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The Chinese Banking System – All is not well? ; By Mr. Rajaram Muthukrishnan

Image Courtesy: Silkroad News

Article No. 28/2019

The Chinese Banking system has always been susceptible to political vagaries in China. The control of the Chinese Banking system by the government and its approach to build a modern banking system has often seen a fits and starts kind of approach when it comes to reforms. More often than not, the Chinese government has used its control over the banking sector to:

  1. Fuel growth by increasing lending to a huge State Owned Enterprise (SOE) that yielded results but also saddled the banking system with huge NPAs

  2. Direct lending to fund investments as per the policy requirements of the government so that the growth happens as planned

  3. Direct lending to SOEs that used up the maximum capital lent by the Banks in order to maintain control over the economy

These strategic objectives of the Chinese government has resulted in the need for periodic bail out of banks and the resulting Non-Performing Assets (NPAs) have sought to be cleansed up using budgetary recapitalization, parking NPAs under Asset Management Company (AMC) and other means.

Of late this seems to be changing. As a report (vide Something Just Broke?- China Repo rates soar 1000 points overnight) indicates that the Chinese central banks and government have refused to back a falling bank – Baosheng Bank resulting in a crisis of confidence in the Chinese Interbank market. This report calls it as China’s “Lehman moment”. It may be a bit of hyperbole to describe it as such, but given the opaque nature of how China reports on its banks’ true state and past record of how NPAs have been handled, it is not surprising that in these days of economic growth rate slowing, increasing debt and lack of domestic demand growth, the confidence in the banking system is taking a beating from within.

As China watchers, this aspect of the economic model of China must be closely watched. This author has often maintained that the Banking sector in China is an Achilles heel. The opaque system has often be used (and abused?) by the Chinese government to hide its economic inefficiencies and inherent contradictions. The attitude of pushing the looming crisis further to placebo measures has been possible largely due to the export led, manufacturer to the world model. The global slowdown, the lack of domestic demand growth, relatively weak services sector of the Chinese economy, the increasing pressure for the Chinese currency to move away from an artificially maintained rates of exchange, increasing debt and break down of domestic bubble sectors like the Real Estate have all cumulatively resulted in the weakness showing up in the banking sector. All of the above factors have also limited the Chinese government’s traditional leverage options to hide or postpone the problem by maintaining an opaque system on Banking sector and controlling it.

Thus the limitations to the ability of the Chinese government to mask its internal incoherence when it comes to managing its economy is showing up finally. That is why it is important to track how the Banking system will evolve in the next years. Xi Jinping’s vision for China hinges on the ability to transition the economy from a low cost manufacturing and export based model to a high value manufacturing, balanced economy model. For that old ways of masking Banking sector problems and continuing the past cycles of periodic cleansing up of their balance sheets through right offs and recapitalization are not going to be enough. Is China ready for this transition? Is the Chinese government’s stand on Baosheng Bank indicative of a new approach of cleaning up the sector through hard choices? Will they be able to pull this off amidst a push towards a transformational agenda? These are questions that need to be examined by young scholars.

The overall Financial Sector of China is a theme that is worthy of serious study in order to understand the future trajectory of China’s transformation to its stated goal of becoming a high income economy by 2035. It is also important from the perspective of the Made in China 2025 perspective that aims to transform China into a high value manufacturing hub of the world.

(Mr. Rajaram Muthukrishnan is an Investor and Director, Voice Snap Services Pvt. Ltd, Chennai; Member, C3S) 

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