“Isn’t slower better?” asks Dai Genyou. When it comes to certain things, he is surely right. But Dai is an official at the People’s Bank of China, the central bank of the People’s Republic, and he is talking about banking reform. When it comes to fixing sick banks, faster is always better.
The four largest of China’s commercial banks (Bank of China, Industrial and Commercial Bank of China, China Construction Bank and Agricultural Bank of China) should have been rehabilitated by now. After all, the Big Four have just benefited from two partial recapitalizations. In 1998 China’s Ministry of Finance injected a sum equal to US$32.5 billion into them. Without providing details, the People’s Bank of China said the recapitalization had lifted their capital adequacy ratios to 8 percent, the international standard. It was a rather large fib, and nobody, not even American economists, were fooled. At the time, however, it seemed like a step in the right direction.
Then came the real deal: US$157.0 billion of relief for the Big Four. Four newly formed asset management companies, one for each of these behemoths, were formed beginning in April 1999. The AMCs, as they are now known, took from these banks nonperforming loans. In return, the banks would receive bonds issued by the Ministry of Finance. This was, in the words of Dai Xianglong, head of the central bank, the end of the line for bailouts for the Big Four. “I consider the establishment of the asset-management companies as the last dinner for the state-owned commercial banks,” said Dai. “I know some people are expecting midnight snacks or breakfast the next morning, but I don’t think this will be possible.”
But are the Big Four ready to face the future now that they have had their last repast? These financial institutions look more modern today and their balance sheets are stronger, but they may be no nearer to a solution than they were a half decade ago. That’s because the AMC program was misconceived from the very beginning. First, the funding was not nearly enough. Beijing was not even willing to spend a third of the amount needed to put the banks on a sound footing.
The AMCs were modeled on the Resolution Trust Corporation, which acquired the assets of failed savings and loans in the United States in the early 1990s. The RTC worked well in America, but the AMCs are failing in China. This we know: when it comes to restructuring commercial banks, only decisive action works. “Do it quickly, do it big, and do it just once,” is the lesson from bank bailouts from around the world. Dentists don’t fill cavities until they remove all the decay, and partial recapitalizations don’t change bad lending practices. In fact, incomplete recapitalizations encourage reckless lending because bankers know there must be further handouts (or to use the central bank’s metaphor, there must be more banquets).
The RTC worked because it was a typical American solution: Recognize a problem, take losses quickly and move on. But in the People’s Republic technocrats and Communist Party bosses proceed cautiously. Beijing’s solution is to implement slowly and in many small steps. The aftershocks of a banking crisis are felt for years even if a government does move fast. When it does not, the crisis simply continues indefinitely. That would seem to be China’s fate, given that there is apparently no end to the cycle of bailouts: Premier Zhu Rongji in his March 5 work report to the National People’s Congress talked about a new round of bank recapitalizations.
Second, the program was designed to assist state borrowers as much as the banks. “Cinda’s main mission is to help enterprises restructure, because an outright liquidation will bring losses to creditors and hardship to the workers,” says Fang Xinghai, the first head of a committee coordinating matters between China Cinda Asset Management Corporation (the first AMC) and China Construction Bank. Fang tells us the AMCs should help state enterprises. He forgets that they are supposed to rescue the banks. Curing the enterprises is a worthy goal, but it’s not the same as saving these financial institutions.
Third, the asset management companies were given a virtually impossible task. “As a shareholder of the indebted firm, Cinda can exert pressure on management to produce a better financial return,” Fang Xinghai says. The concept was that the AMCs could fix the enterprises, which could then retire their debt. The idea, however, ignores reality: The remedies Fang suggests have been tried before without success. How can anyone think that the newly created AMCs, as minority shareholders, will bring about meaningful change when the central government, as a sole or majority shareholder, was not able to do so for over two decades? Besides, enterprises let much of their debt go bad not because they couldn’t repay but because they knew that, in China’s socialist system, they didn’t have to.
In fact, the AMCs are faltering, even at this early date. As the program began, technocrats in the Chinese capital estimated that the new companies would recover at least 30 percent and possibly as much as 40 percent of the debt, but that was delusional. It is true that one of the AMCs claims to have recovered 54 percent of assets in 2001. Even if that number is accurate–and we have to remember that when it comes to banking statistics China has no credibility–the AMCs have been carefully selecting their best assets for the first sales. Specific transactions that have been announced show far lower percentages of recovery.
Now the heads of the four AMCs are predicting that they will salvage less than 30 percent of the face value of assets. Bank of China’s AMC, China Orient, admitted that its recovery rate was 24.25 percent from the time of its formation until the end of 2001. And because the best assets are being sold first, the rate of recovery will undoubtedly sink in the years ahead. If that’s not bad enough, there’s another problem: The volume of transactions will also decline. The first AMC, Cinda, recently announced that its pace of disposals would slow in the future.
The central government should therefore not place too much hope in the AMCs. When AMCs were formed, foreign estimates put anticipated recoveries at 10 percent of the debt, a figure consistent with experience in bankruptcies in China. Jack Rodman, an advisor to one of the AMCs, has tried to put the best face on the situation by calling nonperforming loans “tarnished angels.” Few investors, however, are attracted by his “treasure chest” of bum obligations. He can invent all sorts of cute names for the debt he’s trying to sell, but he won’t be able to raise much money until he can convince investors that deadbeat enterprises will repay their loans.
Where then is the central government going to find the funds to fix the banks? There are two initiatives these days. First, the central bank is hoping that the Big Four grow themselves out of their problems by using profits generated from operations to strengthen balance sheets. Dai Xianglong has said that these banks must reduce their nonperforming loans as a percentage of total lending by two or three percentage points every year. Even if this plan proceeds, arithmetic says the cure could take decades.
A slightly more realistic program is selling stock in each of the Big Four sometime in the next five years. Plans to do so have received a recent setback, however. Bank of China, the nation’s largest foreign exchange dealer, was recently thought to be the most profitable, strong and modern of the Big Four. It was therefore scheduled to be the first bank to enter the public markets. Today, the proposed listing is in tatters. Wang Xuebing, “the celebrity face of China’s push to reform its troubled banking sector” and Premier Zhu’s protégé, was detained in January. The former head of Bank of China stands accused, among other crimes, of embezzling tens of millions of U.S. dollars with the help of his wife.
Wang’s alleged fraud is small beer, however. A few of the bank’s managers in Kaiping, a backwater city in Guangdong Province, made off with a big stash. The Bank of China admits that US$483 million is missing, but newspaper reports say that something in the neighborhood of US$725 million was stolen. Any way you look at it, the Kaiping losses are “the biggest financial scandal in the history of modern China.”
Now everyone knows the truth: Bank of China’s problems will not be solved soon. “Every bank in China has problems like this,” said one banking expert. “Even within the Bank of China, I think you can find worst abuses going on. This sort of problem is a product of the system, and unless the system changes, these kinds of problems may decrease but they won’t disappear.” Bank of China officials tell us that they have immediately corrected all their flaws, but pronouncements of that sort are simply ludicrous. “The authorities have no idea what is happening in their banks,” a foreign banker observed recently.
In China we have seen the central government spend substantial sums rehabilitating the banks. But let us not mistake activity for progress or confuse the talk of reform with reform itself. “If you compare the financial system with [that of] five years ago, not much has really changed,” says Song Guoqing, a noted Beijing University professor. “It will probably be much the same in five years’ time.”
It is certainly not beyond the Chinese government to waste another half decade. It is now being reported that the Wang Xuebing scandal is helping conservative Beijing leaders delay liberalization (as if that were an option). Then again, we should not underestimate the ability of the technocrats to foul up the banking system on their own. After all, these fine men and women have lost their way when it comes to reform. Today, two years after the latest recapitalization ended, the Big Four banks have yet to receive the Ministry of Finance bonds that were going to be used to pay for all the debt transferred to the AMCs. How can the Big Four be called “banks” when they surrender tens of billions of dollars of assets with just an understanding of payment in the indefinite future. No wonder the whole system is in trouble.
Liu Mingkang now has the unenviable job as the head of the Bank of China. When he was an official at the central bank he said that “there is no perfect recipe for strengthening the banking system of a country like China.” For a country like China, there just might not be any recipe at all.
Gordon G. Chang is the author of The Coming Collapse of China, published by Random House.