According to the book Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise, the main obligation of banks, especially the big 4 banks (Bank of China (BOC), China Construction Bank (CCB), Industrial and Commercial Bank of China (ICBC) and Agricultural Bank of China (ABC)) in China is to lend money to State Owned Enterprises (SOEs). SOEs contain almost all of the public facility services and majority highly profitable monopolies. The proceeds were supplied steadily and give SOEs a guarantee for continuing operation.
Because of the “generosity” of the big 4 banks, Chinese economy boomed after the open and revolution policy. Not until the bankruptcy of Guangdong International Trust & Investment Corporation (GITIC), did the problem of this system be found. In fact, the big 4 banks had accumulated an amount of bad debt that could lead the whole financial system collapse. With the support of the then Premier Zhu Rongji, Zhou Xiaochuan, then the chairman of CCB, started a plan to save the precarious financial system.
The first and the most important step of the whole plan was to separate the big 4 banks from the bad debts. With that in mind, 4 Asset Management Companies (AMC), which hold the bad debt as capital and operated to collect it, were founded. The cash flow of these 4 AMCs came from bonds issued to Ministry of Finance (MOF) and the corresponding banks, as well as loans from Peoples Bank of China (PBOC). This accounting manipulation did not change the fact that Nonperforming Loans were by no means collectable, but it created 4 good banks, whose balance sheet was preferred for IPO.
Once the big 4 went public, they would finance enough capital to support the system operating continuously, and the intention to reform is achieved. Chinese stock market was established in 1990, when the whole financial system is primary. It was founded to provide another financing resource for SOEs, as well as improving the Chinese financial system. Before 1990s, there were Over the Counter (OTC) market in east cities, but not formal. Neither investors nor financiers were protected. However, there was little investment awareness in the early 1990s, and the listed companies faced a dilemma of undersubscribed in the beginning.
To solve this problem, the listed companies invited some other SOEs, which were called “strategic investors” (), to participate in the subscription before IPO. With the maturing of Chinese stock market, more and more investors took part in and public companies started to be oversubscribed thereafter. Once oversubscribed, the allocation of these stocks would be based on a lottery. The fact that a huge amount of money needed for application prevented retail investors from subscribing. Therefore, the handsome profit was left to the “Nation Team, its families and friends” ().
The worse thing is, in the culture of pursuing high jump of stock price in the first listing day, the newly listed companies lowered the subscription price and just give “the money left on the table” () to their friends and sell state assets in a cheaper price. The bond market in China was rather stagnant, because banks, especially the big 4 banks, played a major role in SOEs’ financing. Trading volume was low even in 2010, when there were 32 government bonds (CGB) and 55 Chinese Development Bank (CDB) traded in the first trading day ().
The reason lies in the special interest rate market. The interest rate in China was set by PBOC, which was not fluctuated. It guaranteed the profit of big 4, but harm the bond market. On the other hand, the domestic ratings agency gave contradicted ratings. According the book, one of the ratings agencies, Chengxin, gave Beijing Infrastructure Investment Co. AAA ratings while China Salt General Co. AA ratings, however, both of them are guaranteed by CCB Beijing branch (). The absence of objective ratings contributed to the immatureness of Chinese bond market.
Before 2009, only MOF and CDB have authorities to issue bonds. During the financial crises, local governments are permitted to issue bonds to other local government and local financial platforms in order to keep high pace of economy development. The fact that these governments were incapable to redeem the bonds forces them to sell land and give tax subsidies. The disappointing fact is, the whole bonds issued by governments finally went to banks. Therefore, the Chinese bond market was mere a shadow of banking system. From the authors’ perspective