LONDON – The Chinese financial system’s evolution in recent years has been extraordinary. I have observed its transformation as a member of the International Advisory Council of the China Banking Regulatory Commission (CBRC).
Back in 2002, all of China’s major banks were awash in non-performing loans (NPLs), which in some cases amounted to more than 10% of the total balance sheet. None of the major banks met even the Basel 1 standards for capital adequacy. Few financiers in London or New York could have named any bank other than Bank of China, which was often wrongly thought to be the central bank. And to suggest that the United States Federal Reserve, or the United Kingdom’s Financial Services Authority, might have anything to learn from China’s financial authorities would have been thought absurd.
Less than a decade later, much has changed. The old NPL problem was resolved, primarily by establishing asset-management companies to take over doubtful assets, and injecting new capital into the commercial banks. Now, reported NPLs amount to little more than 1% of assets. Foreign partners have been brought in to transfer skills, and minority shareholdings have been floated. Current valuations put four Chinese banks in the global top ten by market capitalization. They are now expanding overseas, fortified by their strong capital backing.
Of course, challenges remain. Even in China there is no magic potion that can revive a loan to a defunct exporter. And China’s big banks have lent large sums, willingly or otherwise, to local governments for infrastructure projects – many of them of dubious economic value. There is an ever-present risk that the property market might one day collapse, though banks would emerge in better shape than have banks in the US and the UK, because much speculative investment has been funded with cash, or with only modest leverage.
The authorities in Beijing, especially the CBRC and the People’s Bank of China (the real central bank), have a good record of managing incipient booms and busts, and I would not bet against their success this time. They have considerable flexibility, owing to a range of policy tools, including variable capital and reserve requirements and direct controls on mortgage lending terms. They have already been tightening the screws on credit growth for several months, with positive effects.
It would be flattering to think that this turnaround in China’s financial system been attributable to the wise counsels of foreign advisers. But, while external influences have been helpful in some ways – the stimulus of Basel 1 and 2 strengthened the hands of those in Beijing determined to clean up the banking system – the Chinese now, not unreasonably, treat advice from the City of London and Wall Street with some skepticism.
For example, recent criticism of Asian regulators by US Treasury Secretary Timothy Geithner is viewed across the region with scorn, not to mention incredulity. A little more humility is in order, given US regulators’ performance in the run-up to the crisis. People who live in glass houses should not throw even rhetorical stones.
The most interesting development is that we can now see increasing convergence in the regulatory philosophies and toolkits in Beijing, London, and New York. Until the recent near-implosion of Western capitalism, the North Atlantic authorities thought that the end of financial history had been reached.
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Chinese finance comes of age