Twofish's Blog

April 5, 2009

Notes on Chinese banking

Filed under: china, finance — twofish @ 6:27 am

http://blogs.cfr.org/setser/2009/04/03/the-london-summits-real-achievement/

Rajesh: The data shows that most of the Chinese savings rate does not come from individuals, the savings occurs in businesses and state owned enterprises.

The current savings rate is 50% households and 50% SOE’s. The amount of household savings has remained constant for the last 30 years, but what happened after 2000 was that you had this burst of SOE savings.

Looking back it now appears that the Chinese banking reforms of the late 1990’s was one of the most successful examples of basic financial restructuring, and it’s something that the US should try to learn from. (And China modeled a lot of the reforms on the US savings loan fix in the 1980’s.)

Rajesh: Now for most small businesses, it is academic whether the savings are attributed to the business or its owner but for the larger enterprises it implies that those funds can not easily be diverted to consumption; they are more likely invested in new plant and equipment.

It’s not that hard. The government can take a dividend and invest in health and education. There are two problems 1) is political which is that the SOE’s don’t want the government to take their money and 2) you need to set things up so that the incentives are right. If the government takes SOE money any time they make a profit then there isn’t much point in making a profit.

Rajesh: Also most of the larger companies, because they have large profit margins, are self-financing and less dependent on banks for loans (which explains why the economy did not slow down as the central authorities raised interest rates and reserve requirements.)

I think that isn’t the big explanation. The government can just order the big companies not to spend money. They are state owned after all, and the government has control over their capital budgets.

The big explanation for why it was hard to cool the Chinese economy I think was that large sectors of the Chinese economy (like exports and construction) were big financed by Western banks. One of the ironies is that the economic downturn hasn’t hit Chinese banks which whose lending to construction was limited, but it has hit Western banks hard.

It’s ironic because for about a decade, Western banks and economists were lecturing Chinese banks on the need to improve risk management and avoid NPL’s, and Chinese banks took those lectures seriously. Western banks didn’t.

Rajesh: Peasants in China for the most part do not have bank accounts. Much of the rural economy is on a cash or barter basis.

This isn’t true, most peasants do have bank accounts. Rural China has a pretty extensive banking network in the form of rural credit cooperatives. A lot of this comes from China’s socialist past. Because the major banks are state-owned, having a bank in a small village is like having a police station or a post office. It’s a sign of state authority (and Japan has a huge postal savings bank).

Most of these rural banks are totally insolvent, but they are there. The fact that rural Chinese are tied into the financial system is what makes China very different from Latin America.

There is a huge problem with rural banks, but it is on the lending side and not on the deposit side. The problem is that because the rural banks are broke, they aren’t lending to rural areas, which is one reason why urban areas are developing so much faster than rural areas.

It’s also why Western banks never got very far in commercial banking. The idea that Western banks had was that they would be so much more efficient, that people would abandon Chinese banks for Western banks. It turns out that at the retail level, people don’t care how efficient your bank is. The care that they have an office around the corner.

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7 Comments »

  1. 你属于中宣部吗?真是个傻瓜。

    Comment by Moumou — April 9, 2009 @ 12:51 am

  2. Quote: “The idea that Western banks had was that they would be so much more efficient, that people would abandon Chinese banks for Western banks. It turns out that at the retail level, people don’t care how efficient your bank is. The care that they have an office around the corner”

    As both lending and deposit rates are tightly regulated, efficiency arguably doesn’t matter much, because it doesn’t translate into a bank’s ability to compete on price. Why would a customer care where he deposits his money or takes out a loan, as long as the rates are identical?

    Comment by Thomas — April 9, 2009 @ 6:58 pm

  3. Thomas: As both lending and deposit rates are tightly regulated, efficiency arguably doesn’t matter much, because it doesn’t translate into a bank’s ability to compete on price.

    But efficiency does matter in that it makes more money for the shareholders. If banks are guaranteed a certain amount of income, then the amount that shareholders get depends on how efficient the bank is. If the banks get a fixed amount of money, but all of it goes to employees, then the shareholders get nothing. One reason that US banks got into trouble is that shareholders in US banks are very weak in comparison to management so when management writes themselves big checks, there is no one to complain.

    Thomas: Why would a customer care where he deposits his money or takes out a loan, as long as the rates are identical?

    In commercial banking, banks can compete on service and location. Since the rates are the same, people tend to choose the bank with the branch that is closest and the nicest tellers which is why you end up with a billion banks branches all over the place. Personally, I think it is a *BAD* idea for banks to compete on interest rates. The problem is that once you eat up all of the gains by increasing efficiency, then the only way of increasing returns is by increasing risk, and because of the structure of commercial banking, that risk ends up being borne by the government.

    Also interest rates in the United States were government regulated until about 1980, which is why you had this funny stereotype of banks offering people toasters if they opened a new account. They had to do this, since they legally couldn’t compete on interest rates or branch location. This system fell apart in the late-1970’s when inflation meant that people’s savings accounts had negative real interest, and so there was huge pressure to come up with things like money market funds.

    Comment by twofish — April 16, 2009 @ 11:30 am

  4. Regarding NPLs:

    I just read that China Import-Export Bank has been “directed” to extend fresh credit lines of 160 bn RMB (17 bn €) to China’s two largest shipyards (both state-owned), because they have cash-flow issues due to massive cancellation of orders.

    Just anecdotal evidence, but it sure sounds like lots of bad loans in the making…

    Comment by Thomas — April 9, 2009 @ 6:59 pm

  5. Not really. China Import-Export Bank is a policy bank and it’s purpose is precisely to serve as the “bailout bank” for Chinese companies. Since the China Import-Export Bank is not expected to make a profit, the fact that it is issuing loans that could turn bad isn’t necessarily a bad thing, since that is it’s job, and it may be a good thing since it means that the for-profit banks said no.

    Something that is important to recognize is that state directed loans for things that cannot and will not make a profit is not necessarily a bad thing. What is bad is if you start mixing “non-profit” and “for-profit” activities. It’s bad for a “for-profit” bank to issue loss-making loans, not so much because those loans shouldn’t be made, but rather because if you don’t keep these activities separate then it is impossible for the for-profit bank to figure out what it should do.

    Comment by twofish — April 16, 2009 @ 11:17 am

  6. Not really. China Import-Export Bank is a policy bank and it’s purpose is precisely to serve as the “bailout bank” for Chinese companies. Since the China Import-Export Bank is not expected to make a profit, the fact that it is issuing loans that could turn bad isn’t necessarily a bad thing, since that is it’s job, and it may be a good thing since it means that the for-profit banks said no.

    Something that is important to recognize is that state directed loans for things that cannot and will not make a profit is not necessarily a bad thing. What is bad is if you start mixing “non-profit” and “for-profit” activities. It’s bad for a “for-profit” bank to issue loss-making loans, not so much because those loans shouldn’t be made, but rather because if you don’t keep these activities separate then it is impossible for the for-profit bank to figure out what it should do.

    Comment by twofish — April 16, 2009 @ 11:17 am

  7. I agree that efficiency matters for the shareholders. What I meant is: It doesn’t matter for the customers, as long as they get the same deal from every bank.

    As for location: I don’t know about the US, but in Germany, bank branches are closing all over the place, because the entire young generation is migrating to the internet, and specifically to banks competing on interest rates.

    Comment by Thomas — April 16, 2009 @ 6:42 pm


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