by dr charles c l kwong associate professor school of arts and social sciences the open university...

by Dr Charles C L Kwong

Associate ProfessorSchool of Arts and Social SciencesThe Open University of Hong Kong

From Mono-banking to Internationalization:the Path of China’s Banking Reform and itsImpacts on Hong Kong’s Financial Market

1. The presentation aims atexamining briefly China’s banking sector during

the pre-reform period (1949-1978);

reviewing the path of China’s banking reform since the late 1970s;

evaluating China’s policy change in banking sector after its accession to World Trade Organization (WTO)

scrutinizing the impacts of China’s banking reform on Hong Kong financial market

2. The Mono-bank System 1949-1978: Intended Isolation

The establishment of People’s Bank of China (PBOC) in 1948 marked the starting point of the banking system under the PRC rule. Prior to the economic reform in the late 1970s, China’s banking sector was characterized as a mono-bank system in which banks operated under a scheme of ‘Tong Shou Tong Zhi’.


All cash (deposits) from individuals and enterprises, mainly state-owned enterprises (SOEs), must be held by the PBOC. All credits (loans) to SOEs and state projects were extended by the PBOC. In a nutshell, the PBOC become the centre of settlement for both deposits and credits.


In the 1950s, the mono-bank system was supported by two extension arms: the Bank of China (BOC) and the People’s Construction Bank of China (PCBC), which were subordinate to the People’s Bank of China (PBOC) and the Ministry of Finance (MOF), respectively.


The BOC functioned as the foreign exchange division of PBOC while the CBC disbursed funds to finance state-owned enterprises (SOEs) and capital-investment projects blueprinted in the government’s economic plan.


On the eve of economic reform, all financial institutions merged into the PBOC or the MOF during the Cultural Revolution (1966-1976). The PBOC became a mono-bank performing both the central bank functions (regulating money supply and determining interest rate) and commercial bank function of financing SOEs and state projects. The PBOC before the reform served as the state’s fiscal agent to divert funds to fulfil the planned targets. The State Planning Commission devised the state plans and ranked their priorities. Then the PBOC was directed to channel bank credit to SOEs and state projects.


The mono-bank system was not in the sense of the conventional views of commercial and central banking. In conformity with the centralist character of the planned economy, the top priority of the central planners was not attached to the consideration of efficiency of the banking system.


The rigid control and intended closeness of China’s mono-bank was to allocate financial resources for the fulfilment of state plans and to ensure insulation from potential domestic and foreign influence. The repercussion of the mono-bank system was extensive since SOEs received interest free loanable funds which led to severe moral hazard problems among cadres who ran the enterprises. The soft-budget constraints and the associated moral hazard behaviour resulted in massive non-performing loans (NPLs) accumulated in the 1980s and the early 1990s.

3. From Mono-banking to Plural-banking System 1979-1992

The underlying factor for diversifying banking institutions in the early 1980s stemmed from the economic reforms in the late 1970s, which entails decentralisation of economic activities. Economic reforms allowed a larger role of market in allocating resources and the development of non-state enterprises, mainly collective enterprises.

3. From Mono-banking to Plural-banking System1979-1992

The share of nominal industrial output decreased from 76 percent to 64.9 percent from 1980 to 1985 while the respective shares by collective enterprises increased from 23.6 percent to 32.1 percent, representing an average annual growth of 18.7 percent for the same period. Expanding non-state sector was accompanied with mounting financial resources held by decentralised units including households, enterprises and local governments.

Table 1 indicates that the share of savings in GDP held by central budget had demonstrated a declining trend while the respective shares held by the decentralised units had exhibited an ongoing uptrend since 1978. Further, the increased connections with the outside world through foreign direct investment and setting up of special economic zones called for a more specialised banks to deal with international financial transactions. The highly centralised mono-banking system in the pre-reform era could no longer accommodate the financial needs brought about by market reform.


Year Total savings Household savings

Enterprise savings

Budgetary savings

1978 33.2 1.1 17.0 15.1

1979 34.6 3.1 21.4 10.0

1980 32.3 4.4 20.7 7.3

1981 30.3 3.4 20.0 6.6

1982 31.6 7.5 18.7 5.4

1983 31.5 9.9 15.9 5.7

1984 32.8 14.4 11.8 6.6

1985 34.5 13.4 14.0 7.0

Table 1: Composition of savings in GDP 1978-1985

Source: Joseph C. H. Chai, China: Transition to a Market Economy, (New York: Clarendon Press Oxford, 1997), p. 118

From 1979 to 1984, four state-owned specialised banks (SBs) were reinstituted and separated from the PBOC. The Agricultural Bank of China (ABC) was re-established in 1979 to handle deposits and lending in rural areas.


The BOC was reinstituted under the State Council (SC) in 1979 to manage the country’s foreign exchange. The People’s Construction Bank of China (PCBC) (renamed as China Construction Bank in 1996) was made subordinate to the SC in 1979 to undertake financing construction and fixed assets investment while the Industrial and Commercial Bank (ICBC), established in 1984, specialised in funding business activities.


On top of reinstituting the SBs, the central government transformed the PBOC into a formal central bank in 1984 by transferring its deposit and lending activities to ICBC. The re-establishment of the SBs and the setting of a formal central bank laid the important foundation of separating central bank and commercial bank functions. The central bank, PBOC, had since then become the main government agency for manoeuvring monetary policy, supervising the financial sector and fine-tuning macroeconomic conditions.


Parallel to the re-establishment of SBs, new commercial banks and non-bank financial institutions (NBFIs) were allowed to open to cater for different financial needs in urban and rural areas. Nine national and regional banks, such as the bank of Communications and the Guangdong Development Bank, were set up in the 1990s. NBFIs also flourished in the 1990s. Up to 1994, about 60,000 rural credit cooperatives (RCCs), 1500 urban credit cooperatives (UCCs), and 590 trust and investment companies (TICs) was set up (Chai 1997: 123).


SBs’ specialised roles had started to blur since the 1980s and each SB had faced increasing competition from other SBs and the new financial institutions.


Though the inflow of foreign direct investment (FDI) had been very substantial since China’s opening up in the 1980s, the presence of foreign bank was very limited in the initial stage of economic reforms. In the early 1980s, only four foreign banks had set up their branches in China.


Though the PBOC enacted the Regulation on Foreign and Joint Venture Financial Institutions in Shanghai in September 1990, their business of foreign banks was subject to many restrictions, including the forbiddance of engaging in yuan (RMB) transactions (Yi 1994: 32-33).


By 1992, a total of 47 foreign banking and financial institutions with 218 branches or representative offices had been set up. This figure represented a negligible share of the branch network of PBOC and the four SBs, which consisted of 125,711 branches and offices across the country. By 1994, foreign banks had total assets of 101.7 billion yuan which was only 0.9 percent of assets of China’s banking sector.



The reinstituting of SBs and the diversification of financial institutions in the 1980s represented only a hierarchical and structural transformation. Though limited competition was introduced, the SBs still dominated the banking sector. The market share, in terms of assets, of SBs was 85.4 percent in 1988 and fell slightly to 84.2 in 1993, and continued to perform the fiscal functions assigned by the central government. SBs were expected to extend loans to SOEs even though many of the state enterprises were loss-making. The soft loans were to maintain the operation of the enterprises by which stable employment could be guaranteed.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsAs elucidated above, to avoid massive layoffs by

ailing SOEs from the mid-1980s to the mid-1990s, the SBs shouldered the key responsibility of rendering ‘soft loans’ to SOEs to keep the loss-making SOEs floating. This strategy reduced the number of losers under reform, but at the same time piled up NPLs of the SBs. The ratio of NPLs of the SBs reached 20.4 percent in 1994 and was estimated to increase by 2% annually.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsThe PBOC lacked effective means of controlling the

lending behaviour of the SBs, which were dominantly affected by central directives. The ‘soft loans’ resulted in spectacular rise in money supply and inflation rates. Money supply (M2) increased from 31.3 percent in 1992 to 34.5 percent in 1993 while the inflation demonstrated a hyper growth from 6.4 percent in 1992 to 24.1 percent in 1994. The runaway inflation alarmed central leaders of the possible macroeconomic instability resulting from quasi uncontrolled bank loans by SBs.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsOn the other front, since the transformation of

the GATT (General Agreement on Tariffs and Trade) to WTO (World Trade Organization) in 1995, China started to request its membership in WTO. As part of the commitments to WTO accession, China was required not only to reduce its tariff and non-tariff barriers for imports, but also open up its telecommunication, banking, financial and insurance sectors to foreign investors.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsFacing both domestic and external pressure on its

banking sector, the central government decided to embark an overhaul of the banking system in 1994, with at least three major aims: (1) to develop the PBOC into an independent and full-fledged modern central bank to regulate the national financial market and maintain macroeconomic stability; (2) to commercialise the four SBs by separating commercial lending from policy lending; and (3) to nourish a more diverse and competitive banking sector by allowing more commercial banks, including foreign competitors to enter the market.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsThe Law of the People’s Republic of China on the

People’s Bank of China (PBCL) was enacted in 1995 to establish a legal foundation for the superior status of the PBOC. The PBCL stipulates that the PBOC, under the leadership of the State Council, devises and implements monetary policy and monitors the operations of the financial sector (Article 2). Article 7 of the PBCL entrusts the PBC with a high level of independence by specifying that the PBOC is free from the intervention of local governments, government departments, organisations and individuals when it performs its central bank and business functions.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsThe central government’s decision explicitly urged

the establishment of a ‘sound macroeconomic control system’. It was clearly stated that ‘the central bank, the People’s Bank of China, under the leadership of the State Council, should implement monetary policy independently’. The independent status was further elucidated in that ‘the power of the central bank and local authorities over economic administration should be rationally delineated’ and ‘the branches of the People’s Bank of China are certified as agencies of its head office.’

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsTo enhance the efficiency and profitability of the

banks, the Chinese authorities also endorsed in the Third Plenum of the 14th Central Committee to separate policy lending from commercial lending. By this, the four SBs would gradually be transformed into state-owned commercial banks (SOCBs). Policy-based loans are designated to the three policy lending banks established in 1994.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsBy do so, the SOCBs could be freed from the

burden of ‘soft loans’ and concentrate their businesses in commercial lending based on market disciplines. However, the transfer of policy lending from the SOCBs to the three policy lending banks was more complicated than expected.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsTwo points are worth noting. First, the newly

established policy banks were reluctant to accept the policy responsibilities, particularly lending to SOEs, previously assumed by the SBs. The SOCBs continued to be a major government-directed funding source for SOEs. Almost half of the short-terms of SOCBs were extended to SOEs in 1997.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsSecond, since the policy banks did not receive

deposits from the public, their operation was financed by state fund by issuing financial bonds to existing financial institutions, primarily the SOCBs. The state banks were under constant pressure and directives from the PBOC to absorb the financial bonds issued by the policy banks. As a result, commercialization of state banks did not substantially improve the balance sheets of SOCBs in the 1990s.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsCommercialising the SOCBs in 1994 aimed at

separating policy and commercial lending, through which enhanced the efficiency of the state banks. However, in practice, the reform failed to institute a credit culture based on market disciplines. Lending decisions were still mainly influenced by state directives instead of profitability consideration.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Commercialization of SBsThe reform was also constrained by lack of

Chinese bankers well-vested with knowledge of running commercial banks. The problem of NPLs had been escalating in the 1990s. Some estimates indicated that the ratio of non-performing loans (NPLs) of the Big Four stayed at an alarmingly high level of 40 percent by 1998 (Woo 2003: 5).

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Recapitalization of SOCBsThe 1994 banking reform had limited impact on

enhancing efficiency of the SOCBs. The central government perceived the need of strengthening the capital position of the Big Four before fulfilling the WTO commitments of opening up the banking sector to foreign competitors. Further, the Asian financial crisis in 1997-98 crystallised the central leaders’ views that the ailing banking sector could be a destabilising factor in the economy when China had established increasing links with the global economy.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Recapitalization of SOCBsTo speed up the pace of improving the balance

sheets of the state banks, the MOF injected US$34 billion into the Big Four to lower the NPLs in 1998. The recapitalization was supposed to alleviate the financial burden of the SOCBs arising from the past policy lending. Such recapitalization by the central coffer was planned to be ‘first and final’.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Recapitalization of SOCBsHowever, instead of fundamentally cleaning up

the NPLs in the SOCBs, four asset management companies (AMCs) were established in 1999 to absorb 1.4 trillion yuan of bad loans from the Big Four. The further recapitalization, amounted to US$75 billion, of the SOCBs in 2003-06 defeated the initial design of an ‘once-and-for-all’ relief plan for China’s debt-ridden state banking system. Table 2 shows that by 2006, official financial support provided for state banks amounted to US$402 billion.

Item Date Amount (US$ billion) SourceCapital injection to Big Four

1998 34 Ministry of Finance

AMC carve-out 1999 5 Ministry of FinanceAMC carve-out 1999 48 People’s Bank of

ChinaAMC carve-out 1999 120 People’s Bank of

ChinaCapital injection to Big Four

2003-06 75 People’s Bank of China

Subsidized NPL carve-out

2004-06 100 People’s Bank of China

Tax relief for NPL write down

2004-06 20 Ministry of Finance

TOTAL 402

Table 2 Official Financial Support to SOCBs since 1998

Source: Jonathan Anderson, ‘China’s New Banking System,’ p. 173

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Recapitalization of SOCBsCentral government’s ongoing financial support has

successfully lifted the capital adequacy ratio (CAR) of the SOBs to a level higher than the international standard of 8 percent and reduces the NPL ratio to an official figure of 7.83 percent in 2007 (Q3). The rapid drop in NPL ratio was also attributable to the double-digit credit growth since 2000.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Recapitalization of SOCBsMore importantly, the bailout of SOCBs only transfer

the financial burden from the state banks to the AMCs and other government agencies such as the PBOC and the Ministry of Financial, instead if instituting an institutional overhaul to solve the government problems.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Recapitalization of SOCBsWorse still, the substantial captital injection did not

result in corresponding enhancement of the SOCBs’ financial indicators. The NPL ratios of ICBC, BOC, CCB and ABC remained at high levels of 25.4%, 23.7%, 15.17% and 36.63% respectively in 2002. the capital adequacy ratio (CAR), a measure of the capital strength of a commercial bank, was still below the prevailing international standard of 8% (Table 3).

Table 3 Capital Adequacy Ratios of the SOCBs (1997-2002) (%)

Year ABC BOC CCB ICBC

1997 2.93 3.91 3.54 4.05

1998 8.13 11.74 9.31 10.40

1999 1.44 8.5 3.79 4.57

2000 n.a. 9.8 6.51 5.38

2001 1.44 8.3 6.88 5.76

2002 n.a. 8.15 6.91 5.54

Source: K. Okazaki, “Banking System Reform in China: The Challenge of Moving Toward a Market-Oriented Economy,” p. 24.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Recapitalization of SOCBsThe results of government financial support were

even less promising when compared with other Asian developing countries. China’s NPL ratio was still higher than some neighbouring countries such as Indonesia, Thailand, and Malaysia in 2007. The NPL ratio of the SOCBs has consistently higher than the joint-stock commercial banks (JSCBs) in recent years. From 2005 to 2006, the smaller city commercial banks, such as the Zhuzhou City Commercial Bank and the Bank of Dalian, achieved a much faster growth of profitability than that of the SOCBs.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Recapitalization of SOCBsThese figures raise the issue of moral hazard and

cost-effectiveness in bailing out these state banks. It is particularly relevant to the future bailout of the Agricultural Bank of China, which is widely believed to be the most severely hit by the massive lending to the rural sector, with a non-performing loan ratio of 24.75 percent reported in 2006. Agricultural Bank may need as much as US$140 billion to reduce bad loans to less than 5 percent, which will be the single largest bailout of a state bank.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Preparing for Market Liberalization?Despite China’s multi-facet reforms in improving

SOCBs’ balance sheet since the late 1990s, China’s approach to opening up its banking sector remained cautious and piecemeal prior to its WTO accession. The central government had relaxed geographical restrictions on foreign banks since 1992. Foreign banks were allowed to operate outside Special Economic Zones (SEZs) and to expand their presence in Shanghai and other seven coastal cities in 1992. In 1994, such relaxation was applied to other selected inland cities.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Preparing for Market Liberalization?However, geographical extension did not entail

corresponding expansion of the scope of business of foreign banks. Until the mid-1990s, foreign competitors were not accessible to RMB-business. It was only in 1996 that RMB-business by foreign banks was tried out in Pudong on an experimental basis. The trial was extended to Shenzhen in 1998.

4. Heading for WTO Accession: Commercialization and Bailout of SBs 1993-2001Preparing for Market Liberalization?The advent of foreign competition in the 1990s

was very minimal due to the fact that restrictions on foreign banks’ business were still numerous and the branch network of foreign competitors were very restricted compared with local counterparts. On the eve of China’s admission to the WTO, the market share of foreign banks, in terms of assets, was about 1-2 percent.

5. Post-WTO Reforms: On the Road to Internationalization?

China’s accession to the WTO in 2001 represented not only China’s further integration into the global economy, but also China’s commitments of opening up its economy to foreign competitors.


The embedded strategic thinking of the central leaders was to expose China’s state banks gradually to foreign cooperation and competition after WTO accession, through which enriching the Chinese SOCBs on foreign experience and international standards, and inserting competitive pressure on reforming the inefficient banking sector.


While foreign investors were keen on entering China’s banking sector in a faster and flexible way, the Chinese government favoured a more step-by-step approach of introducing foreign players. After rounds of negotiations, China was allowed to have a phase-in period of 5 years to incrementally open up its banking sector (Table 4).


After the phase-in period, all foreign banks were endowed with national treatment, which implies that apart from some prudential requirement set by the China Banking Regulatory Commission (CBRC), all restrictions on ownership, branch network and operation would be removed.

Table 4 China’s WTO Commitments in Banking Sector during Phase-in Period (2000-Dec 2006)

Geographical Location

From 2002 to 2006, four cities were opened up for foreign banks each year.

After phase-in period, all geographical restrictions would be eliminated.

Business Immediately after WTO accession, foreign banks were permitted to engage in foreign currency business (both lending and deposits) to all customers.

Within two year of accession, foreign banks are allowed to provide RMB-business for local enterprises.

Within five years, foreign banks are allowed to provide RMB-business for both local enterprises and individuals.

Source: Svenja Schlichting, Internationalizing China’s Financial Markets, p. 53. K. Okazaki, “Banking System Reform in China: The Challenge of Moving Toward a Market-Oriented Economy,” p. 8.


During the phase-in period, China instituted reforms on bank supervision and corporate governance to further strengthen the competiveness of state banks before full liberalization. The most important step of strengthening banking supervision is the setting up of China Banking Regulatory Commission (CBRC) in 2003 to regulate all banks and depository institutions.


One of the major tasks of the CBRC is to ensure that the SOCBs are operating under prudent commercial bank practices such as the 10-plus loan classification system and the internal rating based loan system to evaluate the potential risks of loans extended to the market. It is a vital step to develop a credit culture among SOCBs to avoid piling up NPLs.


China also fulfilled most of the twenty five Core Principles adopted by the BIS (Bank for International Settlements) committee on banking regulation and supervision, but the fulfilment of some principles is still far from de facto. To illustrate, Principle 1 requires the regulatory agency to have full autonomy, power and resources to exercise its supervisory and monitoring role. However, the CBRC is hierarchically under the SC which can veto the decision made by CBRC and the appointment of key officials in CBRC is still under the control of the Communist Party.


In regard of corporate governance, SOCBs were required to recruit independent directors to oversee the decision making procedures and operation of the SOCBs, but most of the independent directors are either government officials or ex-bank staff, who can rarely perform independent supervisory role.


Foreign strategic partners are now more welcome not just for their capital, but also for their knowledge in internal governance, bank practices, product design, and international exposure. The following table reveals the foreign partners of three of the Big Four (ICBC, CCB, BOC).


However, the influence of foreign partners in the Chinese banks should not be overemphasised since the ceiling of foreign ownership in a Chinese bank is 25 percent while the ceiling of a single foreign bank is capped at 20 percent. The state remains to be the major shareholder of the Big Four (Table 5).


In most cases, the foreign investors are entitled to nominate one candidate in the director board, usually consisting of 14 to 16 members, of the state banks, but their role in key decision making is more de jure than de facto. The involvement of foreign partners in daily management is marginal. Instead, Chinese partners are more eager to acquire product knowledge, technical support, know-how on banking operation and human resources training (Table 6).


Though the state banks have tried to recruit foreign bankers to join their senior management, this outside talent, in general, served in the state banks only for a short period of time. Their inputs for improving the banking efficiency are therefore very limited. Influence of foreign partners is substantially constrained by the fact that top positions in state banks are still appointed by the party leadership and the chairperson of a SOCB also serves as the party secretary of the bank. Civil service appointees in top position imply that state banks cannot be fully insulated from government influence on lending decisions.

Table 5 Strategic Investors in three of the Big Four (as of June 2006)Bank Strategic Investors Investment as

percentage of the bank

State Investors Investment as percentage of the bank

Bank of China Royal Bank of Scotland (RBS), Merrill Lynch, Li Ka-shing, UBS, Asian Development Bank

10.0 Central Huijin Investment

69.0

Tamasek 10.0 Social Security Fund

4.6

China Construction Bank

Bank of America 9.0 State Administration of Foreign Exchange (SAFE)

74.3

Tamasek 5.1Industrial and Commercial Bank of China

Goldman Sachs, Allianz, American Express

10.0 Ministry of Finance

35.3

SAFE 35.3Social security Fund

5.3

Source: Hansakul, S. ‘China’s Banking Sector: Ripe for the Next Stage’, Current Issues-China Special, Frankfurt: Deutsche Bank Research, 2006), p. 4.; Costa, P., Curtis, C. T. and Field, J. R. ‘An Analysis of the Chinese Banking Sector Post WTO Accession’, paper prepared for the International Economic Development Program, Ford School of Public Policy, University of Michigan, 2006, p. 16.; Source: Zdenek Kudrna, ‘Banking Reform in China: Driven by International Standards and Chinese Specifics’, p. 21.

Table 6 Functions and Roles Played by Strategic InvestorsBank Strategic Investors Governance/

management responsibility

Provision of technical and managerial assistance

Bank of China Royal Bank of Scotland (RBS), Merrill Lynch, Li Ka-shing, UBS, Asian Development Bank, Temasek

Strategic investors involve no daily management duties. RBS is entitled to nominate one member in the Director Board (DB).

RBS provides support in wealth management and corporate banking while UBS mainly offer assistance in investment banking and security business.

China Construction Bank

Bank of America (BA), Temasek

Strategic investors involve no daily management duties. Each of BA and Temasek is entitled to nominate one member in the DB.

BA has seconded about 50 personnel to assist in risk management, corporate governance, and consumer banking. Temasek concentrates assistance in staff training in treasury, SME credit, and corporate business.

Industrial and Commercial Bank of China

Goldman Sachs, Allianz, American Express

Strategic investors involve no daily management duties. Goldman Sachs is entitled to nominate one member in the DB.

Allianz assist in insurance product and business while BA aid in risk management, investment banking and credit card business.

Source: Zdenek Kudrna, ‘Banking Reform in China: Driven by International Standards and Chinese Specifics ’, p. 25.

6. Impact of China’s Banking Reform on Hong Kong’s Financial Sector

Investment/Wholesale BankingThe further opening up of China’s banking system

to foreign competitors since December 2006 has not fundamentally shaken the dominant status of the SOCBs due to their extensive branch network and well established client base. Nevertheless, rising income has prompted the demand for wealth management for which the foreign banks, in particular Hong Kong banks, demonstrate a clear competitive edge. It is estimated that the high net-worth individuals on the mainland invested one trillion yuan in wealth management products in 2007, which represented a double of figure of 2006.

Investment/Wholesale BankingSince banks in Hong Kong are more experienced

in loan syndication, trade financing, and investment banking, it is predicted that state banks may lose some of the best customers to their foreign counterparts. Actually, anecdotal evidence indicates that this scenario is not hypothetical.


Investment/Wholesale BankingThe successful listing of the BOC, ICBC and CCB

indicates that Hong Kong stock market is still a cost-effective venue for raising capital from both local and overseas sources. It is made possible by Hong Kong’s absence of foreign exchange control.



RMB BusinessBanks in Hong Kong have been allowed to

conduct RMB business for individuals, including RMB deposits, remittances, exchange business and RMB bank cards in Hong Kong since early 2004. RMB deposits in Hong Kong have increased from RMB 12 billion in 2004 to RMB 54 billion as of end-June 2009.


RMB BusinessMainland financial institutions, after obtaining

approval, are allowed to issue RMB bonds in Hong Kong. The first RMB bonds, amounted RMB 5 billion, were issued by the China Development Bank in Hong Kong in July 2007. The Chinese authorities also allowed the mainland branches of Hong Kong banks to issue RMB bonds in Hong Kong. HSBC became the first to issue RMB bonds of RMB 1 billion in Hong Kong in June 2009.

RMB BusinessSince July 2009, Hong Kong banks have been

allowed to settle in RMB trade transactions between Hong Kong and the mainland of China for their customers. Such arrangement reduces risks arising from exchange rates fluctuation and reduces transaction costs.


RMB BusinessThe expanded RMB business in Hong Kong helps

stabilize the business of banks in Hong Kong when the Hong Kong economy is experiencing fluctuation.


Rural BankingBanking reform since 1994 has focused on the institutional

overhaul of banking sector in urban areas. After three decades of reform, the rural financial reforms still lag behind, thus creating the risk of slowing down further rural development. The Postal Savings Bank (PSB) was established in 2007 to take over the rural financial services previously provided by the post offices. The new bank will provide a network of 37,000 branches providing banking services, including small loans to individuals, in rural areas (Kwong 2007b: 5). However, since the postal saving system was not allowed to extend loans to rural households and enterprises prior to 2007. Staffs in PSB are in lack of expertise in extending loans in regard to risk and profitability consideration.


Rural BankingChina Banking Regulatory Commission (BRC),

China's banking regulator, designed a plan to set up 1, 294 new financial institutions in rural areas over a three-year period (2009-2011) to cater for the escalating demand for financial services in rural sector.


Rural BankingThe financial vacuum in rural China allowed

banks in Hong Kong to tap into this underdeveloped market. HSBC established its first rural bank in the Cengdu District of Suizhou City in Hubei Province in 2007. Standard Chartered opened its first village bank in North China's Inner Mongolia Autonomous Region in 2009.


Rural BankingNevertheless, the business in rural China must be

viewed from a gradual and long-term perspective as average size of each loan application in rural areas remains small, which lowers the cost-effectiveness of processing each application. Further, the lack of collaterals from farmers increases the default risks of the loans. Lower profitability and higher risks deter the banks from taking bold steps to tap into the rural business, particularly in poor regions.


7. Conclusion

Over the past three decades, China’s banking reform has been lagging behind reforms in other sectors. Though China’s accomplishments in banking reforms are staggering, particularly in terms of reducing NPLs, lifting up CARs, and enhancing corporate governance, state influence on banks’ operation is still evident, either direct or indirect.

7. Conclusion

The long-term efficiency of China’s banking system relies on whether banks can truly operate according to market principles such as profitability and repayability, which in turn rests on the extent of state dominance in loan decision and setting interest rates. Central leaders are still reluctant to surrender control to the market, not to mention the foreign investors.

7. Conclusion

Foreign banks’ presence in terms of branch network and assets, even after WTO accession, in China is still limited. The market share, in terms of assets, of foreign banks in China only slightly crept from less than 2 percent to 2.38 percent after the phase-in period in 2007.

7. Conclusion

The significance of China’s admission to WTO lies on the fact that China has to converge to international rules and best practices of banks’ operation. Though it may constrain state’s influence in the banking sector, it is a vital step to force Chinese banks to face ‘real’ competition on more equal-footing basis, through which enhances the efficiency of the banking sector.

A well-functioned banking sector with effective mechanism to channel loanable funds to productive projects is fundamental to sustain China’s long-term growth and development. To achieve this, an overhaul of ownership structure of SOCBs and the further opening up China’s banking sector to foreign competitors are crucial.

7. Conclusion

However, financial crises in 1997-98 and 2008 reaffirm central leaders’ cautious approach in dealing with the financial sector. China was relatively unaffected by the two crises due to the slow pace of liberalization in financial sector. Central leaders do not see the urgency of speeding up the pace of liberalization.

7. Conclusion

7. Conclusion

It is prima facie that a closely-regulated and state-dominated banking sector did not tradeoff very much China’s economic performance in the past three decades. Notwithstanding, from a long-term perspective, it may dash foreign investors’ incentive to expand their presence in China and thus impedes its progress in internationalizing the banking sector, which is of primary importance for china’s further integration into the global economy.

ReferencesKwong, Charles C L (2009), ‘Mission Completed

or Problems Unsolved? A Policy Review of China’s Banking Reform,’ in Xiaohui Liu and Wei Zhang (eds.) China's Three Decades of Economic Reforms, Oxon: Routledge.

Kwong, Charles C L (2010), ‘Continued State Dominance in Commercial Banks: the Myth of China’s Pro-market Banking Reforms,’ in Lai-ha Chan, G. Chan and Fung Kwan (eds.) China at Sixty: Global-Local Interactions, Singapore: World-Scientific. (forthcoming)

- Thank You -

by dr charles c l kwong associate professor school of arts and social sciences the open university...

Documents

monobank system

banking system

bank of china boc

central bank functions

intended isolation

channel bank credit

chinas banking sector

path of chinas banking