Chinese Banks: The Path to Reform

1. Chinese Banks: The Path to Reform Dan Fineman International Supervision and Analysis Federal Reserve Bank of San Francisco March 2007

2. Overview • China entered the 21st century with one of Asia’s largest but least-advanced banking sectors • Important reforms have been implemented that have enhanced financial sector stability • But even more difficult reforms are needed to help banks catch up with the rest of the region in terms of efficiency, profitability, corporate governance and credit administration • Bank reform is important for China’s long-term growth and economic health

3. Why Banks Matter Bank Loans vs. Corporate Bonds Outstanding RMB tr Bank loans Corporate bonds Source: Bank for International Settlements, IMF

4. Reforms Implemented So Far

5. The Pre-Reform System • Only four banks, all 100% state-owned • Policy lending prevailed • Little lending to consumers or private sector • High non-performing loans • Poor risk management

6. Big 4 Monopoly Broken Big 4 Banks Market Share % Source: People's Bank of China, China Bank. Reg. Commission

7. State Recapitalizes Banks 2003 2004 2005 2007 1998 1999 Source: Centre D'Etude Prospectives et D'Informations Internationales

8. Balance Sheets Cleansed Major Bank Non-Performing Loans Source: China Banking Regulatory Commission

9. Foreigners Rush to Buy Stakes Source: News reports, FRBSF

10. Most Big Banks Now Listed Source: News reports, FRBSF calculations

11. Banks Shifting to Consumer Lending Financial Inst. Consumer Loans as Percent of Bank Loans % Source: CEIC, FRBSF calculations

12. WTO Commitments • Foreign banks allowed to conduct local-currency business as of this year • Global banks giving China a high priority • Although rapid market share gains unlikely, market liberalization is increasing pressures on local banks to reform

13. Improved Supervision • New regulator – China Banking Regulatory Commission • Tighter accounting standards • Crackdown on fraud and poor banking practices

14. Remaining Problems

15. Rapid Loan Growth Raises Concerns Bank loan growth % Source: CEIC, FRBSF calculations

16. Big Banks Remain in State Hands State Ownership of Top Five Chinese Banks % Source: Bank financial statements, Bloomberg

17. Biggest State Role in Asia Government Links to Top Five Banks of Selected Countries # Source: Fitch, FRBSF

18. Problems with Credit Administration • Policy lending continues • Decentralized approval process • Undeveloped credit culture • Inadequate credit data

19. Market Mechanisms Weak • Interest rates not responsive to market needs • Thin derivatives and capital markets • Insufficient attention to profitability

20. What Bank Reform Means for Business • More stable economic environment • A more vibrant private sector • Stronger consumer sector

21. Conclusion • The pace of bank reform has accelerated the past three years • The authorities are committed to further reform • But serious obstacles to continued reform lie ahead. These obstacles are internal to the banks and inherent in the political and economic system