Economic Survey of China 2005: Reforming the financial system to support the market economy

 

The following OECD assessment and recommendations summarise Chapter 3 of the  Economic Survey of China 2005 published on 16 September 2005.

A significant reform of the banking sector is underway,

One concern of the authorities in moving to a more flexible exchange rate, perhaps overstated given the low exposure of banks to foreign lending, has been the weakness of the banking system, but significant reforms have now been undertaken in this area. Until 1995, banks paid considerable attention to national policies in determining the allocation of bank credit. As a result, banks accumulated around CNY 4 trillion of bad debts mostly as the result of loans made in the period up to 1999. Wide ranging reforms have been introduced since then. Banks have started to modernise their lending and risk management practices. Better risk weightings have been introduced by the banking regulator and the classification system for non-performing loans has been made more realistic. Foreign investors have been allowed to acquire stakes in 12 second-tier joint stock banks. Overall, these reforms appear to have been successful, as since 2000 the new loans made by banks seem to be of a much better quality. With a reform of the banking sector infrastructure in place, the government has embarked on a strategy of recapitalising the major banks and preparing to list them on the stock market. The process of establishing a sound banking system is now well advanced for two of the major banks and has started with a third.

but further changes are still required in this sector.

Re-organisation of the remainder of the banking system is still needed and would be best accompanied by a growing marketisation of the banking sector. Almost 30% of the banking sector remains to be recapitalised. The process may take some time in the rural credit co-operative sector where there are a large number of small institutions with significant problems. Progress has been made in a number of pilot provinces where co-operatives have been converted into commercial banks. The companies set up to dispose of non-performing loans previously owned by the banks are recovering about 20% of their face value and so eventually there will be a need for the government to provide for their refinancing. Taking this into account, the ultimate costs to the government budget of recapitalising the banks, though likely to be substantial, appear manageable. But recapitalisation only represents the first step in improving the banking system. Better governance is also needed. Amongst both the joint-stock banks and city commercial banks one possible route might be to involve the non-state sector to a greater extent than at the present, as there are only a couple of banks controlled by private interests, while limiting the participation of industrial and commercial groups. As to the major banks, policy should focus on improving governance; in particular by introducing a transparent recruitment process for appointments to senior management posts. Given that a move to private ownership and changes in management are likely to take time, the bank regulator will have a key role to play in ensuring that banks put adequate risk management tools into place.

Capital markets need to be developed.

Broadening financial markets is a further crucial aspect of improving the allocation of capital. At present, such markets have a limited role and this generates a concentration of financial risk in the banking sector to a greater extent than in OECD economies. The equity market could be further developed, as the market value of freely tradable shares represented just 9% of GDP in 2004. Moreover, nearly all the quoted companies are state-controlled, while outstanding corporate bonds were equivalent to less than 1% of GDP in 2003. Share markets are unable to act as a market for control as the bulk of issued shares have restrictive covenants that, in theory, limit their transfer. The government is moving in the direction of liberalising the market, by easing restrictions on the sale of state-owned shares in quoted companies. At the same time, the pricing of initial public offers has been put on a more market driven basis, but the final decisions on which companies are listed are still made by the State Council. A freer procedure could be considered subject only to ensuring that issuing criteria have been met and that information disclosure has been adequate. In the corporate bond market, decisions on new issues are still determined administratively and are subject to industrial policy criteria. Here too a more neutral procedure could be considered. Such reforms would allow the developing private sector greater access to capital markets and make the markets more efficient, so helping to avoid the significant waste of savings represented by non-performing bank loans. Moreover, improved financial returns would benefit those saving for retirement.

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A printer-friendly Policy Brief (pdf format) can also be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.

To see the Policy Brief in Chinese, click here.

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For further information please contact the China Desk at the OECD Economics Department at webmaster@oecd.org.  The OECD Secretariat's report was prepared by Richard Herd, Sean Dougherty and Margit Molnar, under the supervision of Silvana Malle. Consultancy support was provided by Charles Pigott, Ping He and Xin Zhang.

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