Japan's advances toward liberalizing its financial markets offer lessons for resolving some of the problems of the dreadful state of China's banking system. Moody's Investors Services estimates that China's top four state banks incurred over a trillion renminbi (US$120 billion) in non-performing loans (NPLs). Such high debts meant that the banks had a high risk of mass default unless Beijing said the NPLs were cleared. The value of the bad loans is about 12 percent of GDP.
While Beijing states that NPLs are 7 to 8 percent of total outstanding debt, informed market observers place the figure closer to 40 percent. This wide disparity arises from China's state-owned banks considering a loan to be non-performing when interest has gone unpaid for two years. International standards identify bad loans as those without servicing for three months.
The four largest state-owned banks control 60 percent of overall lending and several are technically insolvent due to high ratios of non-performing loans. Most of the bad debt arose from many decades of gross mismanagement of depositors' hard-earned savings. The most deeply entrenched aspect of China's financial system involves "policy lending" whereby state-owned banks extend loans to state enterprises regardless of performance.
Perhaps the best way out of the morass is to liberalize its domestic financial market along the lines begun by the Thatcher government's reforms in the early 1980s known as the "Big Bang." In the meantime, those who hope that China's economy can be reformed should watch the unfolding of events in the Intermediate People's Court in Zhengzhou, Henan Province.
That courtroom may be the scene of an important precedent that would affect the status of China's bankruptcy law and may impact upon corporate gover-nance. It may also influence the writing-down of the massive stock of NPLs generated by the four large state-owned banks.
The case involves a petition filed by China Cinda Asset Management. It is one of four asset management companies established by Beijing to rescue the country's four major financial institutions from their crushing problems with bad debt while also relieving state-owned enterprises of their debt burdens. Instead of privatizing its state banks and financial firms, Beijing has decided to recapitalize them. Unfortu-state-owned enternately, majority ownership will remain in the hands of government authorities as will control over investment funds.
In all events, China Cinda's landmark legal action marks the first bankruptcy motion brought by shareholders in a publicly-listed Chinese company. The asset management company engaged in a debt-for-equity swap with Zhengzhou Baiwen and acquired a 1.9 billion yuan (US$230 million) debt in December 1999.
China Cinda is seeking to force liquidation of the state enterprise that listed on the Shanghai Stock Exchange in early 1996. Zhengzhou Baiwen's debts are thought to exceed 160 percent of its 1.4 billion yuan (US$169 million) in assets. It recorded the largest single loss of any of the firms listed on the Shanghai stockmarket in 1998 and has been the subject of frequent criticisms by state securities regulators.
Local and provincial authorities are hoping that they can eliminate debt from loss-making, mismanaged state enterprises. However, only 69 firms have taken part in the debt-for-equity swaps and the total debt covered so far is only about 25 percent of Beijing's goal.
Besides this slow start, there are other questions about how successful China will be in restructuring its banks. One encouraging point is that asset management companies must earn their own way with profits on their restructuring schemes. Yet even so, the burden on the central government of the write-downs of the debts acquired by these companies is likely to be 4 to 5 percent of GDP, assuming that the recovery rate is similar to the experience of other countries of about 30 percent.
Although China Cinda is moving the process in the right direction, more radical steps will be required to insure that the financial system remains solvent and avoids a systemic crisis. One alternative would be to allow individual savers to choose among private investment alternatives that offer market rates of interest. This would allow more savings to go into higher-valued uses.
Although the Chinese people save nearly 40 percent of their incomes, capital for private development is lacking since the state-owned banks have no competitors. Most investment funds go to state enterprises while the non-state sector that now controls over 70 percent of the value of industrial output has little access to capital.
Liberalization of China's financial sector must allow for increased competition, including new private domestic banks as well as increased foreign operations and ownership in domestic markets. Greater transparency and accountability for financial transactions along with improved risk management would provide assurances to foreign capital owners and encourage greater inflows while also providing more access to foreign markets.
If such a "Big Bang" does not take place in China, it is very likely that its banks will go bust.
Christopher Lingle is an independent corporate consultant and adjunct scholar of the Center for Independent Studies in Sydney who authored The Rise and Decline of the Asian Century (His E-mail address is: CLINGLE@ufm.edu.gt).
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