Promoting China s banking sector reform and opening-up

Promoting China s banking sector reform and opening-up

Speech by LIU Mingkang, Chairman of the CBRC,

at the IMC Beijing 2005

June 6, 2005, Beijing

It is a great pleasure for me to address such a distinguished audience. I must congratulate the IMC, together with the BOC and the ICBC, for successfully organizing the first IMC annual meeting in China.

I am sure you all agree with me that China is changing rapidly. The driving force behind such drastic change is the government s determination to reform and open up. In fact, reform and opening-up have become a catch phrase in China, and have brought dynamics to the Chinese economy and financial services industry. To be sure, the need to reform and liberalize China s financial sector is more pressing than before. Maintaining the safety and soundness of China s financial industry, particularly its banking sector, is one of the most important agenda items for structural reform. Therefore, I would like to focus on three major issues: first, how do we benchmark ourselves to international standards and best practices? second, what accomplishments have been achieved in reforming the state-owned commercial banks? And third, what progress has been made in opening the Chinese banking market to foreign participation since the WTO accession and how do we perceive the roles of foreign banks in the post-WTO era?

Benchmarking to international standards and best practice

Over the past two years, the China Banking Regulatory Commission (CBRC) has demonstrated that it can add value to the industry by creating a sound supervisory framework and a safe banking system, while taking advantage of its professionalism and expertise. By way of example, we contributed significant input to the formulation of the law governing the regulation and supervision of banks, which defines the supervisory mandate and methodology, with a clear reference to the Basel Core Principles for Effective Banking Supervision.

In line with its statutory power, the CBRC has issued, so far, over 90 supervisory rules and guidelines on capital adequacy, large exposures, connected lending, underwriting due diligence, derivative transactions and operational risk, just to name a few. And as a natural follow-up in the rule making process, we have started to devote more resources to the implementation of rules as well as the review of newly released rules where appropriate.

Our supervisory efforts have also helped to improve the balance sheet position of banks. The NPL ratio for 16 major banks, namely four state-owned banks and 12 shareholding banks, was 12.72 percent at the end-March 2005, a drop of 3.89 percentage points on a year-on-year basis. And by the end of 2004, following the enforcement of capital requirements, capital adequacy of these banks increased by 2.87 percentage points. At present, the banks that have met the regulatory capital requirement owned 47.53 per cent of the total banking assets.

To design our strategy of banking reform, we have tried to capitalize on the experience and lessons learnt in the past. Experience clearly suggests that a trial and error approach in China could be very costly and runs the risk of losing credibility in the long run. Therefore, in pursuing a building-block approach, we ve got to have a broad vision in building a sound banking industry. In this respect, we benchmark to international standards and best practice, benefiting directly from active participation in the Basel Core Principles Liaison Group and regional supervisory groups.

As a practical step, shortly after we started our operations, we launched another round of more rigorous and objective self-assessment of the Basel Core Principles. This exercise proved extremely important in identifying gaps and weaknesses in the system and drawing up an action plan for the medium to long- term improvement. Based on our action plan, our target is to put in place all the essential elements of effective banking supervision by the end of 2006 and achieve broad compliance with all the principles by the end of 2012. To facilitate such a process, we stand ready to take part in the FSAP next year, the joint IMF and World Bank exercise to effectively promote the soundness of financial systems in member countries.

As we are pleased to see the results of our efforts, we are also fully aware of the challenges ahead, weak asset quality, low capitalization, poor credit culture, lack of skills and infrastructure, just to mention a few. As a result, we have something top on our agenda to underscore the progress in two areas: (1) the reform of the state-owned banks as well as rural financial institutions, and (2) further opening up the banking sector. Now, let me answer the second question:

What have we achieved in reforming the state-owned banks

The significance of reforming the big five state-owned banks is largely to restore the banks solvency and pave the way for ensuing corporate restructuring. In so doing, the reform is intended to create a sound and fair operating basis for the entire banking sector and an enabling environment for the enforcement of more advanced supervisory rules.

To be sure, one of the most important policy challenges is to strike a balance between stability and reform in the financial sector. In the final analysis, the issue is all about balancing the economic, financial and social costs in the short term with potential gains in a long run. Working together with other government agencies, we helped identify the BOC, the CCB and the BOCom as three pilot banks for reform under a broader package, including capital injection, further disposal of NPLs, introduction of foreign strategic investors, public listing on international or domestic stock markets, recovery of the government investment and retreat of the government holdings. As the reform of the three banks is well underway, the reform has been quickly expanded to cover the Industrial and Commercial Bank of China (ICBC), which received, in April this year, a capital injection of US 15 billion dollars, plus a special package to digest its stock of NPLs.

It is encouraging to see that following capital injections and disposals of sizable amounts of NPLs, the balance sheets of the reforming banks have improved dramatically. By end-March this year, the NPLs ratio was 5.20, 3.52 and 2.8 percent respectively for BOC, CCB, and BoCom. Capital adequacy for the three banks was above 8 percent on both consolidated and solo basis. As a result, the ratings on BOC and CCB were raised to investment grade [BBB-], and the outlook for BoCom was changed to positive immediately after its announcement of financial restructuring.

However, the key to turning the state-owned banks around is to introduce sound corporate governance after the financial restructuring. To this end, we issued a set of guidelines on corporate governance, including ten supervisory requirements and seven performance indicators benchmarked against the average level of the top 100 international banks. At present, the reforming banks have already set the institutional framework in line with our guidelines. For example, BOC has set up a board of directors and a supervisory council, plus five specialized committees under the board, such as the asset and liability management committee, the remuneration committee and the audit committee. In addition, in the pursuit of profit maximization, all the three banks are actively seeking to hire, with success, experienced international talents to fill in such key positions as independent directors, chief risk officers, chief operating officers and chief financial officers.

It can be said that in contrast with the previous exercise to inject capital and carve off NPLs in 1998, the reform program this time is a comprehensive package to change the banks ownership structure, corporate governance, management strategy including the appointment of senior management against a set of well-defined benchmarks, within a clear-cut timetable and subject to a vigorous review process. The progress so far is encouraging.

Next, let me turn to the last question:

How do we open up our banking sector and how do we perceive the roles of foreign banks in the post WTO era

The CBRC fully recognizes the importance of foreign financial institutions in the Chinese market. Over the years, foreign financial institutions have been instrumental in changing the landscape of banking industry and have become an important element of China s banking sector. Their presence has enhanced competition and brought in the much-needed technical know-how.

At present, foreign banks have established 244 representative offices and 214 operational branches or subsidiaries. 15 foreign banks are now permitted to engage in inter-net banking, and five foreign bank branches are permitted to offer custodian services for securities transactions for qualified foreign institutional investors. More than 40 foreign banks are authorized to offer services in derivative transactions. Overall, foreign banks in China can offer more than 100 products and services.

By the end-April, this year, the total assets of foreign banks reached US$76.22 billion dollars, including US$28.5 billion in foreign currency loans and US$10 billion in local currency loans. Most importantly, their non-performing asset ratio stood at 1.04 percent, while their non-performing loan ratio was merely 1.16 percent.

On our part, an essential aspect of opening-up policy is to honor China s WTO commitments and promote a level playing field. Upon China s accession into the WTO, foreign banks were immediately permitted to engage in full foreign currency operations. In December 2003, foreign banks were allowed to offer local currency business for local enterprises. At present, 18 major cities are opened to foreign banks local currency operations for local enterprises. As the next step, we will eventually phase out all geographical and customer restrictions for foreign banks by the end of next year.

In a similar way, we have liberalized non-bank financial services market for foreign institutions. So far, six foreign auto financing firms, GM (GMAC-SAIC Automotive Finance Company Ltd.), Toyota (Toyota Motor Financial (China) Corporation), Volkswagen (Volkswagen Finance (China) Co., Ltd), Ford (Ford Automotive Financing Company), DaimlerChrysler (Auto Finance (China) Ltd), and Citroen (Dongfeng Peugeot Citroen Auto Finance Company Ltd) were approved to start preparing their incorporation. Among them, GM, Volkswagen and Toyota have celebrated their business opening.

Beyond WTO commitments, we have also actively promoted foreign participation in our banking sector. In 2003, we issued a set of rules on foreign participation in local banks, whereby we increased the size of a single foreign equity investment up to 20 percent from 15 percent, while the maximum foreign interest remains unchanged at 25 percent.

So far, many foreign financial institutions, including Citibank, the HSBC, Standard Chartered, Commonwealth Bank of Australia, Hang Seng Bank, the IFC, Tameasek and the GIC of Singapore have taken stakes in 12 local banks. In terms of geographical cover, it is also heartening to see that foreign participation has expanded to cover the less developed western region of the country, following the decision of Bank of Nova Scotia to invest in Xi an City Commercial Bank. And in terms of active involvement, following a 19.9 per cent acquisition of US 1.7 billion dollars, the HSBC, in its capacity as the second largest shareholder, is represented both in the board and top management. The presence of qualified foreign strategic investors has become one of essential licensing criteria as in the case of a potential new entrant, Bo Hai Bank, a proposed shareholding bank in Tianjin. In addition, we also welcome foreign participation in the existing and newly licensed finance companies, the restructuring of trust and investment companies and the establishment of securities investment funds sponsored by banks.

We have good reason to believe that foreign financial firms will expand their presence. We are fully supportive of foreign financial institutions to play a bigger role in the Chinese banking sector, as from our perspective, foreign participation in local banks and bank restructuring is a win-win option. On the one hand, foreign participation, besides strengthening banks capital base, will help diversify ownership structure of local banks. And in so doing, foreign participation will be instrumental in improving banks corporate governance and management skill. On the other hand, close ties with local banks will help foreign banks to quickly expand their customer base and establish a niche position in some market segments, such as inter-net banking, credit card, derivative transactions and wealth management. Indeed, some foreign banks look to closer partnership with local banks as a faster channel for growth than organic expansion.

In closing, it is encouraging to see that China s banking industry reform and opening-up has yielded initial success, though more concrete and substantial changes are yet to be seen. Here, I would like to stress that China s banking reform can hardly advance by itself. The success of the reform calls for as much its own endeavors as the betterment of external conditions. For instance, its success heavily rests upon the substantive development of the capital market and well defined property rights infrastructure, the relentless cultivation of a sound and robust credit culture, introduction of credit bureau and prudent accounting framework, adoption of bankruptcy law as well as enforceable rules for bank foreclosure and exit, and active market participation of foreign investors--including qualified fund managers--based on a long-term commitment. I hope the discussions in this conference will shed some light on these important issues.

Finally let me wish this conference a great success and wish you all a pleasant stay in Beijing. Thank you