The evolution, reform and development of the Chinese banking sector

Abstract

Since the late 1970s, a series of banking reforms have been implemented by the Chinese government to improve the performance, enhance the stability, and create a more competitive environment in the banking sector. This chapter will start by reviewing banking reforms since 1979 and then review the structure of the Chinese banking sector. This will be followed by an overview of the Chinese banking sector over the period 2003-11 with emphasis on different indicators such as market share of assets, volume of non-performing loans and non-performing loan ratios, and capital adequacy and profitability of different ownerships of commercial banks.

The chapter is structured as follows: "China's banking reforms" reviews Chinese banking reforms that have taken place over the last three decades. "Structure of the Chinese banking sector" looks at the structure of the Chinese banking sector with a focus on the introduction of banking regulatory authority and different ownerships of commercial banks. "Overview of the Chinese banking sector over the period 2003-11" and "Summary and conclusion" bring the chapter to an end.

Key words

Chinese banking reform

structure of Chinese banking

overview of Chinese banking

China's banking reforms

As an important component of the financial system, the banking sector plays an important role in the development of the country's economy. In order to have a healthy and well-developed banking sector, the Chinese government has implemented a series of reforms that can be split up into three periods: the first covering 1979 to 1994, the second from 1994 to 2001, and the last covers the period since 2001 when China joined the WTO.

The Chinese socialist banking system was established in the late 1940s along the lines of the system in the former Soviet Union. The central bank, the People's Bank of China (PBC), was founded in 1948 by consolidating the former HuaBei Bank, Beihai Bank, and XiBei Peasant Bank. PBC was stripped of its central bank functions during the Cultural Revolution (1966-76), but later regained responsibility for currency issue and monetary control.

Prior to the economic reform in 1978, the Chinese banking industry was a mono-banking system, where the PBC combined the roles of central and commercial banking. Other banks - which were either taken over/restructured into the PBC or under administration by the PBC or the Ministry of Finance - were just part of the hierarchy ensuring that national production plans would be fulfilled and that there was no incentive to compete with one another. Since 1978, a number of reforms have been gradually implemented by the Chinese government in order to improve performance and create a more competitive environment in the banking sector (Yao et al., 2007).

A two-tier banking system was established during the first reform period which lasted from 1979 to 1984 with the purpose of improving banking services given to state-owned enterprises and increasing bank productivity. The first tier of the banking system is the PBC, the central bank of China, which has the responsibility of supervising the operation of various financial institutions such as all specialized banks, non-bank financial institutions, and insurance companies. The second tier of the banking system, on the other hand, mainly comprises four newly established stated-owned commercial banks: the Bank of China (BOC, established in 1912), the China Construction Bank (CCB, established in 1954), the Agricultural Bank of China (ABC, established in 1979), and the Industrial and Commercial Bank of China (ICBC, established in 1984). During this period these four state-owned commercial banks served as the lending arms of the government; they made loans to state-owned enterprises in order to fulfil the state plan under government direction. More specifically, each of these four state-owned commercial banks was responsible for credit allocation in specific economic sectors. For instance, the ABC mainly provided financial services to the agricultural sector, while the CCB made loans to help fund infrastructure projects and urban housing development. The ICBC provided financial support to help fund commercial and industrial activity in urban areas, and the BOC focussed its business on foreign exchange and foreign business transactions. To make it easier for local enterprises to get credit, various branches and local offices were established in different provinces around the country. The operation of these branches is governed by local authorities rather than the central bank. The function of these branches/offices is to help local governments fulfil their production plans and, hence loans are made to state-owned enterprises with no consideration given to profitability.

As a result of state-owned enterprises in China at this time being highly inefficient and making massive losses every year from their operations, the loan provision of state-owned commercial banks to these enterprises increased bank risk and the higher rate of loan default rate built up the number of non-performing loans. Furthermore, as discussed earlier, each of these four state-owned commercial banks provided loan services to specific economic sectors; despite having strong market power in their own designated areas there was no competition among the four banks. In order to increase competition among these four banks and achieve the goal of establishing a market-oriented economy, the four state-owned commercial banks were allowed to make loans to any economic sector without any restriction after 1985. They competed with each other in various areas such as loan and deposit services, fund raising and capital allocation, but the competition at this stage was very limited because there were no foreign banks in the Chinese banking industry and, more importantly, central and local government were still heavily involved in banks' operations (Yao et al., 2007).

In an effort to reduce the high number of non-performing loans in the Chinese banking sector, especially those of state-owned commercial banks, three policy banks were established in 1994 by the Chinese government to take over policy-leading responsibilities: the China Development Bank (CDB); the China Export-Import Bank (CEIB), and the Agriculture Development Bank of China (ADBC). They are funded by issuing bonds and accepting some deposits; they are wholly owned by the government. Their purpose is to accomplish the country's policy of industrial and regional development. Unlike the other institutions mentioned above, they have not been set up to make profits. More specifically, the CDB mainly provides loans to government-invested projects related to infrastructure and pillar industries; while the CEIB mainly supports government in terms of providing loans to help the export and import of capital goods; last but not least, the ADBC mainly funds state-invested projects like agricultural development in rural areas.

Two important banking laws were enacted in 1995: the Law of the People's Bank of China and the Commercial Bank Law. The Law of the People's Bank of China was enacted to define the status and functions of the People's Bank of China, ensure the correct formulation and implementation of monetary policy, establish and improve the macroeconomic management system of the central bank, and maintain financial stability. Furthermore, it stipulates that the People's Bank of China shall be under the leadership of the State Council and is free from intervention by local governments, government departments at various levels, non-governmental organizations, and individuals. The Commercial Bank Law was formulated to protect the legitimate rights and interests of commercial banks, depositors and other clients, standardize the behaviour of commercial banks, improve the quality of funds, strengthen supervision and administration, ensure the safety and soundness of commercial banks, maintain good financial order, and promote the development of a socialist market economy. The establishment of these two laws not only formalizes the operation of Chinese commercial banks, but gives commercial banks more autonomy in terms of credit allocation. Although the policy-lending activities of state-owned commercial banks were taken over by policy banks, central and local government still allocate policy-lending tasks to state-owned commercial banks.

The barriers to entry for new banks have been relaxed by the PBC ever since the mid-1980s, the purpose of which was to increase competition in the banking sector. Joint stock commercial banks (JSCBs) started to be set up and operate nationwide, the aim of which was to maximize profits. In 1987 the Bank of Communication (BOCOM) was established and became the first JSCB in China.1 Several other JSCBs established in the late 1980s and early 1990s include the CITIC Bank, China Merchant Bank, Shenzhen Development Bank,2 China Everbright Bank, Industrial Bank, Guangdong Development Bank,3 Huaxia Bank, Evergrowing Bank and Shanghai Pudong Development Bank. Two JSCBs were established in 1996: Bohai Bank and Minsheng Bank. The most recent JSCBs to be set up in China include Evergrowing Bank and Shanghai Pudong Development Bank, which were established in 2003 and 2004, respectively. Unlike the big four state-owned commercial banks (SOCBs) which are wholly owned by the Chinese government, most JSCBs in China mainly comprise the shares...