Финансовый университет при Правительстве Российской Федерации. BANKING SYSTEM OF CHINA. ITS PROBLEMS, PROSPECTS AND ROLE IN THE NATIONAL ECONOMY.

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1 БАНКОВСКАЯ СИСТЕМА КИТАЯ. ПРОБЛЕМЫ, ПЕРСПЕКТИВЫ И РОЛЬ В НАЦИОНАЛЬНОЙ ЭКОНОМИКЕ. Гурин Я.С., Гурин А.С. Финансовый университет при Правительстве Российской Федерации. Москва, Россия BANKING SYSTEM OF CHINA. ITS PROBLEMS, PROSPECTS AND ROLE IN THE NATIONAL ECONOMY. Gurin Y.S., Gurin A.S Financial University under the Government of the Russian Federation Moscow, Russia This work is prepared in order to present and analyze the current situation in China Mainland banking. It concentrates on the analysis of problems, key tendencies and most significant news of the sector, concerning macroeconomic environment. The research is based on the publications of national and foreign scientists, works of experts in the banking sector, views and experience of professionals, working in banking sector, and data from the official sites. Author tries to make general predictions about the consequences of latest events effecting performance of Chinese banking. In order to do this author overviews the structure of Chinese banking sector, tracks the growth of the sector (through growth of assets and liabilities), examines the problem of nonperforming loans and factor influencing them, considers profitability and risk resistance of Chinese.

2 Evolution of Chinese banking and description of its structure 1.1 Evolution of Chinese banking sector During the whole period of its development, banking sector of China satisfied the needs, which arose as economic policy of the country changed. Banking sector serves as the key instrument of controlling of economic and social processes in China. The role of Chinese banking increased after 1978, as intensive monetarization and commercialization of Chinese economy started. The new reform of 1994 was provided in order to realize strategic goals and solve the problems of stabilization after transition period. The current goals for the BS are development of financial connections with production sector and providing freedom for decision-making and actions of economic entities. The problems which BS has to solve are reorganizing and restructuring, increasing capitalization of commercial, decreasing number of bad loans and reducing risks increasing the banking stability. According to PRC s policy all listed problems are solved considering Chinese specificity. 1.2 Structure of Chinese banking sector Chinese banking sector has two-tire structure. The first level is the Peoples Bank of China (Chinese central bank). The second level includes specialized governmental and wide banking network. In the same time there exist cities cooperatives, rural credit cooperatives and cities, which provide credit and depository operations. Peoples bank of China Private Banks Commercial Banks Specialized governmental Cities credit Cities and rural credit cooperatives Peoples Bank of China is the central bank of PRC. It was founded in 1948 by merger of three largest Chinese. The head of Peoples bank of China is director, who is proposed by prime of the State Council (Prime minister) of the PRC and appointed by 2

3 the decision of National People s Congress. Peoples Bank of China controls the monetary policy of country. It is empowered to use following regulators: Setting up proportions for deductions to the reserve funds Setting up the Bank rate (of central bank) Providing credits to commercial Buying and selling Government bonds. Peoples Bank of China has a right to handle a commercial bank. It occurs when commercial bank is in crisis, which can influence the interests of depositors. Commercial commercial can be divided into two big groups: those, which operate on the mainland and Hong Kong. The authority of Peoples Bank of China is not spread over the Hong Kong territory, so there is no currency control in Hong Kong and the capital movement is not restricted. Previously commercial could have been founded either by government or by both government and big enterprises (on the joint stock basis), however now the foundation of private is allowed. Minimal authorized capital for commercial bank is RMB. Chinese commercial are not allowed to Provide operations with stocks Invest in real estate (except real estate for needs) Invest in nonbank credit organizations. Five largest have leading positions in the sector. These are Bank of China, China Construction Bank, Industrial & Commercial Bank of China, Bank of Communications and China Merchants Bank. They form the basis of Chinese banking having share of approximately 70 80% of all deposits and loans.[1] Initially they were created as providing support of certain economic branches, however lately lost their specification. 3

4 Cities are, which operate only within cities and provide services for companies within certain territory. Credit cooperatives are small institutions, which operate mainly in rural areas. They work as savings and usually reallocate resources to cities. Paradoxically but undeveloped rural areas have more savings than investments. There are about of credit cooperatives in China. The lack of qualified staff and unprofessional management lead to the large amount of bad loans within loan structure of credit cooperatives. Private are not numerous in China. The reason is that decision on promoting and developing private was made only on June Private bank system is supported to improve the current financial system, create a financing market for small and micro-sized enterprises, and form a well-structured financial system, thus provide more targeted and convenient financial services to real economy. Now there are six private in continental China. Foreign are represented by about 200 institutions concentrated in large cities and coastal regions. Their activity is strictly regulated by governmental license system, which makes competition between them and governmental impossible. 4

5 Share of assets of of different types Policy Joint stock commercial Rural commercial Rural credit cooperatives Foreign Large commercial City commercial Rural cooperative Non-bank financial institutions Postal savings bank and New type rural financial institutions Banking sector condition analysis 2.3 Total assets and total liabilities Assets and liabilities remain increasing in 2015, however their growth rates are still lower than rates which correspond to the boom period. Author expects tendency of rates increase to continue due to appearance of private in the sector. Newly formed Chinese private are expected to provide more market oriented, hence more attractive services accelerating the growth rates of assets and liabilities of the whole sector. The historical data concerning the amounts of assets and liabilities and rates of their growth is represented by following two graphs, which are build using CBRC data (see appendix 1 and appendix 2). 5

6 Total Assets and Total liabilities Total Assets (RMB100mln) Total Liabilities (RMB 100mln) Total Assets and Liabilities growth rates. 0,3 0,25 0,2 0,15 0,1 0, Total Assets Growth Rates Total Liabilities Growth Rates 2.4 Non-performing loans One of the most urgent problems in Chinese banking is acceleration of nonperforming loans. According to CBRC non-performing loans are doubtful and loss loans. From 2013 the NPLs of commercial in China showed 46% absolute increase, while their share in loan structure increased by 30,9%. The most significant increase is fixed between the fourth quarter of 2014 and the first quarter of 2015 (14,2%). Today non-performing loans make up 1,39% of Chinese loans. Experts expect that NPLs will keep rising, as factors influencing them strengthen. The rise of non-performing loans and their share in loan structure of the sector can be represented by two following graphs. Graphs are build using information from NBS official site (see appendix 3). 6

7 12000 NPLs NPLs balance RMB 100 millions NPL ratio change. 1,80% 1,60% 1,40% 1,20% 1,00% 0,80% 0,60% 0,40% 0,20% 0,00% 1,59% 1,50% 1,39% 1,25% 1,16% 0,96% 0,96% 0,97% 1% 1,04% 1,08% 2013 Q Q Q Q Q Q Q Q Q Q Q3 2.5 Reasons for the increase of non-performing loans Two reasons, which lead to acceleration of non-performing loans in China, are overcapacity (overproduction) and economic slowdown. Overproduction is followed by decrease of Chinese industrial sector profits growth rates, recorded since the first quarter of During 2015 profits of Chinese industrial sector (which makes up about 40% of economies GDP) contract. It leads to the dramatic increase in nonperforming loans. 7

8 Inductrial sector profits growth rate Quality of loans is related to the economic cycles. History proves that during the economic slowdowns the quality of loans declines, while during the expansion periods credit assets show good quality. According to the IMF data, China shows the lowest rates of real GDP growth rates since PRC s real GDP growth rate in 2015 is 6,8%. 16,0% 14,0% 12,0% 10,0% 8,0% 6,0% 4,0% 2,0% 0,0% People's Republic of China real GDP growth rate. The slowing of Chinese economy can be represented by another significant indicator, which is known as «Li Keqiang» index. «Li Keqiang» index is used to evaluate the situation in Chinese economy using three indicators, which are the railway cargo volume (20%), electricity consumption (40%) and loans disbursed by (40%). 8

9 Li Keqiang Idex According to the growth index used by PRC s prime minister Chinese economy shows the worst growth rates since International monetary fund expects China real GDP growth rates to be on the level 6-7% until Author supposes that as recession in Chinese economy continues non-performing loans balances will keep rising in the next five years. 2.6 Profits of Chinese banking Despite the hard economic situation and obligation to increase capital imposed by regulatory organizations, Chinese succeeded to increase their profitability in 2014 and KPMG experts believe that multiplied their profits through innovative financial services provided to their clients.[5] Nevertheless, China Banking Regulatory Commission reported that growth of profits in the third quarter of 2015 continued to slow down and presented only 2,21% year on year (see appendix4). 30% 25% 23% Change in banking profits increase rate. 26% 28% 20% 17% 15% 10% 13% 13% 10% 5% 0% % 9

10 Now Chinese banking profits growth rates are lowest since the period of World Economic Crisis. However, will banking profits growth rates remain low or will they accelerate is an aspect of debate. On one hand, according to the experts expectations nonperforming loans will continue increasing with simultaneous contraction of borrowings by industrial sector (suffering from decreasing profits). Both factors will definitely negatively influence banking profitability, as interest income makes up 62,2% in Chinese banking income structure. Income structure of banking institutions can be represented by the following pie chart. Income structure of banking institutions (2014) 21,00% 1,80% 0,00% 15,00% 62,20% Income structure of banking institutions Net fee-based in income Others Net interest income Investment returns On the other hand, in the long run author could expect positive effect on banking profitability from two factors, which are appearance of the private in the sector and deposit insurance system implementation. It was already mentioned, that private should provide more market-oriented services and create financing market for small enterprises, their activity should increase profitability of the whole sector. Appearance of deposit insurance system can also increase banking profits. Since deposits are ensured, risks are lower and depositors agree to get less income, hence make lower interest rates deposits. Lower interest rate deposits mean higher profits for. It will take time for described positive factors start working, while negative 10

11 factors are already influencing banking profits. Summing up, author expects that in the nearest future increase of Chinese banking overall income would be relatively low. Later on, previously described factors will play their role. 2.7 Overall risk resistance In the fourth quarter of 2015 China Banking Regulatory Commission provided comments on the supervisory statistics concerning the third quarter of the current year. Regulator underlined that overall risk resistance remains stable. The provision coverage ratio is 190,79%, while the loan loss provision ratio is 3,04%, which is 0,06% more than in the previous quarter. Weighted average CAR (capital to risk adequacy ratio) was 13,15% (For example: Minimum CAR for U.S. is 8%). It means that the situation about the risks is generally under control [4]. 15,00% 10,00% 10,10% 10,20% 10,60% Capital to risk adequacy ratio. 12,20% 13,20% 13,15% 5,00% 0,00% Q3 A very significant step for reducing risks and increasing stability of Chinese banking is introduction of deposit insurance system. The deposit insurance system was introduced in 1 May 2015, however it is rather controversy measure. On one hand, it increases stability as in case of risks or even bankruptcies depositors would not run on the bank, because they know that their deposits are insured. On the other hand, deposit insurance system can change depositors behavior. They can become too confident about risks and check bank s performance less, rather than choosing the most reliable institution. All in all, author is sure that appearance of deposit insurance system will positively affect risk resistance of the sector. 11

12 Conclusion This work allows to resume that Chinese banking sector faces permanent problems as pace of growth declines and the ratio of non-performing loans increases at higher rates with simultaneous decrease of profits growth. Author expects banking sector expansion to continue slowing down due to the recession in the economy and overproduction. In the same time, author is convinced that risk resistance and stability of banking system will increase, because of actions of Chinese regulators and May s deposit insurance system implementation. Author is sure that after recovery of economy, Chines banking sector will start to expand at high rates due to the appearance of private, which are expected to attract clients by more market oriented products and better-quality services. In the long run new players (private ) will grow and increase profitability of the whole sector. 12

13 Appendix 1 Total assets of banking institutions ( ) Unit: RMB 100 million Institutions/ Year Banking institutions Policy & the CDB Large commercial Joint-stock commercial City commercial Rural commercial Rural cooperative Urban credit cooperatives Rural credit cooperatives Non-bank financial institutions , , , , , , , ,053 1,132,873 1,336,224 1,513,547 1,723,355 21,247 24,123 29,283 34,732 42,781 56,454 69,456 76,521 93, , , , ,51 179,82 210,05 242, , , , , , , , ,141 29,599 36,476 44,655 54,446 72,742 88, , , , , , ,801 14,622 17,056 20,367 25,938 33,405 41,320 56,800 78,526 99, , , , ,029 5,038 6,097 9,291 18,661 27,670 42,527 62,751 85, ,273 2,750 4,654 6,460 10,033 12,791 15,002 14,025 12,835 12,322 9,570 1,468 1,787 2,033 1,831 1, ,509 30,767 31,427 34,503 43,434 52,113 54,945 63,911 72,047 79,535 85,951 88,312 9,100 8,727 10,162 10,594 9,717 11,802 15,504 20,896 26,067 32,299 39,681 50,123 Foreign 4,160 5,823 7,155 9,279 12,525 13,448 13,492 17,423 21,535 23,804 25,628 27,921 New-type rural financial institutions & Postal savings bank 8,984 10,850 13,787 16,122 17,687 22,163 27,045 35,101 43,536 53,511 62,110 70,981 Notes: Data for 2003 to 2006 refer to the combined assets of banking institutions within China. Data for 2007 to 2014 refer to the consolidated assets of banking institutions within and outside China. 13

14 Appendix 2 Total liabilities of banking institutions ( ) Unit: RMB 100 million Institutions/ Year Banking institutions Policy & the CDB Large commercial Joint-stock commercial City commercial Rural commercial Rural cooperative Urban credit cooperatives Rural credit cooperatives Non-bank financial institutions Foreign New-type rural financial institutions & Postal savings bank , , , , , , , ,731 1,060,779 1,249,515 1,411,830 1,600,222 20,291 23,005 27,760 33,006 39,203 52,648 65,393 72,159 88, , , , ,18 200,45 228, ,18 306, , , , , , ,135 28,621 35,333 43,320 52,542 69,350 83, ,54 140, , , , ,641 14,123 16,473 19,540 24,723 31,521 38,651 53,213 73,703 93, , , , ,873 4,789 5,767 8,756 17,546 25,643 39,208 57,841 78, ,954 2,574 4,359 6,050 9,381 11,940 13,887 12,959 11,796 11,232 8,732 1,464 1,766 2,001 1,781 1, ,646 30,035 30,106 33,005 41,567 49,893 52,601 61,118 68,575 75,521 81,434 83,270 7,683 7,745 9,126 9,424 7,961 9,492 12,649 17,063 21,310 26,194 31,952 40,384 3,751 5,329 6,530 8,532 11,353 12,028 11,818 15,569 19,431 21,249 22,896 24,832 8,984 10,850 13,787 16,122 17,568 21,942 26,713 34,365 42,247 51,712 59,812 67,972 Notes: Data for 2003 to 2006 refer to the combined assets of banking institutions within China. Data for 2007 to 2014 refer to the consolidated assets of banking institutions within and outside China. 14

15 Appendix 3 NPLs of banking institutions ( ) Unit: RMB 100 million, percent Items/Year Outstanding balance of NPLs 12, , , , ,334.7 Substandard 5, , , , ,295.2 Doubtful 4, , , , ,639.3 Loss 1, , , , ,400.2 NPL ratio Substandard Doubtful Loss Appendix 4 Profit after tax of banking institutions ( ) Unit: RMB 100 million Institutions/Year Banking institutions 4, , , , , , , ,277.4 Policy & the CDB ,079.6 Large commercial 2, , , , , , , ,897.5 Joint-stock commercial , , , , ,211.1 City commercial , , , ,859.5 Rural commercial , ,383.0 Rural cooperative Urban credit cooperatives Rural credit cooperatives Non-bank financial institutions , ,265.2 Foreign New-type rural financial institutions & Postal savings bank

16 Appendix 5 Liquidity ratio of banking institutions ( ) Unit: percent Items/Year Banking institutions Commercial

17 References 1. Shenin R.K. Bankovskiye sistemi stran mira Knorus (2015). 2. Krugman P. and Wells R. Macroeconomics Worth Publishers. 3. Lavrushin O.I. Dengi, Kredit, Banki Knorus (2012). 4. China Banking Regulatory Commission ( 5. KPMG mainland Chinese banking survey (2015). ( 6. Foreign Banks in China Pricewaterhouse Coopers. Hong Kong,