Where Is the Chinese Banking System Going with the Ongoing Reform?

Abstract

The Chinese banking system, characterized by a large proportion of state ownership and low capitalization, has started a reform process based on three main pillars: (i) bank restructuring, with the cleaning up of non performing loans and public capital injections, particularly in the four largest state owned banks; (ii) financial liberalization, with the gradual flexibilizaton of price and quantity controls and the opening up to foreign competition; and (iii) strengthened financial regulation and supervision, as well as better risk management, corporate governance, disclosure, and the introduction of international standards. Although it is still early to judge on the success of the reform, the available evidence does not offer a very optimistic outlook. The solvency of Chinese banks is still very weak, with a stubbornly high level of non performing loans, and profitability is poor. Given the commitment of the Chinese authorities to fully open up its banking system to foreign competition by 2006, it seems crucial that financial reform accelerates so that the Chinese banking system can compete at the international level. This is particularly the case for the reduction of NPLs and bank recapitalization as well as for a furthered improvement of bank regulation and supervision.