The Chinese Banking Industryfaces a myriad of challenges ranging from excessive control by thestate to financial distortions. Among the distortions inherent in thebanking system are shadow banking, wasteful investments, bankdominance in the capital markets, and concentration of credit toState-controlled sectors.
This is the practice of non-banking institutions taking up the role of banks informally and assuming financial risks similar to those of the banks.
Its size is estimated to be worth 44 percent of the Chinese GDP, and it accounts for approximately 25 percent of the outstanding credit and 50 percent of the recently issued credit.
Shadow banks operate outside the formal regulatory framework for commercial banks in China. This implies that they lack a strong foundation for safety purposes, which increases their risks for financial instability.
Loanconcentration in State-owned sectors
Banks prefer lending funds to fund investment projects initiated by the government. This creates favoritism of State-owned-enterprises (SOEs) over private enterprises.
Loans awarded to large SOEs can gain economies of scale, and commercial banks have become more sensitive to their profitability
The concentration of loans to SOEs has created the crowing-out effect, which leaves the private sector with few options to raise capital
Inrecent years, the Banking sector in China has seen the formulationand implementation of key policy reforms in the system. Some of thesereforms have been implemented fully while some are still beingimplemented.
TheKey recent policies are as follows:
The Promotion of Hybrid Bank Ownership
Theaim of advocating for hybrid ownership is to improvecommercialization, corporate governance, and sustainability inperformance. Moreover, it is likely that the advancement of hybridownership will result in the creation of re-rating opportunities.
The Involvement of Strategic Investors
Thegovernment hopes that the strategic investors will lead to theintroduction of new business models that will offer integratedfinancial services. Moreover, strategic investors will enhance theability of Chinese banks to compete in the international market.
Asset Quality Disclosures
Animportant issue of concern in the Chinese banking industry has beenthe mistrust between private investors and Chinese banks regardingreported net profit loss numbers. One way of rectifying the mistrustis to advocate for better disclosure regarding asset quality.
Theliberalization efforts take a number of directions including thefacilitation of foreign competition, freeing interest rates as wellas s liberalizing the foreign exchange controls.
Howto Improve these Issues
The State should withdraw its interference in the banking sector through such mediums as interest rates
The Chinese banking institutions should embrace expansion plans from foreign banks as a way of adapting to the trend of globalization taking place around the world
The banking system should improve its market-orientation and globalization
Diversification of financial services beyond the bank-centric model
Diversificationwill lead to greater financial stability, increased competition, thepromotion of market-based choices and efficiency and elimination ofshadow banking.
Further improvements in the accounting system
Themost important aspect of the accounting reform is the properclassification of existing loans. Proper accounting procedures willattract more foreign investors under the hybrid ownership and createopportunities for rerating.
Improvements in Risk Management Strategies
Thisincludes requiring banks to set up adequate capital for the bankingoperations to mitigate any risks. Apart from the implementation ofstrict capital requirements, the Chinese authorities should alsoperform supervisory reviews to seal any regulatory loopholes.
Enhancement of Information sharing
Governmentauthorities should collect accurate, comprehensive and prompt data toimplement effective monitoring and supervision systems. Greaterinformation sharing will lead to increased preparedness againstsystemic risks.