The Reform of State-Owned Commercial Banks in China Yan Li and Yumin Zhuang ASEAN+3 Workshop on Reform and Development of Banking System in China May 24-26,

The Reform of State-Owned The Reform of State-Owned Commercial Banks in ChinaCommercial Banks in China

Yan Li and Yumin ZhuangYan Li and Yumin ZhuangASEAN+3 Workshop on Reform and ASEAN+3 Workshop on Reform and

Development of Banking System in ChinaDevelopment of Banking System in China

May 24-26, 2005, Shanghai ChinaMay 24-26, 2005, Shanghai China

ContentsContents

Overview of China’s state-owned Overview of China’s state-owned commercial banks commercial banks

The history of state-owned The history of state-owned commercial bankscommercial banks

The process of reform The process of reform Conclusion Conclusion

Overview of China’s state-owned Overview of China’s state-owned commercial banks (SOCBs)commercial banks (SOCBs)


The progress of reform The progress of reform ConclusionConclusion

Overview of China’s SOCBsOverview of China’s SOCBs

Framework of China’s banking Framework of China’s banking systemsystem People’s Bank of China

Big fourIndustrial and commercial

bank of China (ICBC)

Agricultural Bank of China (ABC)

Bank of China (BOC)

Construction Bank of China (CBC)

Joint-stock banks(12 banks)

Policy banks

(3 banks)

City commercial banks

(112 banks)

Rural credit cooperatives

(33,586 banks)

Urban credit cooperatives(709 banks)

Foreign banks(119 operation branches

216 representative offices)

The dominance of banks over capital marketThe dominance of banks over capital market

SI ZE AND COMPOSI TI ON OF CHI NA' S FI NANCI ALSYSTEM- 2002

STOCK MARKETCAPI TALI ZATI O

N15%

GOVERNMENTBONDS

OUTSTANDI NG8%

CORPORATEBONDS

OUTSTANDI NG1%

BANK ASSETS76%

The dominance of big four over The dominance of big four over other banksother banks

COMPOSI TI ON OF BANK ASSETS I N CHI NA- 2004

PostalSavi ngs

I nst i tut i on3%

RuralCommerci al

Banks2%

Rural Credi tCooperat i ves

10%

Forei gn Banks2%

Urban Credi tCooperat i ves

1%

Ci tyCommerci al

Banks5%

Pol i cy Banks8%

SOCBs54%

J oi nt - stockCommerci al

Banks15%

The dominance of big four over all other The dominance of big four over all other financial institutesfinancial institutes

Balance shares Balance shares Balance sharesTotal 316006.68 1 248988.62 1 189298.46 1Policy Banks 24122.48 7.63% 1274.87 0.51% 22228.24 11.74%SOCBs 169320.5 53.58% 144417.48 58.00% 101182.99 53.45%Joint-stock Commercial Banks 46972.2 14.86% 40598.84 16.31% 28859.41 15.25%City Commercial Banks 17056.3 5.40% 14145.58 5.68% 9030.97 4.77%Rural Commercial Banks 565.36 2.34% 500.8 309.7Urban Credit Cooperatives 1786.76 0.57% 1588.76 0.64% 1014.54 0.54%Rural Credit Cooperatives 30767.02 9.74% 27340.16 10.98% 19241.56 10.16%Trust Corporations 2674.09 0.85% 1750.11 0.70% 1331.85 0.70%Finance Companies 5854.1 1.85% 4954.1 1.99% 3097.8 1.64%Leasing Companies 215.37 0.07% 69.32 0.03% 157.2 0.08%Postal Savings Institution 10849.6 3.43% 10849.6 4.36% 0 0.00%Foreign Banks 5822.9 1.84% 1499 0.60% 2844.2 1.50%Source: the People’s Bank of China database, 2004.

Assets Deposits LoansThe Assets, Deposits and Loans of Financial Institutions RMB100 Million yuan, %

Overview of China’s SOCBs Overview of China’s SOCBs (continue)(continue)

Conclusion:Conclusion: Financial institutes are dominated by Financial institutes are dominated by

banksbanks Banks are dominated by SOCBsBanks are dominated by SOCBs China’s fragile financial system China’s fragile financial system

means China’s fragile SOCBs means China’s fragile SOCBs Financial reform Financial reform = = SOCBs reform SOCBs reform

Overview of China’s state-owned Overview of China’s state-owned commercial bankscommercial banks



The history of SOCBs The history of SOCBs SOCBs were born in 1979—the first stage SOCBs were born in 1979—the first stage

of financial reformof financial reform One bank and dual roleOne bank and dual role

Central bank and commercial bankCentral bank and commercial bank Only source of loans and the center of disturbing Only source of loans and the center of disturbing

investment and operating funds to SOEs investment and operating funds to SOEs Confliction of dual functionConfliction of dual function

SOCBs are from Peoples Bank of ChinaSOCBs are from Peoples Bank of China ABC—a rebirth from PBC ABC—a rebirth from PBC BOC—a separation of PBC’s foreign exchange division BOC—a separation of PBC’s foreign exchange division CCB—transferred from PBC (1983)CCB—transferred from PBC (1983) ICBC—transferred from PBC (1984)ICBC—transferred from PBC (1984)

The history of SOCBs The history of SOCBs (continue)(continue)

SOCBs is the products of financial SOCBs is the products of financial reform in Chinareform in China

Problems left in SOCBsProblems left in SOCBs Loan to inefficient SOEsLoan to inefficient SOEs Government agency but “genuine bank”Government agency but “genuine bank”

Non-profit orientationNon-profit orientation Bureaucratism and CorruptionBureaucratism and Corruption Monopoly on specified areasMonopoly on specified areas

– Competition was not allowed among big four Competition was not allowed among big four No risk consciousnessNo risk consciousness

Accumulation of Bad loans Accumulation of Bad loans

Performance Comparison of BOCBs with the Top 10 in Performance Comparison of BOCBs with the Top 10 in 20042004

(Million Dollars)(Million Dollars)Net asset Earnings Earnings

/total asset before tax per employee

Top 10 average991704 4. 51 11224 1. 16 3. 19 152. 19

SOCBs average 472770 4. 26 486 0. 11 19. 2 2. 49

NPLROATotal Assets



The progress of reformThe progress of reform ConclusionConclusion

The progress of reformThe progress of reform

Phase I (1979-1993): the forming Phase I (1979-1993): the forming of framework of modern banking of framework of modern banking systemsystem

Phase II (1994-1999): transition Phase II (1994-1999): transition from specialized bank to from specialized bank to commercial bankcommercial bank

Phase III (since 2000): SOCBs Phase III (since 2000): SOCBs Comprehensive Reform Comprehensive Reform

The progress of reform The progress of reform (cont 1)(cont 1)

Phase II (1994-1999): transition from Phase II (1994-1999): transition from specialized bank to commercial bankspecialized bank to commercial bank 1994, 1994, recast Big Four as commercial banksrecast Big Four as commercial banks

Creating 3 policy banks to divorce Big Four from Creating 3 policy banks to divorce Big Four from “policy loan” dictated by government“policy loan” dictated by government

– China Agriculture Development BankChina Agriculture Development Bank– China Development BankChina Development Bank– China Import and Export Bank China Import and Export Bank

1995, pass the Commercial Bank Law 1995, pass the Commercial Bank Law Enabling Big Four to become genuine commercial Enabling Big Four to become genuine commercial

banksbanks Segregating business operations of banks, Segregating business operations of banks,

securities firms and insurance companies securities firms and insurance companies


Asia financial crisis in 1997 speed up Asia financial crisis in 1997 speed up the reform of SOCBs in 1998the reform of SOCBs in 1998

Highly concentrated supervision power in Highly concentrated supervision power in PBOC was separated into 3 parts: PBOC was separated into 3 parts:

– PBOCPBOC– China Securities Regulatory Commission China Securities Regulatory Commission – China Insurance Regulatory Commission China Insurance Regulatory Commission

Injecting $33 billion of capital into the Big Injecting $33 billion of capital into the Big Four to strengthen their ability of anti-riskFour to strengthen their ability of anti-risk


1999, Establishing four asset-1999, Establishing four asset-management companies, one for management companies, one for each of the bankseach of the banks

AMCs absorbed $169 billion in non-AMCs absorbed $169 billion in non-performing loansperforming loans

By the end of 2003 they had disposed of By the end of 2003 they had disposed of $61.5 billion in bad loans, recovering $61.5 billion in bad loans, recovering some $12 billion some $12 billion


Phase III (since 2000): SOCBs Phase III (since 2000): SOCBs Comprehensive ReformComprehensive Reform A compressed timeframe of reformA compressed timeframe of reform

China’s WTO entrance requires all banks China’s WTO entrance requires all banks (domestic and foreign) compete under (domestic and foreign) compete under the same conditions by the end of 2006the same conditions by the end of 2006

Problems faced by SOCBsProblems faced by SOCBs


High non-performing loan ratioHigh non-performing loan ratio

Source: database from People’s Bank of ChinaSource: database from People’s Bank of China

– A fragile banking system A fragile banking system

2001 2003SOCBs 25. 40% 20. 36%Japanese banks in average 4. 50%French banks in average 4. 20%British banks in average 2. 40%American banks in average 1. 80%

NPL ratio


Low profitabilityLow profitability

Source: China Financial Yearbook, 1999-2003Source: China Financial Yearbook, 1999-2003

1999 2000 2001 2002

SOCBs 0.11% 0.13% 0.12% 0.24%

ICBC 0.14% 0.13%

ABC -0.24% -0.03%

BOC 0.35% 0.45%

CBC 0.21% 0.50%

Joint-stock banks 0.36% 0.39% 0.30% －Foreign banks in China 2.67% 1.92% 2.26% －

Profit on Asset (%)

2003SOCBs(excludes ABC) 2. 5

Top 10 banks in the world 152

Profit Per Employee (thousand dollars)


Capital inadequacyCapital inadequacy

Source: Annual report of Big FourSource: Annual report of Big Four

– Capital adequacy ratio had been reached 8% Capital adequacy ratio had been reached 8% after Ministry of Finance injecting $33 billion after Ministry of Finance injecting $33 billion in SOCBs in 1998. But the ratio kept declining in SOCBs in 1998. But the ratio kept declining after that after that

1997 1999 2002ICBC 2. 55% 5.70% 5. 54%ABC 2. 14% 5. 10% 1. 44%BOC 4. 70% 3. 00% 8. 15%CBC 2. 73% 2. 50% 6. 91%

The Capital Adequacy Ratio of SOCBs


– Reason of capital inadequacy:Reason of capital inadequacy: Few ways of increasing capitalFew ways of increasing capital Low profitability Low profitability Rapid extension of credit Rapid extension of credit

Poor corporate governance mechanismPoor corporate governance mechanism– The principles of corporate governance The principles of corporate governance

mechanism (codified by OECD) include:mechanism (codified by OECD) include: Independent board of directorsIndependent board of directors Treatment of minority shareholdersTreatment of minority shareholders Coordinating the interests of capital Coordinating the interests of capital

owners and business managers.owners and business managers.


– Banks operate on a commercial basis with Banks operate on a commercial basis with modern corporate governance should have:modern corporate governance should have:

Independent boards of directorsIndependent boards of directors Sound internal control and risk managementSound internal control and risk management Comprehensive external auditsComprehensive external audits Foreign strategic investorsForeign strategic investors

– SOCBs have poor corporate governance SOCBs have poor corporate governance mechanismmechanism

Close relation with government. Bankers are Close relation with government. Bankers are government officers but not business men.government officers but not business men.

Weak incentives to support business operating Weak incentives to support business operating Weak internal control and risk managementWeak internal control and risk management


Resolutions Resolutions Improve the supervision and regulation Improve the supervision and regulation

environmentenvironment– Creating China Banking Regulation CommissionCreating China Banking Regulation Commission– Narrowing the focus of PBC on monetary policyNarrowing the focus of PBC on monetary policy

Increase capital adequacy and writing-off Increase capital adequacy and writing-off NPLsNPLs

– Injecting capital into SOCBs Injecting capital into SOCBs $45 billion into BOC and CBC in 2003;$45 billion into BOC and CBC in 2003; $15 billion into ICBC in May 2005$15 billion into ICBC in May 2005

– Issuing subordinated bonds RMB 49.4 billion by Issuing subordinated bonds RMB 49.4 billion by BOC and CBC in 2004 BOC and CBC in 2004

The progress of reform (cont The progress of reform (cont 11)11)

Improve legal environmentImprove legal environment– Passing three banking lawsPassing three banking laws

Transfer from wholly state-owned bank to joint-Transfer from wholly state-owned bank to joint-stockholding bankstockholding bank

– BOC and CBC as the pilot of test suppose to go to BOC and CBC as the pilot of test suppose to go to public in 2005public in 2005

– ICBC suppose to go to public in 2006ICBC suppose to go to public in 2006 Improve corporate governance mechanismImprove corporate governance mechanism

– BOC and CBC have established the General Meeting BOC and CBC have established the General Meeting of Shareholders, the Board of Directors, the Board of Shareholders, the Board of Directors, the Board of supervisorsof supervisors

– Under the board of directors, five committees are Under the board of directors, five committees are set up, including Strategy Committee, Risk set up, including Strategy Committee, Risk Management Committee, Audit Committee, Management Committee, Audit Committee, Nomination & Remuneration Committee, Related Nomination & Remuneration Committee, Related Transaction CommitteeTransaction Committee


– All efforts made to achieve the goals:All efforts made to achieve the goals: Strengthen risk management & internal Strengthen risk management & internal

controlcontrol Reform of the Human Resources Reform of the Human Resources

ManagementManagement Create prudential Accounting SystemCreate prudential Accounting System Increase transparencyIncrease transparency

Establish Huijin company Establish Huijin company – A government agency A government agency – FunctionFunction

A representative of state stock holder A representative of state stock holder Supervise the business operating of Supervise the business operating of

SOCBs SOCBs

The progress of reform (cont The progress of reform (cont 13)13)

Problems in joint-stock holding reform Problems in joint-stock holding reform of SOCBsof SOCBs

Who select the top manager of bank? Who select the top manager of bank? – A dilemma of state control and shareholder’ s A dilemma of state control and shareholder’ s

interest interest – Government doesn't want to give up control Government doesn't want to give up control

How to attract strategic investors?How to attract strategic investors?– The average equity size SOCBs is about RMB The average equity size SOCBs is about RMB

150 billion, take 20% of equity need RMB 30 150 billion, take 20% of equity need RMB 30 billion. It is a huge number for most potential billion. It is a huge number for most potential investorsinvestors




ConclusionConclusion

Reform is slowly but steady during the Reform is slowly but steady during the past quarter of centurypast quarter of century Spin of commercial operating from people’s Spin of commercial operating from people’s

bank of China into separated commercial bank of China into separated commercial banksbanks

Strengthen the rule of law in financial systemStrengthen the rule of law in financial system Fight against NPLsFight against NPLs Improving the governance of banksImproving the governance of banks

It is a long way but a bright way It is a long way but a bright way

THANKS!THANKS!

Documents

The Reform of State-Owned Commercial Banks in China Yan Li and Yumin Zhuang ASEAN+3 Workshop on Reform and Development of Banking System in China May 24-26,