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Market Watch
Cover Stories Series 2012> Q1 Economic Growth Stable> Market Watch
UPDATED: February 20, 2012 NO. 8 FEBRUARY 23, 2012
MARKET WATCH NO. 8, 2012
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OPINION

Further Banking Reform Needed

A debate is heating up about the windfall profits of China's banking industry. A number of commercial banks including China Minsheng Banking Corp. Ltd. and the Huaxia Bank Co. Ltd. recently released their financial results for 2011, and most of them reported year-on-year profit growth of around 50 percent.

Given a slowdown in the macro-economy and financial difficulties facing many enterprises, the banking euphoria has raised widespread suspicions.

The banking sector has outshined other industries in terms of overall scale and profitability. That means market reform of the country's commercial banks several years ago is proving to be successful.

After China entered the WTO in 2001, foreign media were flooded with reports that China's state-owned banks were "technically bankrupt." But in recent years, the state-owned banks have been growing quickly, and they sidestepped the ripple effect of the global financial crisis thanks to less exposure to international markets.

Reform efforts, including going public, introducing strategic investors, restructuring non-performing assets, and pushing forward business innovation, seem to be the reason for turnaround of the banks. Deeper down, a more important shift is that the banks have taken making profits as their top goal, and established performance-based compensation mechanisms for executives.

There are many reasons for the ongoing banking prosperity.

First, the world economy experienced a boom from 2003 to 2007. The Chinese economy, in particular, maintained strong momentum. Even after the global financial crisis broke out in 2008, the fundamentals of the Chinese economy haven't been undermined.

Second, domestic banks have established basic mechanisms for market-based operations.

Third, China's banking industry is actually protected due to the country's slow progress in liberalization of interest rates and government controls on market entry and exit.

Fourth, local governments tried to promote the banking industry as an effort to shore up local economies. The banking sector has become a major contributor to local GDP growth.

So it remains to be seen whether the banking industry has gained the capability of sustainable profitability since it has never experienced a substantial economic downturn.

Another cause for concern is that the Chinese economy has relied too much on the banks as a source of financing. In many foreign countries, government finance has shouldered some of the task. As government protection for the banking industry intensifies in China, the side effects are increasingly being felt. For example, the commercial banks have focused on providing loans to bigger firms, leaving the countryside and many small and medium-sized enterprises in dire straits.

Government protection put banks in an advantageous position to negotiate with borrowers. But that has produced negative impacts on the real economy as commercial banks consider agriculture and smaller firms as bigger risks.

As a result, China now needs to rethink its reform of the state-owned commercial banks. In a bid to dismiss doubts about the banks' windfall profits, the government must address the side effects of the reform, such as optimizing business model of the banks and reducing government intervention. Moreover, policymakers are supposed to push forward liberalization of interest rates and foster competition within the banking industry.

This is an edited excerpt of views of Yang Tao, a research fellow with the Chinese Academy of Social Sciences, published in Guangzhou Daily

Email us at: yushujun@bjreview.com

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