New China, old ways

Despite the laminate of reform pasted onto Chinese banks in preparation for their public offerings, behaviour inside looks quite familiar, says Austan Goolsbee, professor of economics at the University of Chicago Graduate School of Business.

In their study, Anil Kashyap of the University of Chicago and Wendy Dobson of the University of Toronto outline several reasons for their conclusion. For example:

The Chinese government owns the banks and will continue to control them after the public offerings.

The government has always exercised ultimate authority over the banks' lending decisions and, historically, has forced them to lend to corrupt and inefficient state-owned enterprises.

That leaves the banks with a large share of loans that, effectively, default.

To show how bad the lending practice has become, the authors cite an examination by the consulting firm McKinsey & Company of the loans by one Chinese bank:

For some 60 per cent of the loans, the bank had no record of what collateral the borrower had given.

In addition, the bank did not know what industry the borrower was in.

They even failed to note which bank official had made the decision to lend the money.

The authors do admit that so long as China maintains its torrid growth rates, the problems of the banking system will largely go unnoticed. But they are wary about China's ability to sustain its growth rates:

Some 43 per cent of gross domestic product (GDP) has been spent on industrial investment – which has helped drive the current boom – and that these investments have been artificially stimulated by cheap government loans.

In the steel industry, for example, China has 120 million tons of unused capacity and yet is investing in another 70 million tons.

Source: Austan Goolsbee, In the New China, Banks Still Cling to Old Ways, New York Times, October 12, 2006

For text (subscription required): http://www.nytimes.com/2006/10/12/business/12scene.html?_r=1&adxnnl=1&

For study: http://faculty.chicagogsb.edu/anil.kashyap/research/chinabanksoctfullpaper.pdf

For more on International Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=26

FMF Policy Bulletin/ 17 October 2006