Latest Development of China’s Banking Sector

2. Latest Development of China’s Banking Sector Challenges faced by China’s State-owned commercial banks Our response to the Challenges

3. China’s banking sector becomes stronger and more diversified than ever through reforms and opening-up. • As of the end-2003, the assets of the banking institutions in China totaled US$3.4 trillion, 103 times higher than the level at the end of 1980, and account for nearly 95 per cent of the aggregate assets of all financial institutions in China.

4. At the end of 2003, China’s banking sector comprised 4 wholly State-owned commercial banks, 3 policy banks, 11 joint-stock commercial banks, 4 asset management companies, 12 city commercial banks, 192 foreign bank branches and subsidiaries, 209 foreign bank representative offices, 723 urban credit cooperatives, 34577 rural credit cooperatives, 3 rural commercial banks, 1 rural cooperative bank, 74 trust and investment companies, 74 finance companies, 12 financial leasing companies, 3 auto financing companies and numerous postal saving institutions.

5. The trend towards a diversified banking sector is also demonstrated by the increasingly diversified equity structure of the Chinese financial institutions, whose equity owners now range from the government, State-owned enterprises, private companies, shareholding corporations and foreign-funded entities, and the private and foreign equity holding sees a notable increase.

6. China has further opened its banking sector in compliance with the WTO principles and China’s WTO commitments. • By the end of 2003, altogether thirteen cities have been opened to foreign banks to conduct renminbi business, while the eligible foreign banks are now allowed to offer renminbi business to Chinese enterprises. • The permitted equity share of a single foreign investor in a Chinese financial institution is raised to 20 per cent from the previous 15 per cent. • The minimum operating capital requirements for foreign banking institutions are lowered and the procedures and processes for their market entry are streamlined.

7. The State-owned commercial banks are still playing a predominant role. • The four wholly State-owned banks are the major fund raisers and suppliers for the country’s economic construction. As of the end-2003, their assets totaled RMB15 trillion, accounting for 55 per cent of the total banking assets; their deposits made up 57 per cent of the total and loans made up 55 per cent. They also undertook nearly 80 per cent of the gross payment and settlement volume.

8. The big four have made tremendous contributions to China’s economic development and placed an irreplaceable role in China’s economic reforms. • They have provided the needed funding support for numerous development and infrastructure projects neglected by the private capital. • They have played a significant role in promoting the balanced economic and social development. • They have assisted in the economic and social restructuring campaign and assumed part of the associated cost. • They have greatly contributed to the implementation of the nation’s policy strategy of “employment and education to all”.

9. The big four are trying to enhance their internal management though reforms and have made notable progress. • They have all established the mechanisms for asset/liability ratio management and risk management, and adopted the five-category loan classification system and prudent accounting policies and rules. • Their NPL ratio was reduced by 13 percentage points from 33 per cent at the end of 2000 to 20 percent at the end of 2003, and their outstanding balance of NPLs was lowered by RMB340.2 billion during the same time interval.

10. Latest Development of China’s Banking Sector Challenges faced by China’s State-owned commercial banks Our response to the Challenges

11. Despite their achievements, the big four are still confronted with a number of challenges. • There are significant deficiencies in their corporate governance. • Their average NPL ratio registered at a 20-percent high level at the end of 2003 measured by the five-category loan classification criteria. • Their capital adequacy ratio is low and profit earning capacity is weak. • They appear weak in product innovations, and their services still focus on the traditional deposit-taking and lending activities.

12. According to China’s WTO commitments, the Chinese banking market will be fully opened to the outside world at the end of 2006, which means that foreign banks will be allowed to engage in a full range of banking business, and the Chinese banks will have no other choices but to abide by the internationally recognized market rules and participate in the fierce market competition. The Chinese banks, in particular the big four, are facing a crucial task of improving their competitiveness by further deepening their reforms and restructuring.

13. Latest Development of China’s Banking Sector • Challenges faced by China’s State-owned commercial banks • Our response to the Challenges

14. Setting the objective for the reforms • To build the State-owned commercial banks, within the grace period provided by China’s WTO agreement, into internationally competitive joint-stock commercial banks with adequate capital, stringent internal controls, safe and sound business operations, quality products and services as well as desirable profitability.

15. Setting approaches for carrying out reforms • Each bank formulates and implements its own reform policies and strategies • Based on the banks’ progress with reforms, the eligible banks will be allowed to be transformed into joint-stock banks with the government being the controlling shareholder. • After the careful selection, Bank of China (BOC) and China Construction Bank (CCB) were chosen at the end of 2003 to carry out the joint-stock reforms on a pilot basis.

16. Taking measures to relieve the banks of their historical burdens • The non-performing asset burdens of the four banks are largely inherited from the past. • The reasons for the accumulation of NPL burdens at the big four are different from those in western countries. • The loss of Chinese banks is by nature the cost paid by China for the transition towards a market-oriented economic system. • The BOC and the CCB received a capital injection worth of US$45 billion to boost their capital strength and help them forge ahead the pilot joint-stock reforms.

17. Taking measures to root out the deficiencies of banks • We set ten guidelines for building up corporate governance: • To establish a clear corporate governance structure comprising the general shareholders meeting, a board of directors, a board of supervisors and an executive management, with all the necessary checks and balances • To select domestic and foreign strategic investors to form synergy • To set clear-cut business strategies for maximum profitability

18. 4. To establish sound decision-making process, internal controls and risk management system 5. To adopt reduced layers of hierarchy and a line management structure as well as streamline business and management procedures 6. To adopt a human resource management system that highlights accountability and motivation 7. To establish policies and procedures for prudent accounting practices and stringent information disclosure

19. To build up the information technology system to secure quality management and services9. To underpin staff training and recruitment of qualified people for key positions10. To highlight the professional role of intermediary institutions and proceed with the joint-stock restructuring in a prudent manner

20. Setting benchmarks to assess the banks’ reform performance • Assessment of business performance • Net ROA (Return on Assets) ratio will reach 0.6 per cent by 2005, and be further increased to the level of the best international banks by 2007. • Net ROE (Return on Equity) ratio will reach 11 per cent or above by 2005, and be further increased to 13 per cent or above by 2007. • Cost/income ratio will be controlled within the range of 35 to 45 per cent from 2005.

21. Assessment of asset quality • Non-performing asset ratio will be controlled within the range of 3 to 5 per cent. • The BOC and the CCB are required to apply the five-category loan classification criteria for assessing both credit and non-credit assets by the end of this year.

22. Assessment of prudent operations • The largest exposure to a single borrower will be no more than 10 per cent of the total capital. • Capital adequacy ratio will be above 8 per cent at any point. • NPL provisioning coverage ratio will reach 60-80 per cent by 2005 and try to reach 100 per cent by 2007.

23. The joint-stock reforms of State-owned commercial banks are an unprecedented practice in China, but we are prepared for the complex and arduous tasks ahead of us.

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