Chinese banks: too big to compete

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As China transitions to a market-based consumption-led economy, financial reform seems inevitable and yet China’s big four government-backed lenders continue to dominate the landscape. More competition is needed to boost innovation in the formal banking system and lending to small and medium-sized enterprises.


Stillness. Serenity. Dropping in at Bank of China’s (BoC) Beijing headquarters on Fuxingmen Nei Street, these are the kind of emotions that come to mind. Silence is paramount here, as is space: vast windows soar above the cavernous floors of the state-backed bank, all drawn by the pen of the venerable Chinese-American architect IM Pei.

At first blush, it’s hard to criticize this tranquility and, more generally, the stability conferred by China’s state-owned banks, which the Lehman crisis made all too apparent.

In recent years, Chinese leaders have tapped state lenders as their primary vehicle for stimulus policies, confirming the allure of the country’s closed, quiet and highly regulated financial system, in contrast to the dangerous laissez-faire of the west.

China’s state-owned mega-lenders form the bedrock of Beijing’s system of economic and political control, through top-down monetary management and heavily controlled interest rates.

Yet despite the apparent success of this growth model, calls are growing in China for Beijing to retool this financial model and – controversially – to weaken the dominance of the state banks. Critics say China’s banks have simply become too vast, too competitive and too self-entitled. Their politically skewed mandate favours lending to equally bloated state-owned enterprises (SOEs), therefore diverting cash away from fast-growing private firms, and stimulating off-balance sheet lending amid state-controlled interest rates, the argument goes. 

A growing band of critics believe China’s biggest state banks – notably the country’s Big Four lenders, comprising BoC along with Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China and China Construction Bank – have become too secure, too dominant.

These four lenders comprise around 80% of all banking assets and between 65% to 70% of loans across the formal banking sector, with the rest dished out by second-tier lenders, city commercial banks and rural credit cooperatives. Against the shadow of this dominance, calls are growing for greater competition into a semi-isolated industry that, contrary to long-standing World Trade Organization rules, remains largely off-limits to foreign lenders.

“China’s financial structure is not diversified, as a good ecological system [should be],” says Yuan Zhou, a director at boutique Asian financial advisory firm Asia Harvest, who spent years working in the Chinese banking sector. “It’s dominated by banks too inefficient to reliably distribute resources to the national economy.”

If there is a refrain or mantra collecting around this sense of national distortion, it’s a variation on the legacy surrounding the near-collapse of the west’s financial system in late 2008. Then, leading banks were deemed “too big to fail”, forcing them to be propped up by reticent governments.

In China, the reverse is true. While mainland banks are superficially healthy – most avoid on-balance sheet risk and leverage like the plague while turning healthy profits and delivering a regular flow of dividends – the Big Four have become either “too big to manage” or, seen from another angle, “too big to compete”.

The first issue is hard to quantify. On a micro level, this overwhelming power is visible to anyone seeking to borrow money to, say, set up a company.

China’s banks sit happily atop a mountain of savings that exists in large part only because hundreds of millions of mainland depositors have nowhere else to put their cash. Casting around for places to invest that money, said banks usually opt for the politically safe embrace of the country’s often motley collection of SOEs.

This leaves privately run firms – notably the small-but-fast-growing SMEs that drive any economy – scratching around in the dark. Many are forced to borrow from a burgeoning grey - or shadow-banking sector, gaining access to funding only through costly middlemen such as a credit guarantee firms.

Then there’s the concept of risk, a hairy concept that – at least in the minds of China’s safety-at-all-costs leaders – usually results in a spike in non-performing loans. Beijing coughed up billions of dollars to bail out its banks in the mid-2000s, and it doesn’t want a repeat performance.

Yet risk, when used judiciously, is essential for the health and survival of any lender, anywhere in the world. China’s risk-averse banks, in contrast, lack “incentives for prudent risk-taking” due to their “monopoly position and government interventions”, according to Yukon Huang, a former China country director at the World Bank and a senior associate in the Carnegie Asia Programme.

Along with a reticence to lend to many of the “right” sort of borrowers – therefore implicitly favouring public over private firms and exacerbating the already overwhelming power of state interests – China’s lenders also exert unhealthy influence over the economy in other ways.

The ever-lasting shadow of state banks

The dominance of the Big Four lessens the benefit of seeking more flexible rates. Bank lobbying also prevents depositors gaining access to more advanced investment instruments, forcing savers to speculate on one of the few markets open to them: property. Wherever you go, the invisible hand of China’s leading banks is at work.

Then there’s the issue of competition, at home and abroad. Many believe the mainland’s banking system would benefit from more local rivalry, with the creation of non-state, apolitical lenders allowed to think for themselves.

“We just don’t have enough private banks,” says Thomas Yin, managing director of Beijing-based financial adviser United China Consultants. Yet, adds Yin, a former tutor at the China Academy of Social Sciences’ MBA Graduate School, it’s hard to see that changing. “The Communist Party dominates society, which makes it hard to get licences to operate formal private banks. Big banks, controlled by the party, will control the economy for the foreseeable future.”

One option here is to split the Big Four into distinct regional banks, just as Beijing did with its airlines and telecom providers in the late 1990s. This, Huang believes, would be a “powerful means to foster competition and improve governance”.

Added competition would force banks to scour the market for new customers, many of which would, inevitably, come from the private sector. Rivalry at home – including from foreign lenders, most of which struggle to gain traction in China due to the excruciatingly slow process of receiving branch approvals – would also better prepare local lenders for the harsher climes of global banking.

China’s foreign financial experience, barring ICBC’s successful partnership with Standard Bank of South Africa, “hasn’t been good”, says Yin. Note here Minsheng Bank’s disastrous attempt to buy out America’s now-defunct United Commercial Bank before the financial crisis, or Ping An writing off losses of Rmb24 billion ($3.9 billion) after the nationalization of Fortis.

Whether a consensus will be formed that China’s banks, particularly its dominant four, are too big either to manage or, indeed, compete will only become clear in the coming years.

As the country transitions to a market-based consumption-led economy, financial reform seems inevitable. But don’t hold your breath: Beijing rarely operates proactively, however beneficial the long-term prognosis, unless forced to do so.

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