Is It Too Late for Banking Reform to Save China From Economic Collapse?


Political consultancy Global Risk Insights asks whether it’s too late for reform of China’s banking sector to save the country from economic catastrophe.

In an article published by GRI Arthur Guarino, assistant professor in the Finance and Economics Department at Rutgers University Business School, notes that while China has enjoyed remarkable economic growth over the past several decades, is still needs to implement key reforms to its financial sector in order to catch up with advanced OECD nations as well as avert economic calamity.

According to Guarino the commercial and shadow banking sectors are in especially urgent need of reform, otherwise China runs the risk of long-term financial ruin.

With respect to commercial banks, Guarino advocates the creation of more independent lenders who are less beholden to policymakers or the needs of state-owned enterprises, as well as better positioned to boost the efficiency and effectiveness of the sector.

China’s banking sector has long been dominated by state-owned lenders who act primarily at the behest of policymakers as opposed to free market forces.

The big four state-owned banks, comprised of the Agricultural Bank of China, the Bank of China, China Construction Bank and Industrial and Commercial Bank of China, retain an oligopoly that sees them account for almost half of Chinese lending, much of it heavily focused on state-owned enterprises.

While policy-directed financial support of China’s huge state-owned enterprise sector may stem the social turmoil that would be caused by the mass retrenchment of government workers, this comes at the cost of economic efficiency given the often poor management of such companies.

The domination of the big state-owned lenders also serves to stymie the growth of smaller and more agile banks, as the former are perceived as enjoying implicit guarantees from the government that makes them less risky.

In addition to freeing up the banking sector from state-ownership, Guarino also says that China’s central bank must do more to unshackle interest rates, in order to encourage savers to deposit more as well as provide better support to successful businesses.

While PBOC allowed banks to set deposit rates at 20% instead of 10% in 2014, as well as increase them to 1.3 to 1.5 times the benchmark rate, Guarino says that full interest rate liberalisation remains “a pipe dream,” and that the central bank as opposed to the market remains firmly in control of funding costs.

With respect to shadow banking, while the sector provides Chinese businesses with much need funds which can be hard to obtain from the state-dominated formal banking sector, the fact that such activity lies beyond the purview of government oversight by definition could create major risks for the financial system and potential for disaster.

Guarino notes that regulators are keenly aware of the risks associated with shadow banking, launching a concerted crackdown on the sector following the ointment of former Shandong province governor Guo Shuqing as head of China’s banking regulator in February.

Since Guo’s ascent to the top office, CBRC has issued a law of fines to bankers, sought to erect a fire a firewall between banks and trust companies and imposed stricter lending standards, monthly lending ceilings, as well as more stringent disclosure requirements with respect to off-balance sheet assets.

While this heavy-handed regulation of the banking sector may stymie risk in the short-term, Guarino is of the opinion that liberalisation as opposed to authoritarian control will be the best means of safeguarding China’s financial system from disaster.

“Unless immediate and necessary changes are made to China’s banking system, it will be difficult for any type of long or short term economic stability,” writes Guarino. “Banking liberalisation policies will be difficult to implement if the central government insists on maintaining authoritarian control and keeping politics and favouritism at the top of its agenda.”