The Chinese Communist Par-tay! does banking
We don’t know when the game of musical chairs will stop in China, but we know they’ll be having a heck of a time until the music stops. Here’s another bank bailout — of one of the Big 4 — to prove it. This makes $60 billion in bailouts of banks in the last two years — guess who got the loot from all those bad loans. Xinhua:
The State Council also authorized the next-step work plan for the reform of the Bank of China (BOC) and China Construction Bank (CCB), also “big four” banks. Last year, the State Council decided to allocate 45 billion US dollars of the country’s foreign exchange reserves for a pilot joint-stock reform of the two banks. The ICBC, China’s largest bank, witnessed an almost thirtyfold increase in its outstanding deposits from 1984 — when it was inaugurated — to 2004.
Given the bank’s huge size and its bad loan ratio of nearly 20 percent, the amount of capital infusion into ICBC would be phenomenal. The State Council has decided to allocate 15 billion US dollars of the country’s foreign exchange for ICBC’s reform. If it follows the example of the BOC and CCB, who received 22.5billion US dollars each, the ICBC would treat the external money as its new capital, while using its own, accumulated capital to cover loan losses.
Normally, a bank might add a percent or two to commercial and industrial loan loss reserves every year, and write off bad loans against the reserve on an annual basis. Hence, bad loans never go up much on the balance sheet in banks that are run as businesses. Never would a real bank get to a figure of 20% bad loans — and, since it is a government owned bank, do we think the real number is higher or lower than 20%?
We have written about the corruption in China’s banking system previously. It seems pretty clear that government employees have their mitts in the till both directly from government slush funds and indirectly from bribes, payoffs, and kickbacks involving bank loans. The WSJ has a comment on the source of conspicuous consumption in some parts of the country:
For now, government spending is holding up the region’s economy. The GDP of Chongqing municipality — an area including Fengdu and Fuling that is the size of Austria and has a permanent population of almost 30 million — increased 12.2% last year, well above the national rate of 9.5%. Expansion was fueled by $7.4 billion of infrastructure investment. Shopkeeper Zhan Shen, who sells Korean-made women’s fashions in downtown Chongqing, is being swept along by all the spending. He reckons more than 50% of his sales are to government officials, paid for out of secret slush funds bureaucrats use to pamper each other with expensive gifts.
Maybe this is the internet bubble that won’t burst. Maybe pigs will fly. But for now, the Chinese economy is booming, with first quarter growth in GDP a stratospheric 9.5% — and no sign of a slowdown so far.
However, as we have noted and the Economist has written this week, protectionist clouds continue to gather, and China’s clear intent to revalue the yuan soon is an attempt to stave off the confrontation that could result from the increasing trade imbalance with China illustrated above. The bolstering of reserves at the Industrial and Commercial Bank of China appears to us to be one of the short list of remaining preparatory steps to lifting the value of the yuan. China’s head central banker, Zhou Xiaochuan, via Reuters:
Work had to be done to strengthen the big commercial banks, to develop China’s foreign exchange market and to reduce some “over-control in the foreign exchange side,” Zhou told Reuters in an interview on the sidelines of the annual Boao economic conference on the tropical Chinese island of Hainan. Asked what political obstacles remained before a move on the yuan, Zhou said: “There are, I think, no serious political obstacles. We say that for the exchange rate regime, technically we are ready. But for the reform sequencing, we have our own sequencing considerations. “Whether some preparations are already fully done is under certain kinds of review,” he added. “People still have a different opinion on that.”
Here’s the problem: bolstering the reserves is a necessary but not sufficient step for banks who have been acting like drunken venture capitalists investing in their cousins’ businesses. When the yuan is revalued upwards, it has the impact of tightening monetary policy domestically in China, making bad loans even worse. If the credit approval system is fundamentally unsound — and a 20% bad loan figure tells us precisel;y that — then no amount of reserves injected into the bank will cure the problem. In a country so dependent on the constant inflow of investment capital, we continue to see serious problems ahead.