Wu Xiaoling: Conditions and environment for improving corporate governance
structure of China's financial enterprises
Speech by Ms Wu Xiaoling, Deputy Governor of the People's Bank of China, at the 2005 China
International Finance Development Forum, Shanghai, 23 April 2005.
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I. Financial enterprises are playing special and important roles in the performance of
the national economy. Reform of commercial banks takes a significant niche in that of
financial enterprises.
A financial enterprise, in particular, a commercial bank, is a special enterprise that shoulders
formidable social responsibility. A commercial bank is characterized by absorption of savings,
extension of loans and funds settlement for the general public. The profitability of commercial banks
and their ability to provide services will have impacts in many respects. First, they are vital to welfare
of the public, safety of savings of depositors and capital safety and profitability of investors. Second,
they affect efficiency of funds allocation and in turn indirectly influence that of resource allocation in the
whole economy. Third, they entail transaction costs and efficiency of commodity trades and
investment in the economy. It is the sole and specific role played by commercial banks that puts their
reform in a particularly important niche in the whole reform of all financial enterprises.
II. Perfecting governance structure of commercial banks is vital to success of the reform
of commercial banks.
(I) The government decides that reform be implemented in state-owned commercial banks in line with
the mode of "one policy for one bank". The move is aimed at the target that the big four commercial
banks enhance the returns of capital management, upgrade efficiency of resource allocation in the
whole economy and safeguard safety of and preserve valuation of state-owned assets to the greatest
extent, in a bid to mitigate risks in operation of commercial banks and to reduce negative impacts on
the whole society.
The share-holding reform of state-owned commercial banks only represents one means of attaining
the reform target. It is aimed at forming effective corporate governance structure, strengthening
restraints in the capital market and improving performance of banks.
(II) The linchpin of improving corporate governance structure of commercial banks lies in proper
handling of the relationship between commercial banks on one side, and investors, top Management,
employees and other stake-holders on the other, enabling all the parties to restrain one another
according to laws, rules, regulations and contracts.
Good corporate governance structure will help commercial banks set targets for their operation,
determine the approaches to attaining the targets, facilitate implementation of decisions and put in
place effective oversight. It will earn trust of investors and the public, winning more room for better
development. Reversely, poor governance structure will result in failure of operation of commercial
banks as well as the reform itself. Tod Minton (2000) studied 399 companies in Korea, Malaysia, the
Philippines and Thailand and found out that during the Southeastern Asian Crisis the difference in
corporate governance from company to company produced immense impacts. Mckinsey Investor
Opinion Survey (2000) also indicated that most investors were willing to invest large sum of funds in
companies with good corporate governance.
(III) Improvement of corporate governance of commercial banks calls for not only the efforts of the
banks themselves but also favorable environment. During economic transition, favorable environment
has bigger significance. To some extent, favorable environment will directly influence the
establishment and betterment of corporate governance structure in every commercial bank.
The People's Bank of China (PBC), as the agency for implementation of the reform scheme of
stateowned commercial banks, pays particular attention to cultivation of favorable institutional environment
for reform of commercial banks, and is committed to advocating for a favorable legal environment.
III. Conditions and environment for improvement of corporate governance structure of
commercial banks
(I) The aspects of corporate governance structure of commercial banks
The definition varies for corporate governance. To some, it means all the control system of guidance
and control in corporate finance and other aspects (The Cadbury Committee, Financial Aspects of
Corporate Governance). To some, it encompasses an array of relations among corporate
management, Board of Directors, shareholders and other stake-holders (The OECD Principles of
Corporate Governance); Some view that corporate governance deals with the ways in which suppliers
of finance to corporations assure themselves of getting a return on their investment (Shleifer &
Vishny). The Basle Committee on Banking Supervision used the one of the OECD in its Enhancing
Corporate Governance of Banking Organizations in September 1999 and pointed out that it is of vital
importance for a bank to possess strong corporate governance. Central to good corporate governance
structure of commercial banks are: clearly definition of relationships between the Board of Directors,
top Management, the Supervisory Committee, shareholders and other interest parties, establishment
of effective incentive and restraint mechanism and open and transparent disclosure mechanism, in a
bid to safeguard conformity of operation and top Management of banks with the interests of
shareholders and other interest parties.
We believe that corporate governance encompasses internally the relationship between shareholders
and the Board of Directors (Directors), between the Board and top Management, between the Board
and top Management and the Supervisors and between Management and employees. Externally, it
includes the relationship between banks and financial supervisory authorities (e.g. the People's Bank
of China (PBC), the State Administration of Foreign Exchange (SAFE), China Banking Regulatory
Commission (CBRC) and China Securities Regulatory Commission (CSRC)), between banks and
administrative departments of the government and the Party (e.g. the Organization Department of the
CPC Central Committee, the State Council, the Ministry of Finance, State Development and Reform
Commission, National Audit Office and local governments etc.), between banks and industrial
associations and intermediary agents (e.g. self-discipline industrial organizations, accountants,
auditors and legal counsels), between banks and clients and between banks and suppliers of finance
(share-holders and creditors) etc.
In constructing internal and external relationships, banks will deal with the cadres and personnel
system, the employment system, the fiscal and tax system, the financial supervisory system, the
ownership system, the arrangement for protection of consumers' rights, the system of fair competition
and anti-monopoly and the system of service standardization for intermediary organizations etc. The
outside legal environment will greatly influence establishment and effectiveness of internal corporate
governance structure of commercial banks.
The core of corporate governance structure lies in the solution to the principal-agent problem. With
expansion of a company, equity will become ever more diversified and decentralized. The power of the
general meeting of shareholders passes into the hands of the Board and there is severe conflict of
interest between big shareholders and small and medium-sized ones. Operation of companies has
more minute division of responsibilities, enhanced specialization raises the status of professional
managers. Thus, the Board cannot bring its role of restraint into full play. The separation of ownership
leads to the severe problem of insider control. The issue worthy of extensive attention remains how to
choose directors, supervisors and top Management with integrity, loyalty and diligence and how to
institute mutual oversight and restraint among themselves through effective incentive and restraint
mechanism, in a bid to safeguard the interests of owners of the company. In handling the relationship
between the principal and the agent, the personnel system and the ownership system are of vital
importance regarding the external institutional buildup.
(II) We shall reform the personnel system in a bid to select excellent directors, to form a diligent and
responsible board and to appoint outstanding top Management for banks.
1. The key to establishment of adequate corporate governance structure rests with handling well the
relationship between the principle of the Party's supervision over cadres and respecting the rights of
investors.
The Party's supervision over cadres is one of the basic principles of the Communist Party of China
(CPC). The core of the principle is to safeguard implementation of the Party's general and specific
policies through organizational construction. As the ruling party, CPC can recommend party members
and non-party people with both ability and integrity for holding positions in leading groups at various
levels by directly relying on leadership and cohesion of the Party organization. Our party has been
making efforts in strengthening inner-party democratic construction and we shall have the Party
committees play bigger role in choice and hiring of competent personnel in a bid to eradicate
corruption in hiring of personnel due to minority decisions. In such public opinion organizations as the
NPC and the CPPCC and their local subordinates, and in enterprises and social organizations, there is
an issue of the relationship between the ruling party and interest parties in the above entities. In the
new era, the organization and personnel system is confronted with a new issue of how the competent
personnel from viewpoint of the Party organization receive public acceptance and legally hold the
proper positions.
The relationship between shareholders and top Management is a principal-agent relationship. If we'd
like to choose the Board of Directors and the Chairman thereof and to let the Board to have its say in
establishing favorable incentive and restraint mechanism for Top Management, then we shall grant to
investors the right of personnel choice and hiring. As such, the agent will serve the owner in a loyal
manner, so as to eradicate intrusion through insider control into the interest of shareholders.
China's financial enterprises, in particular, the state-owned commercial banks, have continued to use
the administrative system for the Party organizations and government agencies as their personnel
system. There is a strong sense of officialdom and yet to form the ideology of restraint of ownership.
When commercial banks are still wholly state-owned or state-controlled, there is still no intense
contradiction. While the equity is diversified, there could be conflicts between the power by the
shareholders in choice of agents and the existing personnel system. Therefore, the key to improving
corporate governance in financial enterprises lies in dealing well with the relationship between the
principle of the Party's supervision over cadres and the power of shareholders.
2. "Recommendation by the Party organization and acceptance by the public" shall be concrete
reflection of the principle of Party's supervision over cadres.
Today, the country is ruled by law. Persons in charge of enterprises, in particular, members of the
Board and top Management of share-holding enterprises shall go through legal procedures and then
hold relevant posts. First and foremost, the principle of Party's supervision over cadres shall be
reflected in proper choice by the Party of representatives of state-owned equity. We shall recommend
to the Board as representatives of state-owned equity those honest and clean Party members that
have a grasp of the business and those professionals that will carry out in a loyal way the
responsibility of representatives of state-owned assets. Through their work, we shall implement the
Party's general and specific policies. Second, within financial enterprises, the Party organization shall
strengthen cultivation and training of Party members. They will in turn become persons with high
ideals and moral integrity, proficient in professional work and conscientious in carrying out general and
specific policies of the Party. Through the Party-wide education to maintain the progressiveness of
Party members, we shall render Party members in financial enterprises to have adequate
competitiveness in professional work and charismatic character. By expanding admission of party
membership, we shall attract those outstanding talents into the Party that accept Party Constitution so
that candidates recommended by the Party organization will be accepted by internal departments and
staff of the enterprises in election of members of the Board and appointment of top management.
Third, we shall reinforce the Party's work of united front within financial enterprises. We shall carry out
well publicity to the masses of enterprises, in particular, outstanding personage of democratic parties
or without party affiliation, and educate them to conscientiously implement the policies of the
government at their posts. We shall bring into full play the supervisory roles of non-Party democrats on
the work of the Party organization as well as enterprises.
"Recommendation by the Party organization and acceptance by the public" is a practice for which we
have strove as a target for the personnel system since its reform. In other words, it is a system of
competing for posts. As such, we can recommend truly outstanding talents to hold relevant posts. And
only by doing so can we get over the long-standing bad habits of courting promotion through personal
relationships and eradicate corruption in the personnel system.
3. We shall strengthen the reform of the system of hiring financial practitioners, in a bid to ensure that
financial enterprises are governed by qualified Board and that qualified talents provide financial
services to the public.
An enterprise is a social entity that weaves various social relationships. It comes into being in order to
reduce transaction costs and to increase social wealth. Financial enterprises connect with the public
with even stronger social feature and bigger social responsibility. It is of vital importance for them to
select qualified shareholder representatives and qualified managers.
Of the outside conditions for perfecting corporate governance structure of financial enterprises, one is
imperative that supervisory authorities and self-discipline industrial associations shall propose
qualifications for practitioners of the financial industry, in particular, senior officers of financial
enterprises-Chairman of the Board, Directors and top Management. The qualifications are not
"license" requirements. They are, however, standards only attainable with adequate training.
In view of China's practices in mitigating financial risks, it is not the case that he who has funds shall
become Chairman of financial enterprises. The Board will decide as to operational policies, strategies
and the incentive and restraint mechanism. Members of the Board shall possess adequate expertise.
Their expertise may not necessarily be confined to the financial industry, it shall at least cover
adequate business management. To increase efficiency of the Board, there has formed an association
of Directors. The association proposed the qualifications for the Board and compiled guidance for
directors. Many international organizations also proposed the advice of training directors. China's
supervisory authorities have also required of directors to participate in adequate training. All the above
concludes that training of directors constitutes an important aspect of improving corporate governance
structure.
In the early period of instituting corporate governance structure of financial enterprises, the biggest
lesson is, taking the Board as a rubber stamp. As a result, some directors did not have adequate
expertise, without bringing into play the role of the Board in corporate governance. It is encouraging,
however, the situation has been improving. In the recent reform of state-owned commercial banks, the
government has appointed such young, energetic professionals as Mr. Xiao Gang, Mr. Jiang
Chaoliang and Mr. Guo Shuqing as Chairmen of Bank of China (BOC), Bank of Communications
(BoCom) and China Construction Bank (CCB) respectively. The move indicated that we have paid
much attention to organizational ability, expertise and creativity of Directors. The Central Huijin
Investment Corporation sent for 6 Directors to BOC and CCB. They are also selected from the
People's Bank of China (PBC), the Ministry of Finance, China Securities Regulatory Commission
(CSRC), the State Administration of Foreign Exchange (SAFE) and other agencies. They are
professional executives, enthusiastic with the financial industry, full of administrative experience and
proficient in operation of financial enterprises.
Strengthening and improving training arrangement and rules of procedure for members of the Board of
Directors, shall be the focus of the next stage of reform and the gist of the principle of separation of the
functions of enterprises from those of government. We shall grant the managerial power to investors
and their representatives in the real sense. Only by doing so can we have the micro basis for
operation of the market economy.
When China is running short of financial talents, we could as well hire talents abroad or from all walks
of life, thus accelerating growth of China's financial talents.
(III) We shall improve the system of labor safety and set up the personnel system in which one can be
transferred to other jobs or be given a higher or a lower position as required.
Handling well the relationship between the Board and top Management and between the Board and
employees, represents one very important component of corporate governance structure of financial
enterprises. The above calls for establishment of the adequate system of safeguarding labor rights
and interests. Concretely speaking, it entails the employment system and social safety net. In terms of
the reform of China's state-owned enterprises and banks, the success is hinged on instituting the
personnel system in which one can be transferred to other jobs or be given a higher or a lower position
as required.
The sense of security, ownership and enthusiasm of employees of financial enterprises come from the
adequate law of labor safety and social security net. Guanzi once said, he who has immovable
property will have immovable perseverance. When enterprises have clearly established ownership and
when employees have the sense of physical safety, the reform shall proceed smoothly. The Labor Law
prescribes that establishment of employment calls for employment contracts. The contract is the
fundamental basis for safeguarding legal interests of employees during employment. Employment
contracts shall be entered into in conformity with the principle of equality, voluntary participation,
consultation and consensus, which represents complete contractual freedom enjoyed by employees.
Employees of financial enterprises may participate in the management of the enterprise in a
democratic manner and discuss on equal footing with the employer about protection of legal interests
of labor through the General Meeting of employees, trade unions or other means.
Career development program, training program, compensation scheme and Employee Stock
Ownership Plan (ESOP) can create the sense of honor and ownership among employees, arouse their
definite expectation about the future and thus can mobilize their working enthusiasm. The survey
conducted by Mercer Human Resource Consulting on 40 multi-national companies (MNCs) in
Shanghai in November 2003 indicated employee development program (78%), reward and
acknowledgement (60%), compensation and welfare (56%) and training program (40%) were among
the top 4 appealing factors. The economist, Mr. Liang Xiaomin, in his recent presentation about culture
in the Shanxi Merchants, also pointed out that draft banks by Shanxi Merchants in the 19th century
designed the arrangement of "career stock" according to each employee's position, tenure and
performance. The stock could share dividends. The arrangement played apparent incentive role in that
period.
Since 1920s, there were more and more mergers and acquisitions in a horizontal, vertical and mixed
manner and even across borders, bringing about several times the super-banks. After China institutes
its exit mechanism for financial institutions, acquisitions, restructuring and bankruptcy will surface as
well. Under such circumstances, it is of high necessity to establish social safety net for employees and
to make proper arrangements for employees' medical and unemployment and pension insurance.
We shall establish effective incentive and restraint mechanism. We shall gradually establish the
market of professional managers. The situation shall be changed where some operational
performance and reputation mechanism are the important determinants for compensation of top
management in the market and within the enterprises. Government agencies are after all government
agencies, and enterprises are after all enterprises. There shall no longer be an incentive mode based
on "administrative hierarchy". In no event shall executives of top Management with poor performance
be transferred to posts at the same administrative levels or back to posts in administrative agencies.
Professional managers shall cherish their own reputation and get over the complex of "administrative
hierarchy".
For top Management of banks, we shall have incentive compensation. More important, we shall
cultivate expectation linked with future operational earnings, e.g. stock option, long-term incentives like
big pension plan for long tenure, practice practical protection of property safety and personal dignity
for top Management for their hard-working after retirement.
Strong incentives shall be accompanied by strict restraint. We shall form the responsibility mechanism,
by means of supervisor inquiry, proposal for recall, establishment of track records of top Management
and investigation and affixation of responsibility. In the recent revision of the Corporate Law, lessons
have been drawn from the practice of "lifting the veil of the corporations" and constructive proposal has
been put forward regarding "supervisor proceedings" and "shareholder proceedings". For damaging
behavior by directors and top Management, shareholders may ask the supervisory committee or
supervisors to lodge proceedings. In case of emergency, shareholders may lodge proceedings on their
own behalf.
(IV) We shall set up limited government, safeguard ownership in real earnest, create level playing
ground and cultivate the sense of serving the public by financial enterprises.
A real market economy shall be one based on ruling by law. The concept of limited government is the
cream of the principle of ruling by law. Financial enterprises shall be regulated due to its special nature
of public products, externality and information asymmetry. The regulation, however, shall be moderate.
Regulation shall focus on compliance and internal risk controls. The financial industry is an industry
that manages risks. All financial products have inherent risks. The issue herein lies in
acknowledgement of risks, presentation of risks to clients, measures to mitigate and control risks to
the extent capital and reserves of financial enterprises could sustain. Regulation shall be confined to
the extent creativity of financial enterprises will not be stifled and risks shall be fully disclosed to
clients. Reliance solely on regulation will be costly and ineffective. In terms of the financial safety net,
the first priority is self-restraint of financial institutions. Industrial self-discipline and public oversight
ensue with it, while financial regulation comes the fourth.
We shall protect ownership of financial enterprises in real earnest. We shall emphasize prior claim of
banks for their creditor's rights with collateral, and shall establish gradually the basic credit database
fully covering enterprises and individuals, in a bid to improve the social credit environment and to
create favorable environment for banks' operation. Financial institutions are inflicted with costs in
providing services to the public and shall be paid off to be viable enterprises. Many clients, who used
to enjoy free services for some financial products for a long period, are still not used to the practice.
Financial enterprises shall make efforts for explanation and publicity when charging the relevant fees.
Meanwhile, financial enterprises shall in turn sharpen their sense of social responsibility and shall
cherish a sense of accountability to repay the public by providing prime and prompt financial services
for residents in their community and other enterprises as well. As such, banks may charge fees for
their services while clients feel the services are worthwhile of the charges. The Board and top
Management of financial enterprises shall take serving the public as the sole purpose of development
of their enterprises, and earn their room for viability and growth in serving the public.