1

China’s Banking and Financial System

Xingmin YinChina Center for Economic StudiesFudan University

2

Contents1. Introduction2. Financial and banking system3. Financial markets4. Regulation of the financial system5. Performance analysis6. Non-performing loans and the reform of banking system7. Reform progress: Recapitalization 8. New Policies for the reform of banking system: Strategic

investors9. Conclusions10. Questions and Problems

3

1. Introduction Overview of banking industry in China. The banking industry has been growing at an avera

ge annual rate of more than 19% in assets for the past two decades.

Total banking sector assets reached 37.5 trillion yuan in 2005, or 209% of GDP, one of the highest in the world, for example, 140% of GDP in Japan, 146% in Germany, and 297% in UK.

China today boasts one of the largest banking industries in the world.

4

The state-owned commercial banks dominated the banking system.

In recent years, the reform of state-owned banks has been pushed forward steadily due to the pressures imposed by many new issues in the globalization of economy.

The objective of state-owned bank reform is to transform these banks into modern financial institutions with good governance and operations, clear business targets and sound financial performance.

5

A. New Development of China’s Financial Industry Chinese economy is distinguished with the

manufacturing power in development, but tertiary industry gradually increased its share in GDP, from 32.8 percent in 1996 to 40 percent in 2005, and financial industry accounted for 3.4 percent.

Financial sector development helps economic growth through more efficient resource allocation and productivity growth rather than the scale of investment or saving mobilization.

What is the major function of financial industry?

6

Countries with better developed financial system experience faster economic growth, measures of financial development, such as the ratio of M2 to GDP yield similar results.

Credit to GDP is a standard measure of financial intermediary development and in the ratio of claims by deposit money and other financial institutions on the domestic non-financial sector to GDP.

7

Financial Development

M2/GDP Deposits/GDP Loans /GDP

1990 81.92 62.38 81.24

2001 144.36 130.97 141.24

2006 163.89 159.08 106.87

20072008

163.16 157.81

157.49 151.83

106.67 106.31

More savings for economy growth.

8

Financial Development

020406080

100120140160180

Loans/ GDP Deposi ts/ GDP M2/ GDP

%

9

Discussion More savings contributed to China’s

economic development in the past 20 years.

Is it possible for China to continue its investment growth in the support of high saving rate?

10

B. Household Savings in China What is the feature of household savings? High level of household savings, which increased fr

om 7.38 trillion yuan in 2001 to 22.5 trillion yuan by end-2008.

Discussion on the Chinese Saving Puzzle and the Life-cycle Hypothesis by Franco Modiglian and Shi Larry Cao, Journal of Economic Literature, March 2004.

11

Comparison on Saving Amount

China 2001 2006 2007 2008

Household saving, RMB billion 7376.2 16158.7 17253.4 22200.0

USD, billion 891.17 2026.99 2268.99 3248.18

Gross saving, RMBUSD, billion

47800.06993.83

USA, billion Q.2, 2008

Gross saving 1657.6 2038.5 1956.0 1672.9

12

Year-on-Year Increases

0

1000

2000

3000

4000

5000

6000

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

GDP I ncrease Househol d Savi ngs I ncrease

Billion yuan

13

The situation with bank deposits increasing amount has continued to decrease since 2006, although total deposits with the system in December 2007 still keep its rising level, but small numbers with 1.1 trillion yuan in comparison with 2.15 trillion yuan in 2005.

In 2008, households increased their saving amount of 4.75 trillion yuan, accounting for 92.22% of net increases of GDP (5.15 trillion yuan).

What direction for the year of 2009?

14

Discussion on “Global Savings Glut”

Federal Reserve Chair Ben Bernanke called: the global savings glut: the enormous financial surpluses realized by certain countries.

Chinese households save an astonishing 40 percent of their incomes. Why?

Different views on this issue……

15

2. Financial and Banking Systems

A. People’s Bank of China

B. Policy banksC. Depository institutions (commercial banks)

State-owned commercial banks Joint-stock commercial banks Regional commercial banks Urban and rural credit cooperatives Joint-venture Banks and foreign-funded

banks

16

D. Contractual Saving Institutions (Insurance Companies) Domestic funded insurance corporations Joint-venture insurance corporations

E. Investment intermediaries Securities firms Finance companies Credit and investment companies Investment funds

17

A. People’s Bank of China: PBC The unified function of the central bank and

commercial bank. The State Council issued the policy on the

function of PBC as the Central Bank in September 1983.

The People Congress issued The Law of PBC in March 1995.

The PBC set up its 9 regional PBC Branch-Banks throughout the country, which is regarded as the action to follow the Fed System of the USA.

18

The Functions of the PBC

To promote economic growth To stabilize the price To supervise the financial system To make monetary policy under the leaders

hip of the State Council How independent is the PBC in special refer

ence to other countries?

19

B. Policy Banks Suggestions from the World Bank. Practically all developing countries possess speciali

zed public sector: financial institutions such as a variety of development banks.

These development banks have been established to attract foreign resources, to mobilize domestic savings (in part by developing capital markets), and to allocate investable funds efficiently.

Three policy banks provide policy lending functions on behalf of the central government.

20

Breakdown of Policy Banks

Institution Established

Time

Capital Assets(2002)

Sources of Funds

National Development Bank

March 1994

50 1041.71 Bonds, Loans

Export-Import Bank of China

April1994

3.38 110.18 Bonds

Agricultural Development Bank of China

November1994

20 764.47 Bonds, Loans

Unit: billion yuan.

21

Debating on Policy Banks The development banks were viewed and acted

as tools of development policy, channeling resources to publicly promoted or state-owned enterprises and to priority sectors which commercial lenders were unwilling to finance.

Different views on the establishment of the development banks: The development banks are no panacea for

solving the basic problem of credit allocation.

The specialized financial institutions set up to support a problem sector of the economy itself becomes a problem institution.

22

C. Depository Institutions Structure of Banking Industry. There are 133 domestic banking institutions

operating at national and regional level, offering deposits and loan products to retail and corporate customers.

The four tiers of banking industry may be classified in China: state-owned banks, joint-stock banks, regional and local banking institutions, and foreign-funded banks.

23

Market Structure （ billion yuan ）Assets % Liabilitie

s%

Banking industry 26729.5 96.7 25805.8 97.1

Policy banks 2124.7 7.7 2029.1 7.6 State-owned banks 15194.1 55.0 14576.2 54.9 Joint-stock banks 3817.0 13.8 3683.1 13.9 Urban commercial B. 1609.0 5.8 1558.7 5.9 Rural credit coop. 2689.3 9.7 2702.6 10.1 Postal savings bank 898.4 3.3 898.4 3.4 Foreign-funded banks 396.9 1.4 357.7 1.3Non-banking industry 910.0 3.3 768.3 2.9Total 27639.5 100.0 26574.1 100.0

24

Four Tiers of Banking industry1. Four state-owned commercial banks dominate

the banking industry, in spite of the decreasing shares in deposits and loans business.

2. Joint-stock banks……3. Regional and local banking institutions such as

urban commercial banks, rural commercial banks and rural credit cooperatives, and postal saving banks……

4. Foreign banks, after 25 years of Greenfield development committed by foreign banks, the foreign banks activity in China still accounted for a paltry 1.3% of total assets and liabilities in 2003.

25

Commercial Banks

Banks are financial intermediaries in the business of earning profits.

In China, four large state-owned commercial banks dominate the banking industry, while in the United States there are on the order of 9000 commercial banks.

26

State-owned Commercial Banks

BanksAssets(2002)

Share of Total Assets (%)

2002 2007

Industrial and Commercial Bank of China (ICBC)

4734.24 24.03 18.33

Agricultural Bank of China (ABC)

2976.57 15.11 14.28

Bank of China (BOC) 2905.71 19.82 14.15

Construction Bank of China (CBC)

3083.20 15.65 15.57

Sub-total 13699.72 74.61 62.33

27

Joint-Stock Commercial Banks

BanksAssets(2002)

Share of Total Assets(%)2002 2007

Bank of Communications 766.87 3.89 4.96

CITIC Industrial Bank 335.16 1.70 2.39

China Everbright Bank 328.34 1.67 1.74

China Minsheng Bank 246.28 1.25 2.17

China Huaxia Bank 178.15 0.90 1.40

China Merchants Bank 371.66 1.89 3.09

Sub-total 2136.46 11.3 15.75

CITIC: China’s International Trust & Investment Co. .Unit: billion yuan.

28

Regional Commercial BanksAssets(2002)

Share of Total Assets(%)2002 2007

Shanghai Pudong Development Bank

279.30 1.42 2.16

Guangdong Development Bank

219.32 1.11 1.03

Fujian Industrial Bank 178.28 0.90 2.01

Shenzhen Development Bank 166.17 0.84 0.83

Yantai Housing Savings Bank 15.66 0.08 /

Sub-total 858.73 4.35 6.03

A few of regional banks have been established in the past five years. Unit: billion yuan.

29

Discussion What will the structure of the Chinese banking indu

stry look like in the future? Are private banks good things for the development

of the Chinese banking industry? Is it a long-term trend of separation of the banking

and securities industries? An imitation of the Glass-Steagall Act? More choices? Future Prospects……

30

Effects of Financial Crisis on China’s Banking System China is little affected by the crisis, and its

entire financial system plays a relatively small role in its economy, and it apparently has no exposure to the toxic assets.

However, the Chinese government attitudes to financial innovation have changed to be much cautious in the short and medium term.

31

D. Contractual Savings Institutions

Insurance is a growing industry in China. The annual revenues of insurance companies excee

ded 400 billion yuan and 703.6 billion yuan in 2004 and 2007, and further to 978.4 billion yuan in 2008.

Special business opportunity and the emergence of foreign-funded insurance companies.

32

Insurance Companies Insurance companies are considered financial

intermediaries for several reasons: They receive investment funds from their

customers. They place their money in a variety of

money-earning investments. So they take in funds from one sector and

invest it in another.

33

Growth of Premium, Claim and Payment in Insurance Companies

0

200

400

600

800

1000

1200

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Premi um Cl ai m & Payment

Billion yuan

34

Technical Indicators of Property Insurance Companies (2004, 2007)

Item 2004 2007Premium % Pre. C&P

2004 C&P %

Enterprise Property Insurance

13.4 11.91 18.7 10.1 6.9 11.92

Motor Vehicle Insurance 74.5 66.22 148.4 79.0 41.6 71.85

Freight Transport Insurance

4.6 4.09 6.3 2.3 1.6 2.76

Agriculture Insurance 5.3 3.0 Accident Injure Insurance 7.4 2.3 Other Insurance 15.1 14.85 208.7 5.4 10.36

Total 112.5 100 57.9 100.0

35

Economic Indicators of Life Insurance Companies (2004, 2007)Item Premiu

mPercentag

e(%)Claim&

paymentPercentag

e(%)

Life Insurance,2007,

285.1446.3

89.2690.12

30.8106.4

72.3088.59

Health Insurance2007,

25.737.0

8.05 8.83.0

20.66

Unforeseen Human Injury Insurance2007

8.6

11.6

2.69 3.0

10.7

7.04

Total2007

319.4494.9

100100

42.6120.1

100100

Unit: billion yuan.

36

Discussion on the Case of China Why do people pay for insurance when they

know that over the lifetime of their policy, they will probably pay more in premiums than the expected amount of any loss they will suffer?

How to explain the behavior of ordinary people in China: Everyone knows that the insurance company would help

if an emergency occurred, but almost everyone would prefer to setting aside reserves for emergency case.

So these reserves could not be invested long-time but would have to be kept in an extremely liquid form- Household Savings: How to resolve this paradox in China?

37

Fund Use of Insurance Co.year Fund

UsesDeposits G-

BondsFinancial Bonds

Co. Bonds

Invest.Funds

2004 1077.82 507.11 261.84 102.63 63.97 66.63

2005 1409.27 516.55 359.07 180.47 120.46 110.70

2006 1778.54 598.91 364.70 257.53 212.16 91.21

2007

%

2672.19

100.00

651.63

24.39%

396.11

14.82

493.77

18.48%

280.17

10.49

253.05

9.47%

2008 3340.00 808.76

Unit: billion yuan.

38

Discussion Regulations on the fund use of insurance

companies.

Changes of regulations……

39

E. Investment Intermediaries In the last fifteen years, the profitability

of the securities business became evident, and the securities industry expanded so dramatically.

Many securities firms engage in all three securities market activities, acting as brokers, dealers, and investment bankers in China.

Finance companies. New phenomenon: Investment funds.

40

General Information on Investment Funds

2002 2003 2004 2007

Number of Securities Investment Funds

71 95 161 346

Capital of Securities Investment Funds(Billion yuan)

131.89 161.47 330.88 2234

Turnover of Securities Investment Funds(Billion yuan)

116.66 68.27 72.86 862

41

Imitation: Learning By Doing, 2004

Number

Balanced Funds 16

Bond Funds 11

Value Funds 2

Growth Funds 7

Growth and Income Funds 3

Index Funds 3

Other Kind of Funds 10

42

3. Financial Markets The Money Markets.

Inter-Bank Market. Bill Market. Repurchasing Bond Market.

The Capital Markets. Stock Market. Bond Market.

The Future Markets. The Mortgage Markets. The Foreign Exchange Market.

43

Brief Discussion on Money Market

The money market’s prime function is to assist banks in their treasury operations—that is the management of their cash, short-term assets and short-term liabilities.

Commercial paper is a much less important asset and, it is mainly held outside the banking system.

44

The money markets have been active since the early 1990s, and become more important than 1990s.

The money markets will be much more important for the coming years due to indirect manipulation of monetary policy by the PBC.

45

Money market securities have three basic characteristics in common: They are usually sold in the large

denominations. They have low default risk. They mature in one year or less from their

original issue date. Most money market instruments mature in less than 120 days.

46

Money Market Instruments,2004

Amount Percentage

Market loans (deposits)

19949 44%

Treasury bonds

5042 11.1%

Repurchasing agreements

15900 35.1%

Commercial paper

4450 9.8%

Unit: billion yuan.

47

A. The Inter-Bank Borrowing Market

The inter-bank market started in operation on 3rd January, 1996

The number of participants (financial institutions) increased from 96 in 1997 to 918 in 2003.

48

Volume of the Inter-Bank Market

0

500

1000

1500

2000

2500

7 daysoverni ght

49

B. The Repurchase Bond Market Repurchase Agreements (repos) A firm can sell Treasury securities in a repurc

hase agreement whereby the firm agrees to buy back the securities at a specified future date.

Most repos have a very short term, the most common being for 3 to 14 days. There is a market, however, for one-to three-month repos.

50

Open market operation of the PBC

The PBC uses repos in conducting monetary policy.

The conduct of monetary policy typically requires that the PBC adjusts bank reserves on a temporary basis. To accomplish this adjustment, the PBC will buy or sell Treasury bonds in the repo market.

51

The Future of Repo Market From the conduct of monetary policy to the

multiple function of repos. To increase the primary money market play

ers: Commercial Banks Businesses Investment Funds

To expand the dealing scope between financial and non-financial institutions.

52

C. Commercial Paper Market Commercial paper securities are unsecured promissory notes,

issued by corporations that in no more than 270 days. Because these securities are unsecured, only the largest and most creditworthy corporations issue commercial paper.

The interest rate the corporation is charged reflects the firm’s level of risk.

Most commercial paper actually matures in 20 to 45 days. Most commercial paper issued on a discounted basis. The interest rate of rediscount is an important instrument for

the conduct of PBC monetary policy.

53

D. New Trends of Money Market The reform measure for interest-determination

should be based on the market. 1.Foreign currencies and domestic currency; 2.Laons and deposits; 3.Long-term and short-term loans and deposits; 4.Large amount loans and small amount loans. Money market funds Money broker firms: joint-stock firms 51:49

percentage in August 2005. More and more reform measures……

54

4. Regulation of the Financial System

The financial system is among the most heavily regulated sectors of the Chinese economy.

The government regulates financial markets for these main reasons: To increase the information available to

investors. To ensure the soundness of the financial

system. To improve control of monetary policy.

55

Principal Regulatory Agencies of the Chinese Financial and Banking Systems

Regulatory Agency Subject of Regulation Nature of Regulations

People’s Bank of China

All depository institutions

Examines the books of commercial banks, sets reserve requirements for all banks.

Banking Supervisory Commission

State-chartered depository institutions

Character and examine the books of state-chartered banks, impose restrictions on assets they can hold, and impose restrictions on branching.

Insurance Supervisory Commission

State-chartered insurance institutions

Character and examine the books of insurance companies, impose restrictions on assets they can hold.

Securities SupervisoryCommission

Organized exchanges and financial markets

Requires disclosure of information restricts insider trading.

56

Discussion Single (China) or multiple regulatory

agencies (USA). From the PBC to CBRC (China Banking

Regulatory Commission): Political issue in the central government.

Political economy in China……

57

5. Performance Analysis Banks play such a major role in channeling

funds to borrowers with productive investment opportunities, they are important in ensuring that financial system and the economy run smoothly and efficiently.

In China, state-owned commercial banks hold about two-thirds of the assets in the banking industry.

Banks make profits by charging an interest rate on their holdings of securities and loans that is higher than expenses on their liabilities.

58

Top four state-owned commercial banks dominated the Chinese banking system, with more than 60% of market share in deposits and loans, and 62% of total financial institution assets.

The target of the central government is to conduct joint-stock reform of the state-owned commercial banks and establish a modern banking system.

59

The objective of state-owned bank reform is to transform these banks into modern financial institutions with good governance and operations, clear business targets and sound financial performance.

In recent years, the reform of state-owned commercial banks has been pushed forward steadily due to the pressures imposed by many new issues and new phenomenon in the emergence of private sectors.

60

Structure of Commercial Banking4CR, %

Loans Profits Deposits Assets Income

2003 79.22 85.24 72.36 68.78 80.41

2004 59.64 89.80 64.26 65.59 78.10

2005 60.75 80.21 62.98 63.95 76.03

2006 60.41 78.31 61.18 62.50 76.33

2007 62.91 74.38 59.35 62.32 73.14

61

Market Shares of Top Five Banks, 2007

Deposits(%)

Loans(%)

ICBC 18.64 18.36Agriculture Bank of China 14.39 16.15Bank of China 11.89 13.22China Construction Bank 14.43 15.18Bank of Communication 4.20 5.12Total 63.55 68.03

62

Market Shares for Small Banks, 2007

Deposits (%) Loans (%)

CITIC Industrial Bank 2.13 2.67

Everbright Bank 1.51 1.94

Huaxia Bank 1.81 1.42

Minsheng Bank 1.81 2.54

Guangdong Development Bank 0.95 1.12

Shenzhen Development Bank 0.76 1.03

Merchants Bank 2.55 3.04

Fujian Industrial Bank 1.37 1.86

Pudong Development Bank 2.06 2.56

Henfeng Bank 0.18 0.21

Total 15.13 18.39

63

Discussion on Rural Credit Cooperatives

Financial system in China’s rural area.

Basic policy for rural financial sectors.

64

Comments on Performance Scale of bank assets: US$ 350-600 billion for state-owned com

mercial banks. A basic measure of bank profitability that corrects of the size

of the bank is the return on assets (ROA). ROA is a useful measure of how well a bank manager is doing on the job because it indicates how well a bank’s assets are being used to generate profits.

It is reported that global banking institutions recorded a 1.2% overall return on assets, while the figure for Chinese banks was 0.4% of ROA in 2004.

Normal level of capital adequacy ratio is 10% for international banks.

NPL is less than 5% of loans.

65

Indicators of Economic Performance

Item ICBC ABC BOC CCB

Profit after tax 6.53 2.90 9.45 4.30

Profit per person 111 21 299 76

Profit per branch 2.03 0.29 4.32 1.42

Return on assets (%)* 3.7 2.1 4.3 4.0

NPL (%) 25.43 36.63 22.49 15.17

Capital adequacy ratio 5.54 / 8.15 6.91

Unit of profit after tax: billion yuan; Unit of profit per person: thousand yuan; Unit of profit per branch: million yuan. * Based on official data.

66

Bank Capital Requirements Banks also hold capital because they are required t

o do so by regulatory authorities. It is estimated that the four state-owned commerci

al banks should, at least, increase their capital of 340 billion yuan in order to meet the standard of capital requirements issued by the Basel Committee in July 1992.

New progress: with the government now busy vacuuming up nonperforming assets and throwing in new capital, insolvency is no longer even an issue for top four state-owned commercial banks.

67

Income Statement Operating income from interest rate

accounted for more than 90% of total profits in four state-owned commercial banks as well as other kind of commercial banks.

Non-interest income accounted for small share for most commercial banks in China.

Of course, Chinese banks will gradually learn to generate more fee-based income, but keep in mind that margins on regular lending operations are currently propped up at artificially high levels because of state-controlled deposit rates.

68

Off-Balance-Sheet Activities Banks have been aggressively seeking out

profits by engaging in off-balance-sheet activities.

Off-balance-sheet activities involve trading financial instruments and generating income from fees and loan sales, activities that affect bank profits but do not appear on bank balance sheets.

This activity is called income from middle-man and service business in China.

69

Ratio of Non-Interest Income to Total Income for Some Commercial Banks

Bank Non-Interest Income

Bank Non-Interest Income

Bank of China 19 CCB 12.5

ICBC 5 Minsheng B. 1.1

Merchants B. 5.9 Huaxia Bank 3.0

Pudon Dev.B. 2.1 Shenzhen Dev.B. 2.5

Singapore B. 36.9 Hong Kong B. 28.9

Unit: Percentage.

70

6. Non-Performing Loans and the Reform of Banking System

The accumulation of nonperforming loans is generally attributable to a number of factors, including economic downturns and macroeconomic volatility, high interest rates, insider lending and moral hazard.

The problem of NPL in china was widely reported in international media, particularly in the period 1998-2002.

71

Causes of NPL in banking system. Reform measures for NPL. What will be done for NPLs?

72

Causes of NPL in State-Owned Commercial Banks

Institutional factor; Fragmentation of market: state-owned sect

or and private sector; Corporate governance; Short of social credit; Others ……

73

Breakdown of NPL in Commercial Banks

First Quarter 2005 Amount %

Second Quarter 2005 Amount %

NPL 1827.45 12.4 1275.94 8.71

Main Commercial banks 1712.84 12.7 1163.73 8.79 State-Owned 1567.05 15.0 1013.47 10.12 Joint-Stock 145.79 4.9 150.26 4.66Urban commercial banks 107.38 11.5 103.89 10.43Rural commercial banks 3.62 6.1 4.50 6.38Foreign banks 3.60 1.2 3.81 1.14

Unit: billion yuan. Percentage refers to NPL ratio to total loans of commercial banks.

74

Ratios of NPL in Commercial Banks

The occurrence of banking crises has often been associated with a massive accumulation of nonperforming loans which accounted for a sizable share of total assets of insolvent banks and financial institutions, especially during episodes of systemic crises.

Ratio of NPL for state-owned commercial banks was

20.36% on average in end-2003. Ratio of NPL in the first half of in 2003: 9.34% for 11

joint-stock commercial banks, 15.8% for 112 urban commercial banks.

And high ratio for rural commercial banks in 2003. What can commercial banks do it?

75

Reform Measures for NPL: asset Management Companies The reform of state-owned commercial banks has been pushe

d forward steadily. In 1998, given the low capital adequacy ratio and high ratio of

nonperforming loans, the State Council decided to recapitalize the solely state-owned commercial banks by issuing special treasury bond of RMB 270 billion yuan.

In 1999, four asset management companies were established, which took over a portion of non-performing assets owned by the solely state-owned commercial banks, laying a foundation for further reforms. This is the solution with Chinese characteristics.

What are major ways for AMC to deal with NPL?

76

NPL Processing by Asset Management Co.

2005 First Quarter

Second Quarter

Third Quarter

Total 688.55 717.42 736.66

By Cash 140.89 148.46 155.03

Processing (%) 54.95 57.28 58.71

Asset Back (%) 25.50 25.55 25.62

Cash Back (%) 20.46 20.69 21.04

Unit: billion yuan.

77

7. Reform Progress: Recapitalization

Central Huijin Investment Co. Ltd was established on December 16, 2003. The company recapitalized the Bank of China, CCB with US$45 billion at the end of the year and fulfilled its rights and obligations as a shareholder on behalf of the state.

From the end of 2003 through the first half of 2004, the Bank of China and CCB strengthened their disposal of non-performing assets. They wrote off loss loans with their original capital, profits of 2003 and provisions, sold doubtful loans in market-based ways.

78

At the end of June, capital adequacy ratios of these two banks both exceeded 8% and their non-performing assets ratio fell below 6%.

Thus, insolvency is no longer even an issue for four state-owed banks.

79

Towards Corporate Governance On August 26 and September 21 of 2004, the Bank of

China Co. Ltd and China Construction Bank Co. Ltd were established respectively.

Both corporations established the shareholders meeting, Board of Directors and Supervisory Board in accordance with the principles of modern corporate governance.

Special committees and business management and risk control mechanism were set up. Administrative official titles of their employees were cancelled and market-based pricing of human resources was introduced.

Reform of ICBC and ABC is also being advanced in 2004.

80

Case One: Reform of ICBC ICBC is the largest commercial bank in China. Origin of ICBC. Based on the experiences attained in the joint-stock refo

rm process of BOC and CCB, on April 22, 2005, the Central Huijin Investment Company recapitalized the ICBC with foreign reserves totaling US$15 billion, bringing the ICBC’s core capital adequacy ratio up to 6%.

The pilot reform of the BOC and CCB also progressed smoothly.

81

Case Two: Reform of the Rural Credit Cooperatives

At end-2005, PBC, together with CBRC, following strict assessment and examination, made 8 issuance of special bills worth 156 billion yuan in 2263 counties aimed at reforming the rural credit cooperative on a pilot basis.

Recapitalization and equity increases speeded up, leading to a rapid increase of the capital adequacy ratio. The capital adequacy ratios of the rural credit cooperatives, rural cooperative banks, and rural commercial banks were raised to 8.03%, 12.93%, and 8.78% respectively.

82

Rural Financial Development The contents and steps for the reform of rural

financial sector are as follows: 1. to establish corporate governance; 2. to transfer the management of rural credit cooperatives to the provincial governments; and 3. to provide strong support for rural credit cooperatives such as issuing special bills and some subsidies.

By end-2007, 17 rural commercial banks, 113 rural cooperative banks, and 1824 rural credit cooperatives (under county unit) have been established and reorganized respectively.

83

Is it Better Banking Environment?

The banking environment has changed radically over the past 10 years, with better regulation and supervision, better macroeconomic policy making, better internal controls and better borrowers.

Won’t banks get right back into trouble in the coming years, with a flood of new NPLs overwhelming the system?

84

What Will be Done for NPL?

The amount of all bank assets reached 40 trillion yuan by April 2006, according to a recent report.

It is estimated that the bad assets have been accumulated 2.4 trillion yuan for top four state-owned commercial banks.

It is estimated that the magnitude of new NPL flows will be much manageable than in the past.

85

8. New Policies for the Reform of Banking System: Strategic Investors

The joint-stock reform of state-owned commercial banks has been taking smoothly.

To strengthen corporate governance. To put in place an independent internal control s

ystem and risk prevention system. To encourage product innovation. New policy was advertised for “strategic investo

rs”.

86

Pioneer programs from the IFC involving Chinese local commercial banks in the later 1990s: Bank of Shanghai, Bank of Beijing, Fujian Industrial Bank, Minsheng Bank, Nanjing City Commercial Bank and Xi’an City Commercial Bank.……

More strategic investors……

87

Banks On SaleStrategic Investors Shares Amount

2005 BOC Royal B. of Scotland 10% $3.1 bill.

CCB Temasek, Singapore $2.5 bill.

Bohai Bank Standard & Chartered 20%

Jinan Bank Federal B. of Australia 11%

Hangzhou Bank Federal B. of Australia 19.9%

ICBC Bank of Comm.

Goldman SachsHSBC

10%19.9%

$10 bill.$2.25 bil

2006 June CCB Bank of America 9% $ 3 bill.

88

Strategic Investors from OverseasMega-transactions

HSBC bought a 19.9% stake in Bank of Communication for a total cost of US$2.25 billion.

Bank of America announced its US$3 billion investment in CCB in June 2005;

Huge profits for strategic investors……

89

More Transactions Royal Bank of Scotland agreed to take a 10% share of BOC for

US$3.1 billion; Singapore’s Temasek took a similar stake for the same price.

Temasek also committed US$2.5 billion to invest in CCB. Standard and Chartered Bank: 20% share of Bohai Commerci

al Bank. Federal Bank of Australia: 11% share of Jinan Commercial Ba

nk; and 19.9% share of Hangzhou Commercial Bank. A Goldman Sachs-led group signed an agreement to lay down

US$ 3 billion for 10% share of ICBC. More strategic investors……

90

Debate on the Great Chinese Bank SaleNow Open-Door Policy for Banking Industry

At this pace, by the close of 2007 foreign banks and other foreign investors could conceivably control more than one-sixth of the entire Chinese banking system.

It seems the only brake on the process is the 25% ceiling on cumulative foreign ownership of individual banks– a restriction likely to be eased in the near future.

Strong criticism to this kind of sale to foreign investors from a couple of sides: private sector and public opinion……

It seems to be un-reversible for this trend……

91

A Win-Win Situation? China does benefit from having foreign investors bu

y in, and foreign investors benefit from being there. Can overseas investors provide a “one-stop sho

p” for Chinese enterprise reform? In most cases, the result has been better-managed,

more profitable and transparent companies, and this is exactly what China is now hoping to achieve by selling off stakes in the large banks.

What do foreign investors get? How much?

92

IPOs for the State-owned Banks CCB was listed on the Hong Kong stock market on October 27,

2005 and issued 30.5 billion new shares at HK$2.35 per share, raising HK$71.58 billion (or US$9.23 billion).

BOC continued to transform its management mechanism and created favorable conditions for its listing: June 1, 2006. BOC: was listed in HK stock market (June 2006), and in SSE (July 2006).

ICBC was incorporated on October 28, 2005, with registered capital of 248 billion yuan. The Ministry of Finance and Central Huijin Co. each hold 50% of its shares.

ICBC was listed in SSE and HK stock market in October 2006.

93

Bank of Communication was listed in HK (June 2005), and in SSE (May 2007).

ABC is working on a joint-stock reform plan in line with the reform of agricultural financial system

How many commercial banks will follow this pattern of reform?

94

Financial Liberalization? A great growth story in Chinese banking

industry…… More competition is needed for the

performance improvement of banking industry……

More reform policies and measures will be issued……

More discussion on the way of financial liberalization.

Will China follow Latin American story, or take different tack?

95

More Competition Today, the 200-odd foreign commercial

banks active in China mainland still accounted for a paltry 2.73% of total loans and deposits, and a total capital commitment of no more than a few billion dollars.

96

Balance Sheet of Financial Institutions (billion yuan), 2007Financial Institutions

Foreign-funded Banks

FFB/Total

Funds Resources 45427 Total assets 1239.1 2.73

Total Deposits 38937 Various Claims

908.96

Funds Uses 45427 Total Liabilities

1239.1 2.73

Total Loans 26169

97

RMB Business for Foreign-Funded Banks China formally eliminated the limitations on

RMB business for foreign-funded banks in December 11, 2006.

China, as a transitional economy, takes many transitional steps for reform processing, including in the regulation of a transitional process for foreign-funded banks to be a new kind of local commercial banks.

98

The Localization of Foreign-Funded Banks

The list of nine localized foreign-funded banks that are permitted to operate RMB business……

By end-2006, Citigroup, HSBC, Standard and Chartered, total nine foreign-funded banks registered in Shanghai, namely, these banks can called “local” legal person entities……

More and more policies will be issued for the globalization of China’s financial and banking sectors in the coming years, so keep your eyes on it.

99

More Challenges for China How about tomorrow? More overseas strategic investors…… More IPOs…… More reform policies and measures…… Will China follow Latin American story, or take

different tack? Will more international banks do their busine

ss in China?

100

9. Conclusions It is hardly to change the structure of Chinese

banking industry rapidly, which is distinguished with the dominance of the state-owned banks.

Non-state banking institutions will increase their market shares year by year, clearly, more competition will improve the performance of Chinese banking industry.

Gradualism is a major feature in Chinese banking reform procedure, which has shown a direction towards the diversification of ownership in banking industry.

……

101

10. Questions and Problems1. What kind of challenges is raised by Chinese economic

development to the banking system?2. “The commercial banking industry in China is less effic

iency due to the market dominated by four state-owned commercial banks.” Is this statement true, or false? Explain your answer.

3. How to resolve the issue of non-performing loans in the context of China’s financial regulations?

4. Which role will be played by overseas investors in Chinese banking reforms?

5. Is it really a win-win situation for strategic investors and the Chinese government in China’s banking restructuring?

102

Thank You!