Introduction

On Friday April 22nd 2005 the Chinese government intervened with 15 billion dollars to save the Industrial and Construction Bank of China (ICBC), the largest bank of the country, in a liquidity crisis. Such intervention followed the injection, at the end of 2003, of 22.5 billion dollars in support of other two state owned banks: Bank of China and China Construction Bank.¹

Why is there a banking crisis in an economy which has been growing at an average rate of 9% over the last 25 years? Usually, we expect a banking crisis to happen when the entire economy of that country suffers a crisis and the Chinese case seems a puzzle. In reality, this puzzle is only apparent, not actual. To grasp this, we need to go back to the special features of the People’s Republic of China (PRC)’s transition. This helps us understand how strong growth of the economy and a banking crisis are not contradictory but the natural outcome of policy choices. Differently from the experience of most formerly planned economies and well before the others followed their “shock therapy” to the market, opted for a gradual transition strategy.

As most economists now concur, such a choice was far-sighted because it obtained two major results, unavailable to the shock therapy: (i) it avoided the acute tensions (e.g. mass unemployment and destructive disorder of productive processes) linked to the abrupt phasing out of state enterprises; (ii) it allowed some institution building before privatizing some key sectors of the economy, where otherwise PRC risked moving from the problems of state ownership to those of private monopoly (Stiglitz, 2002; Black and Tarassova, 2002; Lau, Qian and Roland, 2000). The gradual transition allowed PRC to keep its robust growth while rooting the new domestic private economy (representing now beyond 75% of GDP) in international production networks.

Nevertheless, there was a darker side of the story: State Owned Enterprises (SOEs) survived the plan economy, thanks to the gradual transition, and kept making losses (Opper, 2001). The four big State Owned Banks (SOBs) took the bulk of those large SOE losses. It is now clear that the unhealthy link between SOEs and SOBs is the chief concern over the future of PRC’s economic miracle. Indeed, bringing better banking to PRC is needed on two main grounds. First, to overcome the macroeconomic threat to continued growth coming from the potential systemic instability associated with the fragility of SOBs. Second, to deliver a much needed improvement in the allocation of loans to enterprises.

The big question is how to achieve better banking in PRC. A preliminary aspect concerns the role of foreign banks. Even though WTO rules will gradually allow foreign banks to acquire full operational status, the size and complexity of the country make it very unlikely that foreign banks by themselves can solve PRC’s banking problem. In other words, as shown by the cases of other big countries, foreign banks can promote competition and better banking indirectly but do not usually take a large share of the market in a big country. This implies that better banking in PRC has to be found at home.

In this respect, we will show that PRC’s banking system is not monolithic: on the side of the problematic “Old Mammoths” (as we label the SOBs), a breed of dynamic “New Tigers” (Joint Stock Banks and City Commercial Banks) is rapidly emerging. These banks show clearly better performance, possibly because the state is not their single shareholder as it is for the SOBs. We conclude that even the New Tigers will not be able by themsleves to solve PRC’s banking problem. As we will show, part of their success seems due not so much to their better corporate governance, as much as to the fact that their business is concentrated in the Eastern belt, the most developed area of PRC. Thus, solving PRC’s banking problem goes back to dealing with the SOBs. Even though the Chinese authorities show activism to tackle the issue, the prospects may still be rather murky.

The rest of this paper is structured as follows. In the second section we review the negative impact of state ownership on the corporate governance of banks. We also discuss why the contribution of foreign banks may be only complementary to solving the deep rooted problems of PRC’s banks. Then, we provide details on the rapid growth of the New Tigers, the new breed of Chinese banks, also giving a comparison of performance between them and the Old Mammoths (the SOBs). This leads us to ask whether the New Tigers offer PRC an option to grow out of its banking problem. Although extrapolating the New Tigers’ growth might lead one to answer that they are rapidly supplanting the Old Mammoths, we posit that an accurate answer to this question requires carefully evaluating the sources of the New Tigers’ better performance. Specifically, we need to understand whether this is caused by better corporate governance only, or whether and to what extent the New Tigers are better simply because they do business in the most developed area of PRC, thus through their location avoiding the economic difficulties the SOBs have to live with.

The third section sheds light on this issue. We report on the results of a field survey that offers evidence on how far , bank performance of the New Tigers differs depending on the level of economic development of the geographical area where banks do their business. This is exactly the rationale behind looking at City Commercial Banks (CCBs), one of the most vibrant segments of the New Tigers, as these are banks located widely across the country. By focusing on 20 CCBs located in three provinces of PRC featuring diverse levels of economic development, we hope to keep corporate governance (relatively) constant and can, thus, ascribe any significant difference in performance across the provinces to their relative underlying prosperity.

After describing the structure of the survey, we show its main results confirming that CCB performance is systematically and positively related to the level of economic development in the provinces in which they are located. Furthermore, the richness of the information obtained through the survey allows us to gain additional insights into other factors affecting bank performance in PRC. Finally, a fourth section summarizes our main findings and briefly discusses policy implications.

Download this Discussion Paper [ PDF 226.3KB| 25 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.