We Are Capable of Managing Banking Sector Risks

--Vice Chairman JIANG Dingzhi s Speech at the 2008 Beijing International Financial Forum

This year marks the thirtieth anniversary of China s opening-up and reform, and we have also seen many challenges brought by the global financial crisis. Today we have a valuable opportunity to review what we have achieved during the past three decades and think about what we should do to deal with the current crisis. So I would like to address the following three topics.

1. financial crisis at the current stage

Now, the global financial crisis has become worse so that more and more extraordinary government interventions have kicked in. Constraints on credit availability have started to generate substantial slowing in economic activities from developed countries to the emerging markets. There are mainly three challenges in this backdrop:

1) The international financial market is very unstable and very challenging. Despite the extraordinary rate cuts by central banks and fiscal stimulus packages, the market confidence remains vulnerable. So far, the aggregated loss of large Western financial institutions has reached over USD 700 billion; IMF estimation of the loss is USD 1.4 trillion. Following the large institutions, we anticipate small and medium-sized banks, hedge funds and CDS market to expose more losses. Therefore, the market turbulence is impossible to come to an end in short term.

2) The financial crisis has hit the real economy. The BDI, a leading indicator of the world economy, has dropped from its peak 11793 in May to 824 in November. In US, the retail in October dropped 2.8%, the historical record of decrease together with the slowdown in the industrial and housing sector. Also the UK has seen the first negative growth in 16 years, also on the verge of recession. Similarly, enterprises in Germany, Japan and Netherlands are experiencing hardships and planning to cut output and jobs.

3) Risks in emerging markets have become greater concerns. The recent events have revealed the weakness in the financial system of a number of countries including South Korea, Iceland, and Baltic Countries. Ukraine and Hungary are already recipients of the IMF emergency assistance, while Pakistan, Turkey and others are waiting in the line.

The financial crisis has not only hit the financial and economic activities, but also challenged the current international monetary system and the underlying global financial supervisory arrangement. For China, we should work on the following aspects to ensure a sound and resilient financial system: First, deposits and risk management are of key importance. Second, financial innovation should be prudential and suitable for investors. Third, the regulators should adhere to prudential regulatory principles. Fourth, an effective global emergency scheme for financial crisis is needed and emerging markets should have greater roles to play in international financial institutions.

2. Banking sector performance and banking supervision in China

Chinese banks have maintained strong and steady growth over the years. It is mainly demonstrated in the following six aspects:

1) The banking assets has expanded to RMB 59.3 trillion yuan as of end-September 2008, doubling the figure in 2003 and 195 times than that of 30 years ago when the opening-up and reformed started.

2) The banking assets quality has improved a lot. Both the stock and the ratio of non-performing loans have dropped. Now the NPL ratio is only around 5.5%.

3) The capital adequacy ratio of Chinese banks has increased. A total of 192 banks have reached the 8% CAR requirement. And ranked by tier-1 capital, two Chinese banks are among the world top ten banks.

4) Banks are more resilient to shocks as they have built stronger loan loss provisions. As of end-September 2008, the total loan loss provisions by Chinese banks amounted to RMB 890.1 billion and the average provision coverage ratio in China s banking sector will exceed 100% after the reform of the Agricultural Bank of China.

5) Banks are generating more profit. The profit of major commercial banks jumped from RMB 36.4 billion in 2002 to RMB 446.7 billion in 2008. Both the ROE and ROA are comparable with the international active banks.

6) They have become more transparent. All banking institutions have followed strict and prudent accounting rules. They disclose their business operation to the market and put themselves under public discipline.

Such great achievements are underpinned by our strict and sound regulation and supervision, which is featured by the following four aspects.

1) We have gradually established a sound supervisory scheme with more focus on risk-based supervision, consolidated supervision and quantitative supervision.

2) We have introduced a number of rules to lay the institutional foundation for our supervision, including market access criteria, capital adequacy requirement, risk concentration ratio, risk management practices, internal controls and connected transactions. As there is a firewall between the banking market and the capital market, the risk in the capital market has not spread into commercial banks.

3) The state-owned banks have been commercialized. It was indeed an arduous task to turn around large state-owned banks. With our sequenced approach, they have enjoyed a rebirth, which has encouraged a number of small and medium-sized banks to launch their reform and get listed in the market.

4) We adopted forward-looking and counter-cyclical measures to mitigate the systematic risk. For instance, when the stock market was booming, we clearly banned the bank funding from being invested into the stock market. Also when the housing price surged, we immediately raised the lending requirements for second house purchase. As the recent credit crunch revealed that the financial innovation in the US has gone too far, we must adhere to the back to basics principle to avoid systematic instability.

3. Banking sector outlook

The current crisis is still far from the bottom. Next year will likely be more challenging. The global economic activities remain weak along with intensification of the crisis. And the global slowdown will hit our domestic economy, which will make the credit quality a great concern for us. In the export-oriented industries and small businesses, the credit risk is rising and the housing sector, in particular, may expose more default in the deteriorating environment.

Against this backdrop, we should first have confidence. The banking sector should support the State Council s massive fiscal stimulus package. Credit should be more available and accessible for environmental-friendly sectors, rural households, as well as small businesses. In the meantime, risk management has become more important in coping with the financial shocks. Commercial banks should not lend to energy-intensive and heavy-polluting industries. The CBRC should monitor the risk exposures carefully and share the information with the banks. In addition, the CBRC, together with other government agencies, will prepare contingency plans and strongly back the foreign banks if they come across liquidity problems. Commercial banks should stress test their liquidity plan to improve their own resilience in the adverse scenario.

Chinese banks have outperformed its international peers in this credit crunch because we have correct policy measures. While the global environment remains volatile, we have the confidence as well as the capability of managing the risk in China s banking sector.