For Chinese Reform, It’s Private Banks or Bust

For Chinese Reform, It’s Private Banks or Bust

Rate liberalization cannot occur until there is more privatization in banking.

DEREK SCISSORS

March 17, 2014 11:13 a.m. ET

The annual meetings of China’s National People’s Congress this month offered two main signals about reform under President Xi Jinping. First, the battle has been joined in finance between the market’s decisive role and the state’s dominant role. Second, there is no battle outside finance—the status quo of state dominance was otherwise left almost entirely unscathed.

Outside finance, reform was noticeable only for its absence. Premier Li Keqiang‘s work report, traditionally the heart of these annual meetings, could have been presented years ago by reform-averse former Premier Wen Jiabao. From labor rights to competition for state-owned enterprises, the policy accomplishments remained few, while Mr. Li’s promises were numerous and vague.

It is possible that Messrs. Xi and Li are sincere where their predecessors were not, but this month’s policy documents fail to advance the ambitious, broad plan offered at last fall’s Party Congress, which included such bold pledges as the integration of urban and rural land markets and generally seemed too good to be true.

Messrs. Xi and Li appear focused on macroeconomic stability, as China’s leadership has been for most of the past five years. The true macroeconomic situation and the correct policy response are open to (much) debate, but the implication for market-oriented change is chilling. If difficult reforms such as opening the capital account won’t proceed until macroeconomic conditions are acceptable, Beijing has caught itself in a vicious cycle: The long absence of market reform has led to macroeconomic weakness, which in turn is now inhibiting reform.

The best bet to break the cycle is finance. The People’s Bank of China is leading the charge as it has for a decade, and Messrs. Xi and Li appear more willing than their predecessors to let the central bank move forward, as with its decision to widen the yuan’s trading band against the dollar. Therefore Governor Zhou Xiaochuan made the loudest reform announcement of the National Party Congress, offering his opinion that within two years the ceiling on bank-deposit rates would be lifted.

This appears to be a big deal. The ceiling on deposit yields is the last major, direct interest-rate control remaining, and two years is an aggressive time frame for its removal. At this point in 2016, there may be no formal regulatory limits on the price of money. Given the extreme size of China’s money supply—65% larger than America’s—a competitive market price for money would be transformative.

But don’t take that bet. Even if the ceiling is lifted in two years, there will be no competitive market price because there will be no competitive market. Banks may technically be free to compete for depositors, but they won’t do so.

The reason is that state banks are too important a tool for the government. They cannot be allowed to fail or even totter because that would jeopardize their capacity to act as fiscal agents in crisis (as they did with massive stimulus in 2009). Approximately 90% of banking assets are owned by the state, so the vast bulk of the banking sector won’t act competitively in 2016 no matter the situation with interest-rate controls. Authentic rate liberalization cannot occur until there is far more extensive privatization in banking.

That’s why the real reform news this month was Beijing’s approval in principle of five new private banks, which received far less attention. Officials have been unclear about timing, but the participants are intriguing. They include the conglomerate Fosun and the auto-parts giant Wanxiang, whose deep pockets have been illustrated by multiple investments overseas. More important, the group includes Alibaba and Tencent, the Internet titans that already have online banking businesses of sorts.

The creation of a competitive banking industry requires the private share of assets to climb sharply. Only if this happens can genuine competition ensue and a market interest rate emerge. The existing customer bases of Tencent (with a market cap of over $100 billion) and Alibaba (which appears headed for one of history’s largest initial public offerings) suggest that they may be able to scale up especially quickly, pushing the process along despite the gigantic asset lead that state banks possess.

The National People’s Congress was a disappointment, but it is true that an eventual market price for money would be transformative. The main thing to watch in coming months is how quickly Beijing’s Bank Regulatory Commission moves on letting private banks open.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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