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China's banking reforms

By Ezra Klein

As I mentioned earlier, I spent the morning in a discussion of the Chinese banking system that included a quick overview of the sector's development in recent years, which I'm going to reproduce here simply because I find it interesting.

A couple decades back, Chinese banks didn't work like the banks we're used to. That is to say, they didn't take deposits and then make loans in order to turn a profit. Instead, they were tools of the state, and in that capacity, they ended up giving out a lot of loans to friends of the state, and industries favored by the state, and various other causes that may or may not have made sense but definitely didn't fit under the "will we make money on this loan?" rubric. About 20 percent or 30 percent of the loans were bad.

As part of the conditions for entering the World Trade Organization in 2002, China has to liberalize its financial sector somewhat. But no outside companies want to invest in banks that are saddled with massive amounts of crummy loans. So China creates a bad bank that cleans the loans from the largest, or tier one, banks. Suddenly, their percentage of bad loans goes down from 30 percent to less than 5 percent. This is about $440 billion in loans (using current exchange rates) and makes them safer investments for foreign companies that want a foothold in the Chinese market.

The deal China gives these companies is a bit odd: They can't own more than 20 percent of a bank, which means they don't direct the bank. But if they come in early, they can get up to 20 percent of the bank, and they can get a foothold in a major market, and many of them are making a bet that China will liberalize its banking system further as time goes on and they'll be in on the ground floor. Meanwhile, China wants foreign capital, foreign bank-management expertise, and help floating debt for their banks in order to get the sort of regulation that debt markets provide (as China's regulatory ability remained weak, at least at this point).

It's not a deal these banks would make in most markets -- who wants to be a minority shareholder in a country where the government could simply decide to take over your shares? -- but it was a deal they were willing to make to get access to China's markets. And thus far, it seems to have worked out, with the private banks making serious profits, the initial stock offerings going well, and China's banking system working much more effectively than was previously the case.

The hitch in the road, at least for the outside banks, was the financial crisis: Where China was thought to be moving in the direction of giving foreign banks even more power before the crisis, that now appears to have stopped, as China is no longer as confident that these financial powerhouses know what they are doing and can be trusted to contribute to the country's long-term financial stability. China has also made some moves to repel the over-financialization of the economy, setting rules to make it much, much more difficult for people to buy homes.

By Ezra Klein  |  May 24, 2010; 11:42 AM ET
Categories:  China  
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Resolution trust for savings and loan bank crisis? Wasn't that the time when the particular innovation of 'bad bank' was used? Around 2 decades back in USA. Are we to say, that might have influenced the Chinese choice of this particular route to clean their bad banks? At the same time problems of Japanese banks in 'not cleaning' bad loans were all getting publicized to prompt any other country to be more prudent. Full marks to Chinese Authorities in internalizing these lessons.

And Western banks would not find 20% ownership not that lucrative except for the local market access - are you waking up now for the reality of how Chinese have been duping rest of the world all along on the pretext of 'market access'? Since 'Westerns powers be' were hostage to 'any access to Chinese market' for short term profit (Rubin and Summers were advising Bill Clinton then); we have been sold to China in this dubious way.

Your own paper had an excellent article a week back how China has been arm twisting Global Companies for their know how and money on the lure of market access which in many cases does not materialize.

More than Yuan appreciation, all these kinds of trade distortions are far more important to challenge head on and lot more consequential to USA.

Posted by: umesh409 | May 24, 2010 1:29 PM | Report abuse

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