A leading foreign expert on the Chinese financial system says that one of the most urgent tasks for the newly appointed head of the People’s Bank of China will be to reform the banking system and clean up its endemic bad loans.
Writing for the New York Times, Cornell University professor Eswar Pasad notes that the appointment of deputy PBOC governor Yi Gang to the position of central bank chief coincides with reforms of China’s financial regulatory system that will expand PBOC’s role, chiefly by giving it the authority to draft key banking regulations.
Pasad contends that PBOC’s new governor should use the central bank’s expanded powers to address long-standing problems with the Chinese banking system, chief amongst them the huge volume of bad loans to state-owned enterprises that pose a threat to the financial system, as well as broader economic stability.
“Mr. Yi must push these banks to clean up their books,” writes Pasad. “Otherwise, depositors might eventually lose confidence and pull out their savings.
“If China’s banks falter, that could set off a sharp drop in growth because China would no longer be able to rely on debt-fueled spending to keep its economy growing.”
According to Pasad the chief means for improving the health of the Chinese financial system will be to change the incentives for banks, by removing government guarantees for lending to inefficient state-owned enterprises in unprofitable or overcapacity sectors.
“[Yi] can encourage [banks] to focus instead on lending to private firms at the higher interest rates that they are now allowed to charge…otherwise, China’s government will not be able to shift its growth model from one driven by (often wasteful) investment in unproductive factories and ghost cities to one driven by consumer spending.”
Prasad also calls for Yi to make PBOC more transparent and predictable in the eyes of the market, in order to avoid the shocks caused by abrupt policy changes such as its sudden adjustment of exchange rate settings in August 2015.
While this reform was well-meaning, the lack of preliminary signals jolted global financial markets and prompted an exodus of capital from China.
According to Prasad this shock cost Beijing nearly in $1 trillion foreign exchange reserves, as part of efforts to steady the yuan’s disrupted exchange rate.