Timid banks hinder reform
By Francesco Sisci
BEIJING - At the end of 2002, China's outstanding deposits were 18.3 trillion yuan, more than US$2 trillion, an increase of 18.1 percent over the previous year. Outstanding loans were 14 trillion yuan, an increase of 14.4 percent over the previous year. These two figures alone tell everything about the issue of bad and non-performing loans (NPLs) of China. The problem is not that banks and financial institutions are inefficient, it is that they lend too little, not too much.
The difference between deposits and loans is 4.3 trillion yuan, or more than 30 percent of the total of outstanding loans. NPLs are officially reckoned at 20 percent of all outstanding loans, so even if all NPLs were to become bad loans, something impossible because a part of those loans could be recovered, banks would have more than enough money to cover their losses. In the late 1990s the fear was that bad debts and NPLs were too high compared with deposits, and if all the NPLs went bad, banks would not have enough cash to refund all debtors. This is no longer the case.
As the figures show, there is a new reality - banks are too cautious in lending their money and keep a huge amount idle. This is because they want a backup for the NPLs. But this new caution is costly in terms of growth. Interests on deposits are about 1 percent but interest on loans can be about 5 percent. There is a huge spread, borrowing money is extremely expensive and this explains the NPLs. Large borrowers from state-owned enterprises (SOEs) have little incentive to return their money on time, that is, banks won’t punish their bad behavior with fines or confiscation. Both the bank managers and the chairmen of the SOEs are state employees but often the SOE chairman has a rank higher than the bank manager, so how can the bank force the debtor to return its money? It can try persuasion, creating the curious phenomenon of bank managers wining and dining large debtors to get them to repay their loans.
Furthermore, the banking structure tolerates NPLs as a form of state subsidy or support. In fact there is very little use of rollover debts. Many of the NPLs in the West would be rolled-over debts, of the kind any large companies in the world has without raising any trouble or doubt. The difficulty with some Sino-foreign joint ventures with millions of dollars' of investment in China and billions of assets abroad is that they do not get financed for their cash-flow cycle, the time between the delivery of the merchandise and its payment. That creates a bottleneck for the growth of the company, which has to put down some cash to self-finance its business cycle.
On the other hand, depositors in China are far more accepting of regulation than their counterparts in the West. For withdrawals of over $10,000 they have to call one or two days in advance, and even then they are not sure about getting their money, but nobody protests. Even if new restrictions were to be introduced they would be accepted silently. Banks in China are not seen as serving their clients, they are seen as another arm of the state, which uses banks for such things as investigating tax evasion. Banks have difficulties in cashing checks from another bank or from out of town. Complex procedures are necessary for such services and the use of debit cards (unlike with credit cards, the money must be in the account and when funds are exhausted the debit card is suspended) is spreading among consumers. The result is that a large part of the Chinese economy is cash-based and operates outside the banking system or finds its way to comparatively discreet Hong Kong.
Interest on loans for small and medium enterprises (SMEs) can be quite large, normally about 10-15 percent, sometimes even greater. The banking system, because of its restrictive policies, is imposing an extra burden to SMEs, which could grow faster if they paid less interest - that is, if they were supported by the banks. If we project this situation to the national level, we must take into account that some 70 percent of gross domestic product (GDP) is created by the non-state sector (mostly SMEs) using some 30 percent of all outstanding loans (see "Trimming the fat", February 5, link above). The percentage is the opposite for the state sector. Even small changes of the lending system to favor SMEs would create extra growth for China without increasing the money flow. This would help solve the issue of NPLs, as SMEs are more efficient and less in need of support even to roll over their debts.
But SOEs own, at least in theory, about 70 percent of all China’s assets, so from this point of view it is right for the banks to lend 70 percent of all outstanding loans to them, and the rest to the entities that own the remaining 30 percent of national assets. This is the crux of the matter: SMEs have little or no collateral to offer because some of their collateral was obtained through tax evasion or exploiting the loopholes of the law. To have better access to credit they need a better law to protect and fully legalize their assets, thus allowing them to expand. Here the new civil code is fundamental to allow the change. The new protection of property rights could reveal a different picture of the assets in China and thus swerve loans toward the new assets. If this were possible NPLs and bad debts could be minimized and the banking system could become more efficient.
In the past years China has promoted growth with investment in infrastructure, which has long-term financial returns but is helping creating a unified market in China. Highways have shortened transportation and communication times and thus have linked the lagging west with the more efficient east. These investments were necessary and if anything they were overdue; they have burdened the state coffers but have also distributed some wealth among the inland peasants hired as construction workers for building the roads. China needs infrastructure improvements. Roads must be built, but with better efficiency within the banking system.
Chinese numbers present inconsistencies and are often unreliable. Perhaps it is worth viewing them from a reliable vantage point: foreign trade is difficult to tamper with, as foreign trading partners should logically mirror foreign trade figures. Forty percent of China's GDP is created through foreign trade. This figure is just too large for a country like China. Even in Japan, a classic trading country, foreign trade accounts for less than 20 percent of GDP. A trip to the Chinese interior allows one to see many peasants relatively well off, with houses, TV sets and air conditioning. If anything, official figures may underestimate China's GDP and its growth, one reason there are growing arguments for the revaluation of the yuan. |
