China's Banking Reform: A Single Step in A Thousand-mile Journey (2001)

ABSTRACT We present an analytical framework to comprehend the ramifications of recent banking, state-owned banks (SOBs) as well as state-owned enterprises (SOEs) reforms. We update, review and discuss the most recent banking reform efforts of China within the framework presented for the period from 1998 to August 2000. We then discuss the continued challenges of the efforts given current and political conditions surrounding China. Specifically, we argue the major challenge to China's banking reform is to maintain a balance between the sustainability of continued growth of the economy and the opening up the economy to the world. Economic reforms in China are unfinished until free market mechanisms truly pervade in all businesses including both banking and non-banking sectors, even though the non-performing loan problems in the SOBs are resolved and the balance sheets of SOEs are cleaned up. JEL: G28, P21, 053 Keywords: Chinese banking reforms; State-owned enterprises; Chinese economy I. INTRODUCTION With the transformation from a central-planned economy into a market-based economy mandated by Deng Xiaoping in 1978, China has since grown into a major power in the world. China has then further confirmed its reputation as a major economic power player among the G7 countries after it had steered its economy tactfully through the turbulent 1997 Asian currency crisis and played an instrumental role in stabilizing the neighboring economies. The phenomenal growth and recognition as a world leader, however, do not come without a price. Voluminous research has surfaced to explain how China managed to become an miracle, while many other emerging markets failed miserably. The early research focuses on the management and operational aspects of different types of enterprises that thrived under the market-based economy. Accolades seemed stop coming when state-owned enterprises (SOEs) started to show financial weakness. When non-performing loans (NPLs) kept piling up at the state-owned banks (SOBs) and posed serious threat to the financial system, the government started a series of reforms on both SOEs and SOBs to curb the deterioration of their financial conditions. After the Asian currency crisis and the resulting turmoil in the financial sectors of the East Asian countries, these problems are under close scrutiny by the Chinese government as well as international banks and investors. This paper presents an analytical framework to comprehend the ramifications of recent banking as well as SOEs reforms. We also update, review and discuss the most recent banking reform efforts of China within the framework presented for the period from 1998 to August 2000. Furthermore, we discuss the continued challenges of the efforts given current and political conditions surrounding China. Previous research suggests that major challenges to banking reform include SOEs reforms, NPLs workout, recapitalization of banks, fiscal sustainability of bank reform program, and corporate governance. We believe, however, the major challenge to China's banking reform is to maintain a balance between the sustainability of continued growth of the economy and the opening up the economy to the world. Economic reforms in China are unfinished until free market mechanisms truly pervade in all businesses including both banking and non-banking sectors, even though the NPLs problems are resolved and the balance sheets of the SOEs are cleaned up. First, we present an analytical framework in the next section, which helps us understand the origin and nature of the problems associated with the SOEs and the banking sector. This section also puts the nexus of the problems in perspective in the grand scheme of China's transformation into a market-based economy since 1978. We then briefly review the NPLs problem and those measures that have taken in the capital markets to deal with it. …