Q&A: (Almost) all you need to know about China Development Bank (CDB)

Q&A: (Almost) all you need to know about China Development Bank

May 29, 2013 12:33pm by Simon Rabinovitch

China Development Bank is one of the world’s largest but least understood financial institutions. Riddled by debt 15 years ago, CDB has now comfortably surpassed the World Bank as the biggest international lender to developing countries. And that only begins to tell the story about CDB. Overseas development lending is a small part of its overall business, with most of its Rmb7.5tn ($1.2tn) in assets focused on catalysing China’s own growth. But CDB is an opaque institution. Chinese banks are difficult to penetrate under the best of circumstances. Unlike its major domestic peers, CDB is unlisted and hence provides even less disclosure.

In China’s Superbank, a book published late last year, Bloomberg reporters Henry Sanderson and Michael Forsythe peeled back the lid on CDB. With the bank entering a new era under Hu Huaibang, who took CDB’s helm last month, it seemed an opportune time for beyondbrics to check in with Messrs Sanderson and Forsythe.

Without further ado, here is what they had to say about CDB – how it works, why it has come to be such a big force and what its future might hold.

1. You have described CDB as the world’s “most powerful bank”. What is the case for that claim?

We look at three factors: its impact on people’s lives, its political power, and its sheer financial muscle. The bank invented China’s system of local government finance that helped accelerate urbanisation in the past decade, lifting tens of millions of people out of poverty. The bank’s innovation provided trillions of renminbi of shovel-ready projects that helped China quickly recover from the global financial crisis. What other bank – with the possible exception of the Fed – can claim that kind of power over so many people’s lives This system has many problems – displacement of farmers and a surge in debt – but it’s hard to ignore the benefits CDB’s local government financing system brought.

Politically, the bank has connections that a Washington lobbyist could only dream about. It was led until just this year by a man – Chen Yuan – whose political connections and clout dominated the bank since 1998. His stature as the son of one of the founders of the People’s Republic helped CDB take a leading role in guiding China’s economy. And Chen Yuan himself (pictured above) was already a player on the international stage – representing China at the annual meetings of the World Bank and IMF – before taking his post at CDB.

And when it came time for the country’s companies to become global players, CDB was front-and-center, providing more than $120bn in lines of credit to Chinese telecommunications, solar and wind companies and financing the country’s oil-for-loans program.

Those are numbers that other development banks can’t match, and the explosion of companies like Huawei, ZTE and Yingli on the world stage is testimony to CDB’s influence. The massive scale of CDB’s financing muscle is also evident in the country’s oil-for-loans program, such as the more than $40bn in lending to Venezuela since 2008. CDB is China’s biggest foreign currency lender.

2. To what extent is CDB able to function as an independent actor, making its own decisions and not simply following the Chinese government’s lead?

From day one when Chen Yuan was appointed by Zhu Rongji to take over CDB in 1998, he was determined to make CDB into a world-class bank. Up until that time the State Planning Commission (the forerunner of today’s National Development and Reform Commission) selected the projects and CDB lent; the bank was considered a “free lunch” and as a result was drowning in bad loans. CDB was just following the government’s lead.

Chen launched a dramatic transformation. He saw that China was about to enter the WTO and face tough global competition. To survive as a bank and reduce the bad loans Chen believed the bank had to become more professional, independently select its own projects and follow market forces. Independent loan committees were set up. As a result today the bank selects many of the projects it lends to, including international projects. This lending is based on the bank’s own judgement.

Yet this doesn’t mean that the bank doesn’t have a special role to play in carrying out the strategic objectives of the Chinese government. It does. But because it is itself part of the Communist Party and government system it has helped define those strategic objectives. It doesn’t act at the beck and call of the government; it is part of the system and has influence within it. Chen’s focus and determination that the bank would make a profit at the same time as serving the strategic needs of the government has also meant that the bank has had to be independent in how it achieves these goals. It is in no way comparable to western banks: if it went flagrantly beyond these strategic goals it would be reined in. Though that would be rare as it is part of the system it serves.

3. CDB profit was up 38 per cent last year, twice as fast as Chinese commercial banks. What is the secret of its success?

Under Chen the bank has really prided itself on having a low non-performing loan ratio and selecting good projects. It has certain advantages compared to commercial banks: its funding is cheap and reliable through the sale of bonds to other state-owned banks and it doesn’t have to have branches. CDB bonds are considered de facto sovereign debt, meaning they have yields comparable to that of Chinese government bonds. It has also managed to elbow in on some of the best opportunities stemming from China’s urbanisation, through its tight cooperation with local governments, as well as forging strong relationships with some of China’s best companies such as Huawei.

There are many areas of concern though. Some of CDB’s biggest clients – from Chinese solar makers to ZTE – are losing money. Local government debt continues to worry top officials. And the political turmoil in Venezuela following the death in February of President Hugo Chávez is a reminder of the political risks that come with CDB’s global lending.

4. As you lay out, CDB is the single most important lender to Chinese local governments, some of the riskiest debtors in China. Has CDB done enough to manage these risks?

CDB has considerable flexibility compared to commercial banks, and that goes back to how it structured its local government lending starting from 1998. Having invented the system of local-government financing vehicles, LGFVs, CDB traditionally worked with a local government to select projects, and what the bank calls “incubate” the projects, to make them viable. The lending takes place through “co-operation” agreements rather than straight loans. Repayment can also come from a range of sources such as share buybacks, debt sales, public offerings and even fiscal revenue from the local government.

But while the CDB system has flexibility, in many cases the lending relies hugely on land sales, continuing urbanisation and economic growth. There are risks as China’s growth slows. There is also the question of the efficiency of the projects that the bank and the local governments have selected. It will be a test of CDB’s system as to whether bad loans start to appear.

However, CDB is likely to be the last bank that local governments default on – people tell us that trust companies and local banks will be the first to feel the pain. Defaulting on CDB loans is tantamount to defaulting on a loan from the Chinese government.

5. CDB is central to China’s loan deals with emerging markets in Africa, Asia and Latin America. Has CDB been a force for good or ill in international development?

CDB is a force for good as the bank has brought a new source of capital and offered opportunities for developing countries outside of western lenders and the ideologies of the World Bank and IMF. More choice is always a good thing, as are competing philosophies of development. Having moved from a poverty-stricken state-controlled system to a market-based system without sudden political change, collapse or chaos, China has learned valuable experiences it can teach.

CDB has brought back a focus on infrastructure in countries in Africa and Latin America, and that in many ways has been beneficial to those countries. CDB can help structure the whole package, and bring Chinese companies along to build the infrastructure.

Yet the countries face some difficult choices about how to deal with the bank. CDB exists to protect China’s national interests, and it works under the strategic guidance of the Chinese government. It wants to lend to secure resources, provide opportunities for Chinese companies, and develop local economies, but rarely out of the goodness of its heart. It will be up to these countries to see if the best deal for CDB is the best deal for the country, and to set up policies accordingly to protect the quality of the projects and the labour force on those projects.

Where its record isn’t as bright is in its scrutiny of how loans are used. It has only lately been focusing more on trying to uphold global norms on environmental and labour standards. CDB’s loans to Venezuela, for example, have been used by the ruling party to bolster its electoral base.

In Ghana and Venezuela, most of the loans must be used for cooperation projects between those countries and China. That truly makes it win-win: China wins twice. CDB secures oil or other resources for China with the loan, and China’s biggest companies – almost always big CDB clients – win contracts.

6. What does the end of Chen Yuan’s leadership mean for CDB? Is there a chance its power will be diminished?

Absolutely. Chen was the ideological force and leader of CDB in so many way. His ambition created the bank we see today. His princeling status allowed him to become the longest serving head of a major Chinese bank and serve beyond the normal retirement age. In many ways he has created a unique institution within the Chinese Communist Party system. It is hard to see a successor having the same amount of influence.

Whether CDB remains powerful will be a key test of the integrity and reliability of the institutions that Chen set up within the bank. He always wanted China to have a world-class financial system, and that involved setting up procedures, rules and a sense of pride in what CDB the institution has been doing.

Chen’s own legacy will certainly be judged by whether the bank can be run without him. If so, then it will be fitting testament to his concepts of “development finance” and his building of an institution rather than just carving out a personality-led fiefdom.

One litmus test for his successor: will CDB’s bonds be allowed to keep their quasi-sovereign status? If not, the bank may have to pay more to borrow money, and banks will have to set aside some capital when they buy CDB debt, making the bonds less attractive.

For more, see: China’s Superbank: Debt, Oil and Influence – How China Development Bank is Rewriting the Rules of Finance, by Henry Sanderson and Michael Forsythe