to domestic investors. SPDB will be listed on the Shanghai stock exchange – although by late October that had not yet happened.

New strategy
These moves have been interpreted as evidence of the government's strategy to make the banking industry independent, competitive and commercially viable.

"The fact that they are letting Pudong Development Bank go ahead with the listing means that they are starting to talk about privatisation even in the banking sector," said Mr. Qu Hongbin, an economist with Bank of China's investment banking division in Hong Kong. "Once Pudong Development Bank is listed, you will see more banks start to list, and that opens the door for the government to gradually cut its stake in the banks."

?Privatisation' is a word that the Communist government seldom uses, but a consensus seems to have emerged among the party and government hierarchy that a drastic readjustment of the ownership structure is needed to shake up the banking industry – without the state actually relinquishing control.

In the case of SPDB, 16.6 percent of the shares will be held by private investors and 18.45 percent by mutual funds. The government will hold 10.75 percent directly and 54.2 percent indirectly through other state-owned institutions.

It may be relatively easy to sell the shares domestically as both private and institutional investors are starved of adequate investment products. Western money might be harder to attract, since many foreign analysts believe that the level of bad debt in China's banks is so high that the sector is technically insolvent.

In its August report entitled China: Banking System Outlook, the credit rating agency Moody's gave SPDB a negative outlook rating, together with other four state-owned commercial banks – Everbright Bank, China Merchants Bank, Shenzhen Development Bank and Guangdong Development Bank. Only one Chinese bank, Citic Industrial Bank, did not receive a negative rating from Moody's.

Commercial viability
One important element missing from the banking reforms is a change to the lending culture of state-owned banks, according to the Moody's report. ?State-owned banks still have to lend massively to prop up the slowing economy and the faltering state industrial sector, aggravating their already weak financial condition,? it says. Nearly 90 percent of state bank lending in the first half of this year was made to state-owned companies despite their poor performance, the report adds.

Non-performing loans to the state sector, officially estimated at about US$300bn, have long plagued the banking industry. Banks have been accustomed to a culture of extending credit to meet political rather than commercial targets.

To clean up the balance sheets of all state-owned banks, the central government took a bold step earlier this year by creating asset management companies. At the forefront of change is China Construction Bank (CCB), one of the big four national commercial banks, which is transferring its non-performing loans to its asset management company Cinda.

Cinda Asset Management Corporation was set up in April with a registered capital of Yn10bn provided by the Ministry of Finance. I be company is to buy at face value from CCB about Yn200bn-worth of its non-performing loans. It is funding the purchase by issuing bonds backed by the ministry.

Debt-for-equity swaps are likely to be Cinda's main method of dealing with indebted enterprises that still have prospects, according to its president Zhu Dengshan. Officials hope that debt-for-equity deals can alleviate the crippling burden of interest payments and capital repayments on state enterprises that have over-borrowed, and so leave holders of equity with something more valuable than a non-performing loan. Cinda has recently undertaken a debt-for-equity swap involving a Yn600m loan to Beijing Cement Plant. It has also announced that it is working on similar arrangements with indebted enterprises such as Nanjing Panda Electronics, which is shifting its business from television manufacturing to telecommunications.

On October 15 China Orient Asset Management was created to clean up the bad loans held by Bank of China. China Orient was the second such company to be established and it has registered capital of Yn10bn. The third was set up a few days later by Agricultural Bank of China creating Great Wall Asset Management.

Mr. Dai Xianglong, governor of the People's Bank of China, believes that separating part of the non-performing assets from the balance sheets of commercial banks via asset management companies, "will not only improve the overall balance sheets of the banks, but also reduce the debt service of the state enterprises." Moody's, however, is less optimistic. It is concerned that the lending culture continues to create non-performing loans, even though banks are being relieved of responsibility for their past mistakes.

In April this year the Guangzhou branch of the central bank released a circular to provide ?guidance' over monetary policies and credit allocations for the state-owned commercial banks under its purview. Among other things, the circular said that new loans for agriculture from the banks should comprise at least 10 percent of their total new loans in Guangdong and at least 15 percent in Guangxi and Hainan. It stressed that reasonable capital demands from state-owned enterprises should be met. Together with various city commercial banks and urban monetary cooperatives, Minsheng Bank was also urged to allocate more than 40 percent of its aggregate new loans to its main clients. Minsheng is arguably the only private commercial bank in the country, set up in 1996 to boost lending to private and collective firms.

Despite Governor Dai's insistence that commercial banks should be accountable for their own credit decisions and that the government would stop interfering with their operations, few believe bank managers have actually been given the freedom to conduct their own business independently.

Management incentives
Credit lending, risk management and personnel training, practices in the banking sector have been shaken up over recent years, though local banks remain virtually the only source of borrowing for the majority of state enterprises.

To combat rampant bribery and corruption, CCB is planning a remuneration scheme that involves doubling the pay of top executives and introducing performance-related bonus packages. Under the proposed scheme, CCB would become the first big state-owned commercial bank to have any-thing remotely approaching a commercial pay structure that rewards bankers for sound judgment and good performance.

At the moment, the highest-ranking bank executives are only allowed a salary three times that of the most junior banker. The proposal will allow the bank to double the amount paid to its top executives. Mr. Zhou Xiaochuan,' CCB president with 400,000 employees under him, for example, will receive an increase to his monthly basic pay of just Yn3,000 (US$360). Under the current system, he is provided with various perks and benefits including a chauffeur-driven car and free home telephone.

The remuneration system is more flexible in the regions, where the local head of a big state bank could take home about Yn8,000 every month, according to Mr. Ernest Zheng, a local banker who was formerly assistant to the general manager of China Communications Bank. But he says that perks and benefits in the banking sector are so widespread that they have even reached the level of division chiefs.

CCB is also working on plans to monetise perks that executives enjoy. Any proposals relating to changes in the pay system, however, will have to be approved by the government.

Starting from the early 1990s, foreign banks were allowed to set up offices in China. They have since poached many young, competent and English-speaking bankers from local banks – including Zheng, who is currently the Beijing chief representative of Fortis, the Dutch-Belgian bank. But the fear of a brain drain has not materialised, according to Zheng.

"Managers in local banks have an unrivalled position among state enterprises [due to lack of competition from Western banks]," he observes. "Apart from the perks they get from their own banks, they enjoy a great deal of corporate hospitality provided by their clients or potential clients. It is a comfortable life, compared with the hire-and-fire, roller-coaster life with a Western bank."

However, Zheng believes the rigours of a shareholding system and the gradual introduction of Western management ideas will transform the banking sector in the long run.

For example, the International Finance Corporation, the World Bank's private sector lending arm, has recently taken a seat on the board and a five percent stake in the Bank of Shanghai, formerly known as the City Cooperative Bank. Now that the government is starting to address the issue of ownership structure in banking, "the regional banks that are relatively new, with reason-ably respectable balance sheets and a good management team will attract a lot of interest from Western banks," Zheng says.