Xinhua Finance notes that macroeconomic measures, employed in response to the global economic downturn as the global financial crisis began to affect the real economy, have at this stage already had a strong negative impact on the creditworthiness of China’s banking industry. As of now, the growth rate of bank loans has begun to decline and loan quality is deteriorating. Particularly worrisome is the decline in asset quality in the manufacturing and real estate industries that account for a large portion of the loan portfolio. Indications are also appearing of slowing in the retail business.
However, Xinhua Finance is optimistic regarding China’s medium to long-term economic development. Dr. Chung-Hsing Chen, vice president of and head of ratings and research for Xinhua Finance, notes that "With sufficient foreign exchange reserves and fiscal surplus, the government is capable of handling the external challenges. Moreover, China's fiscal and monetary policy still has considerable leeway for adjustment. The various measures introduced by government will play a positive role in promoting economic growth, which will provide a sound basis for the banking sector’s development. However, economic restructuring is a long-term process, and it takes time to together implement a large number of measures. During this process banks will need to observe stringent credit standards in order to avoid the creation of new non-performing loans."
In the current environment of macroeconomic adjustments, improvement in a bank’s creditworthiness will primarily rely on taking advantage of opportunities provided by government policies and economic restructuring to improve and transform business operations, and improve management and risk control capabilities. With the country's macroeconomic adjustment policies and the possible narrowing of interest rate spreads, banks must seek breakthroughs in differentiated pricing capabilities, progressively increase the proportion of fees and commissions and other non-interest revenue, and improve the quality of earnings. The banking industry should seize opportunities arising from national economic policy adjustments to expand financing of infrastructure projects and small and medium enterprises, realize diversification of the loan portfolio, and enhance operational stability and the ability to withstand cyclical changes in the economy. On a separate note, the developmental process of commercializing and modernizing the industry has occurred over a relatively brief period of time. After a period of rapid maturation, the industry now also needs to work on enhancing internal management and risk control capabilities.
With regards to the problem of financing small and medium enterprises, the report points out that actual domestic bank credit exposure to SME losses is relatively limited, since SME’s have historically not been a lending focus for domestic banks, especially large banks. Unless a policy is put in place providing SME credit guarantees, banks will continue to limit their participation in such business. Regarding this, Dr. Chung-Hsing Chen states that "Development of the SME credit business will depend on improvement in banks’ ability to control risks and price risk. Developing a national rather than local SME Credit Guarantee Fund is also a good policy which has been successfully implemented in many countries. Providing guarantees for SME loans directly reduces the risk to financial institutions of financing SMEs, improving their willingness to lend. In addition, simultaneous matching reforms and development will be required in areas such as capital markets, credit systems, and tax policies.
Xinhua Finance views positively the Chinese government once again stressing the need to increase the scale of the central government’s special fund for SME development and enhance SME credit guarantees, and the establishment of the first provincial level SME re-guarantee company on November 16th, 2008. However, Xinhua Finance states that due to the disparity in financial resources available to local governments and the limitation in overall size, the development of a national SME Credit Guarantee Fund is still necessary.
Xinhua Finance views with caution the establishment of small and medium enterprise banks. The report notes that the risk in lending to SME’s is relatively high, and if a bank primarily engages in SME lending then the risk will be excessively concentrated. Furthermore, since small to medium size banks are limited in scale, the cost of capital may be too high. The business environment for small to medium size banks will become more precarious once major banks join the competition for SME loans. While small to medium size banks can be part of the solution for the immediate problems, it is highly likely that they will become one of the next major problems in the financial markets, increasing financial system risk.
Xinhua Finance also views with caution the experimental SME bonds that will be available in the near future. Although SME bonds will add variety to the bond market, their high-risk characteristics are not suitable to a bond market where institutional investors act as the mainstay. Given the historical vicissitudes of SME bonds, clearly the mainstay for bond markets are the large and healthy enterprises. SME bonds rely more on credit-enhancing guarantees and insurance, and place higher requirements on the capabilities and accountability of credit rating agencies.
Lastly, the report also discusses the insights gained by financial regulators due to the financial crisis. It emphasizes that implementation of China’s regulatory system should draw not only on international experience, but also take into account the practical needs of China. For instance, the implementation of universal banking/financial holding company system should not be undertaken in undue haste: first, there remains much room for improvement in each of the individual financial sectors; second, China’s domestic regulatory environment, risk control capabilities, and IT infrastructure is insufficient to support the development of universal banking/financial holding company system; third, risks inherent in mixed financial services, such as systemic risk, leverage and operational risk, and inadequate transparency clearly cannot be disregarded.
In regards to implementation of the Basel II Capital Accord in China, Xinhua Finance recommends a practical evaluation of China’s current situation and evolutionary steps. Xinhua Finance in addition notes that use of the Internal Ratings-Based approach to calculate regulatory capital would not be the best choice for China’s banking industry. With the exception of several larger banks, Bank of China, Agricultural Bank of China, Industrial and Commercial Bank, China Construction Bank, and Bank of Communications, commercial banks should either continue to use the previous Basel method or choose the Standard Method when calculating regulatory capital. Doing so will allow them to avoid unnecessary burdens resulting from an overly complex monitoring system and the impact of further amendments of the capital accord inspired by the financial crisis.
Xinhua Finance again suggests establishment of a unified financial regulatory institution with the sector regulatory bodies as its foundation. This on the one hand would allow macroscopic and strategic planning and coordination across the entire financial industry, guaranteeing linkage and interaction between the various financial markets and enhancing efficient allocation of resources across the financial markets. On the other hand, as a response to the appearance of financial holding companies and cross-business services, it is a necessary further step forward in the development of the financial industry and prevention of financial risks. Adjustment by China of its regulatory regime at a time of imminent reform of the international financial structure would be especially significant.
