China Mono-Banking System

1. Introduction 1. The evolution of banking risk management in china Previously, China adopted the mono-banking system where there was virtually no need for banking risk management. During then, every step involving the supply and utilization was predetermined by the Chinese government. People’s Bank of China (PBC), being the only bank simply received instructions from the government about the allocation of the funds. [1]

However, things took a change when the four specialized banks namely the Industrial and Commercial Bank of China, the Agricultural Bank of China, Bank of China and the China Construction Bank were converted into state-owned commercial banks in the late 1970s. With the transformation, commercial loans were being made and this brings the banks to the issue on risk management. 1. 2 Credit and liquidity risk Therefore, this term paper sets to explore on how banks in China practices banking risk management. In light of the Central Bank’s recent aggressive stance in curbing loans, this paper will highlight on credit risk and liquidity risk.

The former is an increasing concern for the Chinese banks. It should also be noted that the Chinese economy is still operating under a relatively conservative banking climate. The rules and regulations set by the banks are tightly linked with the government’s policies. 2. 1 Time line of Chinese banks curbing loans (2004-2010) Important Events: 2003: In order to rein in the obviously excessive credit growth, the PBC raised the required reserve ratio by one pp on September 21, 2003. ICBC set up an industry research center in 2003 to improve its risk control management.

2004: effective on April 25, 2004 bank reserve ratio was increased by 0. 5% to 7. 5%. Chinese firms are financed by banks at a rate of 98 per cent but often fail to pay back their loans, as a result, there are almost half of the bank’s assets are unpaid, caused half of the banks insolvent. In 2004, there was US$ 45 billion used to save China’s second and third largest banks, the Bank of China and the China Construction Bank. Subsequently, another US$ 100 billion were used to save the Industrial and Commercial Bank of China and the Agricultural Bank of China. [2]

2006: On April 28, the People’s Bank of China (PBOC) raised lending rates for the first time since October 2004, boosting the one-year benchmark rate by 27 base points to 5. 85 per cent, as part of efforts to curb the overheating in some sectors such as real estate. 2007: With effect on june 5 2007, the bank reserved ratio is to increase by 0. 5% to 11. 5%. Bad-loan ratio fell again in 2007 after tight credit monitoring. 2008: The reserve ratio was increased by 0. 5% to 12% on starting August 15,2008 Jan 2010: The central bank raised the reserve requirement ratio by 0.

5% with effective day on 18 Jan 2010. It’s a clear sign that it was determined to drain excessive liquidity in the market and curb lending. Time Line: |Time |Change in reserve ratio |Direction |Notes | |1987 |10% to 12% |Up | | |1988 |12% to 13% |Up | | |1998-03-21 |13% to 8% |Down | | |1999-11-21 |8% to 6% |Down | | |2003-09-21 |6% to 7% |Up | | |2004-04-25 |7% to 7. 5% |Up | | |2006-07-05 |7. 5% to 8. 0% |Up | | |2006-08-15 |8. 0% to 8. 5% |Up | | |2006-11-15 |8. 5% to 9% |Up | | |2007-01-15 |9% to 9. 5% |Up | | |2007-02-25 |9. 5% to 10% |Up | | |2007-04-16 |10% to 10.

5% |Up | | |2007-05-15 |10. 5% to 11% |Up | | |2007-06-05 |11% to 11. 5% |Up | | |2007-08-15 |11. 5% to 12% |Up | | |2007-09-25 |12% to 12. 5% |Up | | |2007-10-25 |12. 5% to 13% |Up | | |2007-11-26 |13% to 13. 5% |Up | | |2007-12-25 |13. 5% to 14. 5% |Up | | |2008-01-25 |14. 5% to 15% |Up | | |2008-03-25 |15% to 15. 5% |Up | | |2008-04-25 |15. 5% to 16% |Up | | |2008-05-20 |16% to 16. 5% |Up | | |2008-06-15 |16. 5% to 17% |Up |an increase of 1%, two steps of operation | |2008-06-25 |17% to 17. 5% |Up |an increase of 1%, two steps of operation | |2008-09-25 |17.

5% to 16. 5% |Down |reduction of some financial institutions | |2008-10-15 |16. 5% to 16. 0% |Down |17. 5% down to 17. 0% (six banks ICBC, etc. ) | |2008-12-05 |16. 0% to 14. 0% |Down |17. 0% down to 16. 0% (six banks ICBC, etc | |2008-12-25 |14. 0% to 13. 5% |Down |16. 0% down to 15. 5% (six banks ICBC, etc | |2010-1-12 |15. 5% to 16% |Up |rural credit cooperatives and other micro-finance | | | | |institution | |2010-2-25 |16% to 16. 5% |Up |rural credit cooperatives and other micro-finance | | | | |institution | 2. 1. 1. Reasons for ineffective policies

In 2004, there was inflation about 3%, highest among many years. For example, food prices increased 8. 1%, edible oil prices rised by 27. 2%, vegetables increased 19. 4% and grain up by 10. 8%, according to the National Bureau of Statistics, property investment was up 34. 9 percent in the first quarter of 2003, far outstripping China’s 8 percent GDP growth. [3] Furthermore, the major banks in China were suffering from insolvency problem. About half of the banks’ assets are unpaid, and an expected amount of US$518 billion (40% of China’s GDP) was needed to put banks back a sound footing.

As a result, Chinese authorities are trying to contain inflationary pressures and prevent the speculative and real estate bubble from bursting because its effects would be devastating. However, the increase of 1% in the bank reserve ratio has only affected the economy to a limited extent. As shown in the Statistics from the Beijing Construction Committee 2005, the house selling rate in the first months of the year jumped 18 per cent to 130 per cent compared to the same period last year. China’s banking sector is teetering along. Non-performing loans, a legacy of policy lending by state-owned banks to state-owned enterprises, are staggering.

New loans to those with connections, to cronies and to those in power have continued. It is also no secret that publicly recorded non-performing loan figures are severely understated and it gives one the jitters to think how much is hidden behind the almighty Chinese “state secrets. ” Raised reserve requirements will not be even close to what is needed to address banking sector dilemmas. Regulations intended to strengthen the supervision of bank lending and risk management took effect on Feb. 1, 2004. [4] 2. 1. 2 Methods of curbing loans: Raising interest rates v.

s increasing loan reserve requirement. (which method is the Chinese banks using & why? ) China’s economy, currently right in the transition period, is not comparable to command or developed market economy. The macroeconomic development poses challenges to monetary policy. In this connection, the Chinese Government can only utilize various monetary policy instruments in a flexible manner, in order to reach the monetary policy targets. At present, the major monetary policy instruments include: open market operation, reserve requirement, interest rate policy, re-lending and rediscount, and credit policy.

i) Sterilize Excessive Forex Position Through Open Market Operation While Maintaining Sufficient Liquidity in the Market Over the past two years, China’s foreign exchange reserve has grown fast, leading to substantial increase in base money injection as a result of Forex purchase. In line with the overall money and credit plan, the People’s Bank of China (PBC) has maintained the stable growth of base money through open market operation. ii) Use Reserve Requirement Policy in a Flexile Way to Lower the Cost of Currency Withdraw and Improve the Operation of commercial banks.

In order to rein in the obviously excessive credit growth, the PBC raised the required reserve ratio by 1% on September 21, 2003. Traditional Money and Banking theories regard required reserve ratio hike as a relatively drastic measure, nevertheless the central bank interpreted it as a mild move. The differentiated required reserve ratio scheme is both a transitional policy in line with China’s current financial system, and an innovation based on the original purpose of required reserve ratio policy, i. e.

to ensure the payment and settlement of commercial banks, and to prevent over-lending by financial institutions attracted to favorable loan terms which may undermine their liquidity and payment capacity. The required reserve ratio policy then gradually evolved into a monetary policy instrument, and the deposit insurance regime combined with supervision on capital adequacy ratio started to replace it as policy tools to impose prompt corrective actions on financial institutions based on different risk profiles.

Given the fact that China has yet to establish deposit insurance system, and quite a number of financial institutions failed to reach the 8% capital adequacy ratio, the differentiated required reserve ratio scheme is conducive to curb excessive credit expansion of the financial institutions with low capital adequacy ratio and poor asset quality, and to prevent the one-size-fits-all approach in macro financial adjustment and regulation. iii) Utilize Other Monetary Policy Instruments At the same time, the PBC can strengthen credit management by curbing loans to over-invested industries, and keeping the proportion of medium and long term loans at reasonable level.

The PBC will also endeavor to adjust loan structure, urge financial institutions to implement credit policy, promote financial ecological development, enhance re-lending and rediscount management, continue to improve financial service to rural economy, and further promote inter-bank market development.

The reason why Chinese government has a better interest in raising the reserve ratio is, as mentioned earlier, easier to implement and have less negative effect on the economy, both domestically and globally. 2. 2 Current situation in China 2. 2. 1 Excess liquidity and risk of overheating in China economy i)Foreign reserve accumulation National Bureau Statistics of China showed that there has been a boom in China’s reserve accumulation from the early 2000s till present, as shown by the diagram below.

This could be driven by China’s monetary policy to maintain an (adjustable) pegged exchange rate. [5] Besides that, China has a large amount of current account surpluses, steady inflows of foreign direct investments and very large portfolio capital inflows. [pic] Sources: National Bureau of Statistics ii)Inflow of ‘hot money’ into china’s economy We interpret these non-FDI capital inflows, as “hot money” that could potentially switch direction within a short horizon. [6] All the subcomponents of China’s non-FDI capital inflows move in similar cyclical swing.

These swings in “hot money” suggest that China’s capital inflows are sensitive to market considerations, changes in interest rates and can be highly speculative. This speculative capital inflow is believed to have caused inflation, driven up stock prices, and helped to create a worrisome real estate market bubble. [7]However, the upside to inflow of speculative funds is that it makes the market more effervescent, stimulating the demand for stock shares and property, which in turns drive up the prices as well. Hot money creates enormous volatility in the financial markets due to it large size and its short term nature of investing.

Instead of moving with changes in the financial fundamentals of companies, stock prices are moved by liquidity shock stemmed from hot money. [8] According to Martin and Morrison (2008), speculators have been using various ways to circumvent Chinese Laws and regulations. More than 50% of speculative funds or capital flow into China take the form of over-reported or forged FDI. [pic] Sources: National Bureau of Statistics. The increase in reserve accumulation could lead to several monetary implications. The increase in liquidity may lead to economic overheating and inflationary pressures.

[9] It also depends on the domestic banking system’s ability to intermediate and manage the extra liquidity. The Chinese Government could sell Government bonds to soak up liquidity through open market operations to soak up excess liquidity. However, central banks must be able offer higher yields to convince domestic firms to hold them. [10] Besides that, the government could also tighten bank reserve and lending requirements (loan limits) to decouple the link between reserve money growth and broad money growth. [11] Broad money growth is linked to spending growth and inflation.

In mid-2006, the PBC began to rely less on bond issuance and more on reserve requirement increase and greater window guidance to control excess liquidity and keep the broader money aggregates in control. [pic] Source: National Bureau of Statistics China has high saving rates, both household and firms, which lead to a vast flow of liquidity into the banking system, as savers have lesser alternative investment opportunities (until stock market reform in 2005). [12] As shown in the figure above, the increase in reserve requirements lead to a decrease in M2-reserve requirement multiplier. 2. 2.

2 Exposure to Credit risk in property market 2. 2. 2. 1 Credit surge Chinese banks are experiencing a credit surge as new loans extended in 2009 more than doubled from 2008. The total new loans made increased from 4. 9 trillion yuan in 2008 to a record-breaking 9. 59 trillion yuan in 2009. [13] Figure 1 compares the volume of new loans between 2008 and 2009 for the first 5 months of the year. [14] Figure 1 |New loans |2008 |2009 |Increase from 2008 to 2009 | |January |804 |1,600 |99% | |February |243 |1,100 |352% | |March |286 |1,900 |564% | |April |464 |591 |28% | |May |319 |665 |108% |

The main reason behind the credit surge is low interest rates which promoted easy credit. 2. 2. 2. 2 Property market boom What is most worrying out of the credit surge is the area that the funds are channeled into. In a speech given by Wang Zhaoxing, vice-chairman of the China Bank Regulatory Commission, he mentioned that about 20% of all loans made by Chinese banks are now flowing into the property market. [15] The central bank revealed that individual mortgage loans in the first three quarters of 2009 totaled 925 billion yuan, almost quadrupling the amount given out in the same period in 2008.

[16] With record new loans extended, it has boosted property buying for home ownership and also possibly for the less desirable purpose, property speculation. Consequently, property sales jumped in conjunction with a hike in property prices. It is reported that in 2009, property sales surged by 75. 5% to 4. 4 trillion yuan, especially in eastern cities of Zhejiang and Shanghai. [17] Standard Chartered Bank also calculated that land prices have soared by 106% in 2009. [18] Figure 2 shows that average property prices (new and second hand houses) is on an increasing trend, with the 9.

5% rise recorded in Jan 2010 being the highest increase in 21 months. [19] Figure 2 [pic] The housing price appreciation phenomenon is taking place in all parts of China. Goldman Sachs reported that over the past six years, the surge in property prices had exceeded the growth of income by 30 % point in Shanghai and 80 % points in Beijing. In Beijing, it is estimated that on average, a resident needs to fork out 7 months of his salary to afford per square meter of the house. [20] In shanghai, prices of second-hand properties experienced an annual increase of 41%, up to 14,700 yuan per square meter average in December.

For new properties, there is a 65% annual surge in prices to an average of 20,187 yuan per square meter in December. [21] Similarly, property market boom is taking place even in the poor cities of China. In the comparatively less prosperous Xinyang, property prices appreciated by 10% over 2009 and this figure is far more than the country’s benchmark deposit rate of 2. 25. 2. 2. 2. 3 Possible growth of asset bubble The question now remains whether an asset bubble is forming in the property market or has it already been developed.

Excessive property speculation has fuelled the property boom. To make things worse, large portion of funds lent to industries like manufacturing have been indirectly channelled into the property market. It will be disastrous if China follows America’s footsteps in the subprime mortgage crisis. If China’s property market is indeed experiencing a bubble, its burst will deflate housing prices greatly and hurt the banks with unpaid loans. Therefore, it is imperative for the Chinese banks to manage the high credit risk associated with the lending binge. 2. 2.

3 Exposure to Credit risk in stocks market 2. 2. 3. 1 Commodity speculation Apart from the property sector, the credit surge is taking effect in China’s commodity market. With easy credit, speculative investments are undertaken in the commodities market. Since March 2009, commodities prices have surged and the Reuters-Jefferies CRB Index has increased by nearly one-third When extending loans for commodity purchases, it is the practice of Chinese banks to permit the usage of underlying commodities collateral. Similar to property lending, the loans are structured like mortgages.

Since commodity prices are much more unstable than housing prices, the increase in speculative commodity trading exposes the banks to high credit risks. [22] 2. 2. 4 Exposure to liquidity risk With the surge in lending, the banks may be sowing seeds for future liquidity risks. High volume of funds is being channeled out of the banks and hence, there may be insufficient funds left to respond to payment of debs due. Furthermore, the house and commodity mortgage loans have poor liquidity. Liquidity risk management is especially pertinent in the face of the current global financial crisis.

2. 2. 5 Non-Performing Loans (NPLs) in China 2. 2. 5. 1 Overall outlook on NPLs The lending spree coupled with the slowing of global economy may have set a hotbed for the increase in NPLs. Plunging enterprise profits may lead corporate firms to default on their loans. [23] It is estimated that for every 1 % point slow down in annual economic expansion, the banks’ NPL ratio could increase by 0. 99 point. [24] Despite so, the China Banking Regulatory Commission (CBRC) reported that the NPL of Chinese commercial banks dipped by 62.

89 billion yuan to 497. 33 yuan in 2009. The NPL ratio also decreased by 0. 84 % point to reach 1. 58 % point. [25] However, these figures may not necessarily indicate an improvement of the bank’s balance sheet as new loans are used to displace delinquent commitments. Moreover, Chinese banks are now conducting off balance sheet activities like repackaging of loans to hide bad loans off their balance sheets. [26] The issue of NPLs may also not be evident yet as fresh loans haven’t gone bad.

The prevalence of bullet-oriented payment structure also indicates that any default with new lending will not surface until the loan is due. Therefore, the lending spree may have sown seeds for future NPLs which are not yet visible. 2. 2. 5. 2 NPL in property market In particular, there is increasing risk of NPL associated with property loans in Shanghai. In a statement released, Yan Qingmin, head of the Shanghai Bureau of the China Banking Regulatory Commission expressed the concern that the unsettled amount of bad loans on commercial property in Shanghai escalated in 2009.

[27] In 2009, banks in Shanghai have offered 163 billion yuan of new loans to the property sector, including mortgages and loans to developers. [28] This figure does not reflect the total risk exposure of Shanghai banks to real estate debt as loans extended to some state-owned companies as industrial lending may have been channelled into the property market. Moreover, Chinese bank regulators have calculated that if housing prices fall by 10% in Shanghai, it will multiply the ratio of delinquent mortgages by three times and a 30% drop will result in a five-fold increase.

[29] In Beijing, empty office buildings are sprouting across the capital of China. This is a result of oversupply of skyscrapers due to the easy credit extended to land developers. [30] Therefore, the banks in Beijing are also facing a high risk of bad loans. If the property market plunges, it will be accompanied with an escalation of NPLs. 2. 3 Impact of policy On Jan 20 Chinese banking authorities have asked some main banks to curb their lending for the rest of the . Meanwhile, for nonstate-owned lenders

like Citi Bank and Everbright Bank, the Central Bank asked them to increase their reserve requirement ratio by half a percentage point. It is the first time of China’s central bank to raise bank reserve requirements since June 2008. The direct cause of this action is the surge of new lending. Chinese banks doled out a record 9. 6 trillion yuan ($1. 4 trillion) in new loans last year. The lending surge, combined with Beijing’s 4 trillion yuan stimulus plan helped kick-start the economy after a late 2008 slump, but aroused fears of overheating.

[31] Also, consumer inflation has accelerated significantly in December. All this has triggered a series of intensifying policy by Central Bank to rid the financial system of excess cash that can fuel inflation and asset bubbles. Regulators, worried about potential inflation, asset bubbles and bad loans, feel they must set limits on total credit growth, but by doing so they create incentives for banks to churn out loans quickly to gain as much of the industry quota as possible. 2. 3. 1 Positive impacts China’s banking system is healthy despite last year’s explosive growth in credit.

So the authorities controlled the growth in credit with the instruction of curbing loans. Regulators were paying special attention to loans for local government projects and real estate. All banks have been ordered to “heighten their vigilance against an impossible, embedded credit risk,” Liu said. New leverage and liquidity restrictions would be imposed, he added. This action has not changed the government’s stance of a tight credit but a loose monetary policy, nor has it changed the prospects or the expected the timing of hikes of the central bank’s benchmark deposit and lending rates.

It helps the Central bank continue to control the pace and amount of credit supply. And the decision to raise the proportion of deposits that banks must hold in reserve is a small first step toward reducing the massive stimulus provided to its economy. The Chinese authorities were acting preemptively to handle with the increasing risk of a bubble in the property market and inflation. Just last week, China raised its capital reserve requirement for banks for the first time since June 2008 in an effort to drain excess cash from the financial system.

Earlier in the month, the central bank raised the interest rate on its three-month bills for the first time since August 13 and has been jacking up the rates on short-term bills to absorb liquidity. The reality is that liquidity remains very ample in the Chinese banking system; and credit has to remain strong in China this year to finish the on-going projects. [32] By moving now to tighten loose lending and deal with other negative side effects of an aggressive fiscal and monetary policy adopted during the global crisis, the central bank has achieved the goal of control the problem with inflation and property bubble.

2. 3. 2 Negative consequences With the announcement of curbing lending, China stocks drop 2-3 percent, led by bank shares. Worries over the impact of lending curbs knocked Shanghai’s benchmark index . SSEC down 2. 7 percent, weighed on the rest of Asia-Pacific and hurt the Australian dollar. Shares of Bank of China and China Construction Bank traded in Hong Kong tumbled 4 percent. [33] Lending in the first 10 days of 2010 was strong, after domestic media said that banks dished out 600 billion yuan ($87. 9 billion) in new loans in the first week of the year alone.

Some economists estimate banks have already lent over 1 trillion yuan so far this year. Worries that the Chinese economic growth engine is about to slow markedly because of tighter monetary policy sent shudders through global stock, commodity and currency markets. The currencies most linked to commodities trade – the Canadian, Australian and New Zealand dollars – all took an immediate hit, as oil, gold and copper fell. And stocks suffered losses, as fears mounted that the 10-month rally could come unglued. U. S.

Treasuries climbed, thanks to their appeal as a safe haven. Losses were heaviest in Hong Kong and mainland China while benchmarks in other markets fell about 1. 5 percent or less. Oil dropped to near $80 a barrel while the dollar was slightly higher against the yen and a tad lower versus the euro. Regulators announced this month an increase in the share of deposits banks must hold on reserve, but most of the latest measures haven’t been publicly disclosed, and they bear little resemblance to how monetary policy typically is conducted in other economies.

Shanghai’s benchmark stock index has fallen 9% so far this year, and concerns about credit policy have roiled markets from Hong Kong to New York. The news pushed the dollar higher, and oil and gold lower. That in turn hit the euro, which was already under pressure from controversy surrounding deficits and public finances in Greece, and a report on Tuesday showing a bigger-than-expected decline in German investor sentiment. 2. 3. 3. Access to credit for SOEs and SMEs China’s state-owned banks have never been the best allocators of credit.

As an extension of the state, these banks favor loans for state-owned enterprises (SOEs) over small and medium enterprises (SMEs). In the first half of 2009, China’s state-owned banks have granted SOEs 84 percent of total bank loans, even though they only contribute 45 percent of GDP and employ merely 25 percent of the labour force. [34] By funding more overcapacity, banks are throwing good money after bad — large industrial enterprises in China already have an average debt ratio of as much as 60 percent.

Large firms are so flush with credit that they have started punting on stocks and properties, while China’s small enterprises are so short of credit that they pay double the legal lending rate for unofficial loans which are usually obtained from the underground lenders. In late November 2007, the People’s Bank of China (PBC), which is the central bank, orally requested all banks with RMB licences to curb their RMB lending over the long term to cool the economy and control inflation.

These measures unnecessarily damage economic activities and have a disproportionate effect on SMEs because they do not rely on a large pool of liquid assets and thus, their short term solvency largely depends on bank loans. Moreover, the tightening of lending restrictions in 2010 may likely have more impact on the credit liquidity of SMEs. The new loan curbing policy has capped a monthly ceiling of 900 billion yuan, although the total credit supply is still believed to be sufficient, loans flowing to the private sector may reduce and private enterprises could be the first to feel the pinch.

[35] Limiting loans for SOEs and SMEs, however, may also force the less productive SOEs to improve their operations to continue to attract finance, or else they will have to face the risk of shutting down. Financial analysts and economists of China believed that over the next five years, this dynamic would go a long way to closing the productivity gap between SOEs and SMEs, raising GDP by as much as 13%, or $259 billion annually. [36]

While controlling lending to both SMEs and SOEs also forces the central bank of China to maintain a reasonable and balanced pace. For example, more restrictions has been applied to industries with overcapacity and high pollution, ICBC said it would continue to offer finance to ongoing government-backed projects, environmentally, friendly emerging industries, small- and medium-sized enterprises, and for consumer spending. [37] 2. 4. Curbing loans policy in the 1990s

China’s banking sector is dominated by four large multi-purposes, extensively branched, state-owned banks (SOBs) that account for more than 70% of both credits to enterprises and household deposits. From the late 1970s to the late 1990s, the financing responsibility for large SOEs shifted from the fiscal budget to these SOBs. During this period, fiscal revenues to GDP fell from 30% to 12% while bank loans to GDP increased from 50% to 120%. [38]

2. 4. 1. The Problem of Un-performing Loans (UPLs) Between 1980 and 1994, enterprise expenditures on social welfare increased by six times and, in the mid-1990s, it was roughly half of the SOEs’ total wage bill (Huang et al 1999). Consequently, the profitability of SOEs fell sharply and, from 1996, the consolidated state sector became a net loss-maker. As a result, SOBs were often forced to extend new loans to illiquid SOEs. However, the overly optimistic expansion of credit that China experienced in the early 1990s was an additional source of NPLs. It overheated the economy and created runaway inflation.

Domestic credit grew at the rate of 30% per year between 1991 and 1995, a rate significantly higher than the average growth rate of 21. 3% in the 1980s. [39]During that same period of time, real estate lending increased rapidly and fueled property development that was far beyond the limits of the country’s demands. Many of the problem loans that now plague China’s banks were created by the credit boom in the 1990s and by subsequent asset price NPLs are the survivors of loans to, and assets of, failed SOEs.

By the mid-1990s, over one-half of SOEs were making losses and about three-quarters of the loans on the books of these banks were to SOEs. Many of these loans were classified as non-performing. By 1999, three of these SOBs would be insolvent, if assets were marked to market, although all four remain highly liquid because of their dominant share of household deposits in an economy with a high savings rate and few competing assets for household portfolios.

2. 4. 2. The 1990s Reform In the mid-1990s, the Chinese authorities engaged in a series of reforms to deal with the bad loans problem culminating in the creation of four asset management companies (AMCs), one for each bank, to take on these bad loans. In 1999, the Chinese authorities established four AMCs as temporary institutions to deal with bad loans originated before 1996 that totaled 19% of 1999 GDP. AMCs are charged with both the disposal of assets and the restructuring of SOEs, with the latter facilitated by debt-equity swaps approved by State Economic and Trade Commission (SETC).

They are responsible to three government agencies; in addition to the SETC, these are the Ministry of Finance and the People’s Bank of China (PBC), the central bank. In an effort control lendin