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Summary:
(1) Too many bad loans? Not a problem.
(2) Deposit insurance: why do it for the sake of doing it?
http://www.economist.com/blogs/freeexchange/2013/09/chinas-economy
Reasons to be bullish on Chinese banks
(Free Exchange, The Economist)
On a Monday morning three autumns ago, I was at my brother's home in Jingmen City in Hubei Province. There were some gentle knocks at the door. I opened it to see two smiling, well-dressed young officers from the Government Audit Office. They asked to speak with my brother, Hualiang. The officers wanted Hualiang to spend the next few days with them to collect some unpaid debts local companies owed to the then-defunct state-owned lender, Golden Shrimp Credit Union. Hualiang had been the head of the Golden Shrimp Credit Union until the lender went belly up amid mounting bad debts seven years earlier.
I was very surprised, and impressed. I had worked at the People's Bank of China, the country’s central bank, in the 1980s, and later at foreign banks for nearly two decades. But I had not known of a place where senior bankers would be held accountable for bad lending decisions seven years after the bank had gone bust. By 2003, most Chinese banks and credit unions had phased in a "Life-time Responsibility System" for senior credit officers, Hualiang explained to me. Later on, I conducted a straw poll with a few banks. Sure enough: they all had some variant of that scheme in place.
That was good for the country, though it ruined my plan to spend some quality time with my siblings and parents in the remote village where I grew up.
Lately there has been much talk among analysts and investors of crippling bad debts at Chinese banks. Although the banks keep reporting bad debts of only about 1% of their total loan balance, few people actually believe those figures. And I certainly don't.
In recent months, various scary estimates of bad loans at Chinese banks have come up from independent observers. Let us assume they are right and that over 10% of all loans in the sector are indeed dead. Is that the end of the world? My answer is no.
First of all, the high-level of bad loans will not affect the banks' normal operations. What's happened has happened. Whether the banks report those bad debts faithfully or not is not that important. After all, it is merely an accounting matter. You may argue that it would shake confidence to the ground. But we have been here before, and depositors did not run for the hills. In fact, most Chinese people were not even interested in the news. They just did not care, despite media reports that the banks were technically bankrupt. From 2000 to 2002, the Chinese banks and the government made no secret of the fact that around one-third of the banking sector’s loans were dead. In response, the government created four Asset Management Companies (Cinda, Orient, Great Wall, and Huarong) to take over those bad loans.
Since then, everyone has applauded the government's creation of the asset management companies and the subsequent injection of new equity capital into the banks.
But where did the new money come from? From the Ministry of Finance, in the first instance. But ultimately it came from taxpayers and savers. At the turn of the century, the central bank widened the “spread” between the banks’ minimum lending rate and their maximum deposit rate. That generous interest-rate margin enabled the banks to make unprecedented profits, helping to restore their capital. It also allowed the banks to pay taxes to the Ministry of Finance, which then injected the money back into the banks.
In hindsight, I would argue that the new "equity" the government put in the banks did more harm than good. It gave the banks a false confidence that they had suddenly become clean banks, and that they could count on another rescue operation if their bad loans piled up again.
Unlike in the United States and elsewhere, there is no deposit insurance system in China. But the public has full confidence in the safety of their deposits in even the smallest of banks and credit unions. In the late 1990s, Hainan Development Bank collapsed, but there was absolutely no panic, and the government arranged for ICBC to take it over. In the past three decades, we have seen the failure of a large number of other non-bank lenders, but depositors have suffered virtually no losses.
In fact, the Chinese public does not differentiate between deposit-taking institutions on the basis of their safety. Convenience and services matter much more. Today, Chinese township and village banks thrive despite a severe slowdown in the Chinese economy and a turbulent global environment. Given this implicit deposit-insurance system, many officials see the introduction of a formal insurance system as unnecessary (as do I).
Imagine the catastrophe in the Chinese banking system today if the government had not recapitalised the banks a decade ago! But I think we would have had a much more efficient and leaner banking system today. More importantly, we would not have had the unpleasant inflation and credit explosion that ensued.
Bad loans and thin capital cushions are indeed a worry. But a much bigger threat to a bank’s survival is a weak economy and thus poor demand for loans, as has been the case in Japan in the past two decades.
Fortunately, the Chinese banks do not have that problem today. Despite diminishing returns on investment and much-dreaded industrial overcapacity, demand for loans remains strong in China. The ultimate safety of the banking industry rests on two factors: public confidence and the shape of the economy. If either of these two factors is off, no amount of equity cushion is sufficient. When both factors are sound, one can even have too much equity.
Ultimately, Chinese banks are very liquid today. As long as the economy is still growing, albeit at a much slower pace, the banks will continue to make more loans, and most loans will still bring back interest as well as principal, enabling the banks to keep lending. Savers will continue to put money in the banks. Time is a wonderful doctor and, in a few years, the Chinese banks will have enough retained earnings to replenish their equity base. In the meantime, neither the government nor the equity investors have to do anything but just sit back and relax.
Joe Zhang is Chairman of Guangzhou Wansui Micro Credit Company, and the author of "Inside China's Shadow Banking: The Next Subprime Crisis?".
(1) Too many bad loans? Not a problem.
(2) Deposit insurance: why do it for the sake of doing it?
http://www.economist.com/blogs/freeexchange/2013/09/chinas-economy
Reasons to be bullish on Chinese banks
(Free Exchange, The Economist)
On a Monday morning three autumns ago, I was at my brother's home in Jingmen City in Hubei Province. There were some gentle knocks at the door. I opened it to see two smiling, well-dressed young officers from the Government Audit Office. They asked to speak with my brother, Hualiang. The officers wanted Hualiang to spend the next few days with them to collect some unpaid debts local companies owed to the then-defunct state-owned lender, Golden Shrimp Credit Union. Hualiang had been the head of the Golden Shrimp Credit Union until the lender went belly up amid mounting bad debts seven years earlier.
I was very surprised, and impressed. I had worked at the People's Bank of China, the country’s central bank, in the 1980s, and later at foreign banks for nearly two decades. But I had not known of a place where senior bankers would be held accountable for bad lending decisions seven years after the bank had gone bust. By 2003, most Chinese banks and credit unions had phased in a "Life-time Responsibility System" for senior credit officers, Hualiang explained to me. Later on, I conducted a straw poll with a few banks. Sure enough: they all had some variant of that scheme in place.
That was good for the country, though it ruined my plan to spend some quality time with my siblings and parents in the remote village where I grew up.
Lately there has been much talk among analysts and investors of crippling bad debts at Chinese banks. Although the banks keep reporting bad debts of only about 1% of their total loan balance, few people actually believe those figures. And I certainly don't.
In recent months, various scary estimates of bad loans at Chinese banks have come up from independent observers. Let us assume they are right and that over 10% of all loans in the sector are indeed dead. Is that the end of the world? My answer is no.
First of all, the high-level of bad loans will not affect the banks' normal operations. What's happened has happened. Whether the banks report those bad debts faithfully or not is not that important. After all, it is merely an accounting matter. You may argue that it would shake confidence to the ground. But we have been here before, and depositors did not run for the hills. In fact, most Chinese people were not even interested in the news. They just did not care, despite media reports that the banks were technically bankrupt. From 2000 to 2002, the Chinese banks and the government made no secret of the fact that around one-third of the banking sector’s loans were dead. In response, the government created four Asset Management Companies (Cinda, Orient, Great Wall, and Huarong) to take over those bad loans.
Since then, everyone has applauded the government's creation of the asset management companies and the subsequent injection of new equity capital into the banks.
But where did the new money come from? From the Ministry of Finance, in the first instance. But ultimately it came from taxpayers and savers. At the turn of the century, the central bank widened the “spread” between the banks’ minimum lending rate and their maximum deposit rate. That generous interest-rate margin enabled the banks to make unprecedented profits, helping to restore their capital. It also allowed the banks to pay taxes to the Ministry of Finance, which then injected the money back into the banks.
In hindsight, I would argue that the new "equity" the government put in the banks did more harm than good. It gave the banks a false confidence that they had suddenly become clean banks, and that they could count on another rescue operation if their bad loans piled up again.
Unlike in the United States and elsewhere, there is no deposit insurance system in China. But the public has full confidence in the safety of their deposits in even the smallest of banks and credit unions. In the late 1990s, Hainan Development Bank collapsed, but there was absolutely no panic, and the government arranged for ICBC to take it over. In the past three decades, we have seen the failure of a large number of other non-bank lenders, but depositors have suffered virtually no losses.
In fact, the Chinese public does not differentiate between deposit-taking institutions on the basis of their safety. Convenience and services matter much more. Today, Chinese township and village banks thrive despite a severe slowdown in the Chinese economy and a turbulent global environment. Given this implicit deposit-insurance system, many officials see the introduction of a formal insurance system as unnecessary (as do I).
Imagine the catastrophe in the Chinese banking system today if the government had not recapitalised the banks a decade ago! But I think we would have had a much more efficient and leaner banking system today. More importantly, we would not have had the unpleasant inflation and credit explosion that ensued.
Bad loans and thin capital cushions are indeed a worry. But a much bigger threat to a bank’s survival is a weak economy and thus poor demand for loans, as has been the case in Japan in the past two decades.
Fortunately, the Chinese banks do not have that problem today. Despite diminishing returns on investment and much-dreaded industrial overcapacity, demand for loans remains strong in China. The ultimate safety of the banking industry rests on two factors: public confidence and the shape of the economy. If either of these two factors is off, no amount of equity cushion is sufficient. When both factors are sound, one can even have too much equity.
Ultimately, Chinese banks are very liquid today. As long as the economy is still growing, albeit at a much slower pace, the banks will continue to make more loans, and most loans will still bring back interest as well as principal, enabling the banks to keep lending. Savers will continue to put money in the banks. Time is a wonderful doctor and, in a few years, the Chinese banks will have enough retained earnings to replenish their equity base. In the meantime, neither the government nor the equity investors have to do anything but just sit back and relax.
Joe Zhang is Chairman of Guangzhou Wansui Micro Credit Company, and the author of "Inside China's Shadow Banking: The Next Subprime Crisis?".
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