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Don’t Blame the (Chinese) Banks

April 5, 2012

The main reason I disliked the Academy Award-winning documentary Inside Job was that it sought to explain America’s subprime financial crisis in terms of good guys vs. bad guys.  If only there were more good guys than bad guys, and more people listened to the good guys, then bad things wouldn’t have happened.

I don’t think you have to whitewash the misconduct that did take place to find this — intellectually, if not emotionally — a deeply unsatisfying explanation.  To me, the more interesting and important question is why so many people — good, bad, and in-between — behaved in ways that seemed rational at the time but ended up producing such a disastrous outcome.  And this, despite the fact there were at least some people who saw it coming.

Over the past few days, I’ve received numerous calls and emails from people wondering what I think about Premier Wen Jiabao’s public criticism of Chinese banks (as quoted below from Reuters):

“Frankly, our banks make profits far too easily. Why? Because a small number of major banks occupy a monopoly position, meaning one can only go to them for loans and capital,” China National Radio quoted Wen as telling local businesses at a roundtable discussion.

“That’s why right now, as we’re dealing with the issue of getting private capital into the finance sector, essentially, that means we have to break up their monopoly,” the radio news service reported Wen as saying on its website.

Now, I don’t think anyone would mistake me as an apologist for Chinese banks.  As I’ve written before on this blog and elsewhere, I think China’s state-run banks have made what will prove to be a barge-full of bad loans over the past several years, financing a property bubble and a whole host of officially-sponsored boondoggles in order to meet inflated GDP targets.  Their reported NPL ratios (approximately 1%) are a joke, which means their supposed profits (which Wen worries are too large) are a lie.   When confronted with PBOC efforts to rein in their lending, and hence their make-believe profits, the banks repackaged risky loans as investment products, which they then sold to the Chinese public with the implied suggestion that they were risk-free.  They have financed guarantee companies which, in turn — much like AIG — purport to insure those very same banks from loan losses, while investing their funds in those same bank-sponsored investment products.  In short, whether anyone realizes or admits it or not, China’s banking system is an absolute mess.

In fact, it’s the dawning realization of the extent of this mess, at China’s highest leadership levels, that likely prompted Premier Wen’s remarks.  Last October, Wen was dispatched to Wenzhou, not to deal with a high-speed train crash (as in June) but with an implosion in the city’s shadow banking system.  This emergency visit, along with the high-profile trial of Wu Ying, an otherwise typical Chinese businesswoman facing the death penalty for engaging in “illegal lending,” have cast a spotlight on the inadequacies of China’s formal banking system.  Reformers have begun arguing that “illegal” lending to small and medium entrepreneurs meets a critical economic need that China’s state-run banks are unwilling or incapable of meeting, and that bringing the sector out from the “shadows” can play a vital role in reforming the broader financial system.  That won’t be easy, but in the long-run, it’s probably correct.

But to be fair to China’s banks, they’re not really the villains here.  They are creatures of the State; they do what they are told, and incentivized, to do.  And what they have been told, and incentivized, to do is to lend generously, without counting the cost, to companies and projects that carry the imprimatur (and implicit guarantee) of the Mother State.  They know that any losses incurred in this pursuit will be forgiven, one way or the other.  They know that, given fixed deposit and minimum lending rates, the more money they lend towards this end, the greater profits they can record, regardless of the eventual outcome.

China’s state banks are not run by  “bad” people, nor are they (necessarily) entrenched and greedy interests, staving off reform.  Some of them fully recognize the problems they are contributing to, and wish they could do things differently, although most find ways to rationalize their doubts, figuring that somebody higher-up must know what they are doing and will make everything alright — deus ex machina as a business plan.

The “monopoly” or protected position that Chinese banks occupy was given to them intentionally, so that they could serve as a slush fund to promote “growth” (in the form of limitless investment) regardless of whether market conditions told them it was profitable or not.  Premier Wen is as much to blame for framing this task as anyone.  At the 2009 National People’s Congress (NPC), he outlined the following vision of how China’s economy should be managed (bold text mine):

We must continue to make use of both market mechanisms and macro-control, that is, at the same time as we keep our reforms oriented toward a market economy, let market forces play their basic role in allocating resources, and stimulate the market’s vitality, we must make best use of the socialist system’s advantages, which enable us to make decisions efficiently, organize effectively, and concentrate resources to accomplish large undertakings.

In order words, the secret to China’s success, Wen maintained, is that it can command (among other things) a captive and insulated banking system to drive growth forward, overcoming the obstacle of market forces.

I think Premier Wen was wrong then, and is right now.  I suspect the cost of playing “the socialist system’s advantages,” in the form of mounting bad debt, persistent inflation, and stagnating growth, are becoming more and more evident to him by the day.  But the solution isn’t to blame the bankers, who are mere functionaries in this equation.  It’s the system, and the system’s priorities, that need fixing.  Getting “private capital” to play a more vital role in China’s financial sector, as Wen proposes, means accepting limits on the government’s ability to define risk and allocate resources as it pleases.  That’s going to be a whole lot harder than fingering “bad guys.”

12 Comments leave one →
  1. Guy de Jonquières permalink
    April 5, 2012 4:36 pm

    Good points. But I think there is another, key, one. The state-owned banks and their bosses may not, as you say, be SOBs. But it is precisely because of their usefulness to those in power as instruments for implementing political agendas that meaningful reforms will face strong opposition from within the party. Some will doubtless argue that re-capitalising them as and when necessary is a price worth paying for retaining control.

  2. ljubilee permalink
    April 5, 2012 4:44 pm

    Dear Prof,

    Bravo! You hit the nail on the right head.🙂

  3. ronbergwerk permalink
    April 5, 2012 7:16 pm

    very cogent analysis

  4. princess1960 permalink
    April 6, 2012 12:23 am

    you are right.(.im not.) your analysis is very clear allways..really ..makari i can do something..to help .. you know i prefer” bad guy”who have the curages to make sacrifice ..for him life just to have sucsess in work..for me really i can’t saperate ..what is good and what is bad…Sentimental..or emotional how you want i can say ..y a g g because this is the reason you have sucsess..in work (don’t see now) in this time all is in very bad situation even 1%trust me..I know if someone wated something to much in life he or she can have..THIS IS POSITIVE POWER ENERGY we have inside ..many many times we are in defficult position .but we never let down allways never give up..this i learn from my life ..for me important is to have good health everything ells will come with hart work ..i feel sorry to say all this without topic but im trying to give you understande i am really a person i care to much ….

  5. Daniel permalink
    April 6, 2012 2:20 am

    Remarkable post! Difficult not to agree with both the content and the wording.:)

    I’d be glad that you could deliver your view on the savings side of the Chinese banking industry.

    Especially on the way interest rates are perceived – from a moral, economic and policy point of view – and… administered.

  6. Auberville du Chatelle permalink
    April 6, 2012 10:46 am

    Again Victor Shih’s analysis of how the Chinese political structure spawn the banking dystopia still rings true to this day. Under Premier Wen’s regime we saw the state further solidifying their hold on the banking system and everything else. He speaks such enlightened words, all the while executing the most skillful technocrat faction power grab. People frequently equate the Party’s powerful control over individuals with mastery of the economy, which is an easy mistake to make. The true picture is a political structure that is out of control, chaotic, fractious, rotten to the core, and does not even know what it can do to ensure it’s survival. All political structures decay; One can only pray that the structure has some ways to make the decay and the regeneration less painful. I fear the PRC has less in common with the USA but more with the Qing and Ming and Tang dynasties in terms of dealing with the failure of a political structure, and those failures are coming sooner than we thought possible.

  7. Y Kai permalink
    April 7, 2012 11:25 am

    Good thing they didn’t ask you to actually analyse Wen’s original speech. That would have been terribly tough, you not being able to understand Chinese.

    You did tell those “numerous” people who called you that fact, yes?

    Also that this is your opinion as a blogger, not an actual expert on Chinese finance?

    Kind of you to take a break from your new assignment as China politics expert, and talk about economics.

    Still waiting for your “expert analysis” on Syria. Or maybe South Sudan.

  8. Prometheus permalink
    April 7, 2012 11:44 am

    Your insights on China are always interesting to read, and this one is no exception.

    On reading this post, it reminded me of the story of the classic novel “Frankenstein” where Mr. Frankenstein first sets out to create the “perfect human” but is disgusted by its end result, and tries to flee from it.

    It’s going to be interesting if this story is going to play out like the original novel, or whether it’s going to have a different ending

  9. Rasmus permalink
    April 13, 2012 12:03 pm

    It really is a joke to hear Wen Jiabao critisize the state owned banks in this way. Its all about personal image i think. Wen often comes out with this kind of quite sympathetic statements, but they have little to do with reality.
    The incentive structure in China is the problem. Banks have no incentive to lend to other than SOEs and SOEs have no incentive not to borrow.

    Just one thing though, I am quite sure your quote from the NPC is from 2010, and not 2009. Macro-control is a term often used by the leadership and it does mean something completely different to the western reader than the chinese reader. In chinese, the term has come to mean exaclty the part of the quote in bold, that is, the effective mobilisation of resources by the state.

  10. FrParlentAuxFr permalink
    April 14, 2012 11:00 am

    Well if you consider that in the West some countries did the inevitable right thing to do, that is in the restore a wall between deposit bank and investment bank, and nationalize bank and strip some bankers of their knighthood (that is in the UK).In the US however shareholders got whole, the bank got gov but the bankers were free to pay bonus and reneg on pledge not to pay dividends, the whole of housing is subsidized by Freddie and Fannie and banks are all in subsidized by balance sheet expansion from Fed. Tough to find the the US banking truely XIX century like with no bail-out, large stakes in their own banks and personal unlimited liability on loss. No need for BASEL III in that case. At least in China subsidized bankers shut up and have a hard time lobby the politburo with election contributions (allowed bribe).

Trackbacks

  1. Links 5 April 2012 | Depth Dynamics
  2. Emerging and Frontier Markets Headlines 2012.04.09 | | Diverging MarketsDiverging Markets

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