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Banking Reform High Priority for New Chinese Leaders - 2003-03-10

China's banks are staggering under $400 billion in debts that are not likely to be repaid, a situation that threatens economic growth and the badly needed jobs that go with it. Reforming China's banks and other financial institutions is a top priority for the nation's new leaders who will be formally appointed during the current session of the National People's Congress.

Financial experts say the bad loan burden for China's four biggest banks is a huge 40 percent of the country's gross domestic product.

In percentage terms, the debt burden is about four times the level of Japan's banking crisis, which is blamed for stalling economic growth there for more than a decade.

China's leaders are eager to keep the economy growing to create new jobs and head off social instability that could be caused by angry unemployed workers. Tens of millions of workers have been left jobless by the collapse of inefficient state-owned companies.

Millions more impoverished farmers have left the land to seek jobs in the cities. The lack of jobs led to demonstrations by tens of thousands of people last year.

Andy Rothman is a financial analyst at investment bank CLSA in Shanghai. He says the unemployment situation will not improve until the four biggest state-owned banks, which dominate the financial system, stop lending money to doomed state-owned companies and start lending to healthy private businesses.

The government-owned banks generally will not lend to private companies. Most of their money is tied up in loans the government ordered them to make to state enterprises. And the banks are inexperienced at evaluating the soundness of private companies, so they avoid lending to them.

Private companies already create most of China's new jobs. They could employ even more people if they could get the loans they need to expand. "Chinese entrepreneurs who have been really struggling for a few years had to rely on what they've saved, borrowing money from friends and family and retained earnings. Well, that led to a lot of growth lately, but there is a limit to how much this thing can grow," says Mr. Rothman.

Reforming the banks and creating new jobs top the agenda for China's National People's Congress, now holding its annual two-week legislative session. The NPC has approved a new cabinet-level regulatory agency for the banks.

Other recent reforms mean China's banks now are supposed to lend based on a company's ability to repay the loan, instead lending to those with good political connections.

But Nicholas Lardy of the Institute for International Economics in Washington says the government-owned banks still follow official orders to lend money to failing state companies. "The banks have still been in the situation where they had to continue to make policy loans of significant amounts," he says. "And some of those loans have either gone bad or will become non-performing in the next few years."

Mr. Lardy says even after banks reform their lending practices, they will still need government help to become part of the efficient financial system that China needs to prosper.

He says banks must be allowed to charge different interest rates for loans, with low rates for borrowers judged likely to repay and higher ones for riskier clients.

And he says the banks need more government help to shed their bad loans. Beijing has already put about $200 billion into a program to restructure the bad debts, but Mr. Lardy says the effort was too small.

The plan allows asset management companies to buy the debts at a deep discount and then try to collect them. This means the banks recover at least a portion of what they are owed. Companies that cannot pay back their loans are put out of business and their assets are sold to satisfy some of their debts. Other companies that seem potentially profitable are reorganized, streamlined, and put back to work.

In Beijing, financial analyst He Jun of the Anbound Group says it is politically difficult to cut off loans to failing state-owned companies with thousands of workers. But he says China's probable next prime minister, Wen Jiabao, seems to have the political will and the clout to make reforms work.

Mr. He and most other financial experts say China's leaders have bet the country's future on the private sector, and realize it will not work without an efficient banking system.