Modern Banking
.pdf
[ 298 ]
M O D E R N B A N K I N G
the rouble, which was devalued four times. Unable to service its debts, Russia defaulted on its domestic debt and declared a moratorium on the repayment of foreign debt.
The short-term government bonds had been a major share of banks’ assets up to August 1998, and the default announcement created severe liquidity problems among banks, which in turn prompted a series of defaults. Customers panicked and withdrew their deposits: in the month of August, rouble deposits declined by 20% and foreign currency deposits by 24%. Since the end of the Soviet era, Russians had favoured holding foreign (mainly US dollar) cash or deposits,17 but withdrew any dollar deposits because of a concern they would be frozen.
In response to the crisis, the central bank sought to restore liquidity by buying the debt in exchange for loans to banks. Sberbank, trusted by most Russian depositors, was able to honour the demands of its domestic and foreign customers and, for this reason, the assets of weak commercial banks were transferred to it. In late 1998, the Agency for the Restructuring of Credit Organisations (ARCO) was established and staffed by the government and CBR. Its remit was to manage all problem banks, and by 2000 the banking crisis had been largely resolved.
With a devalued rouble, the Russian economy began to recover in 1999, and subsequently experienced five years of sustained growth, for the following reasons.
žA devalued rouble made exports more competitive, and import substitution stimulated demand for Russian goods at home. With a sharp appreciation of the rouble in 1999, import volumes began to rise, and doubled by 2003.
žThe rising price of oil, and growth in export revenues. The dependence on oil and other commodities has been a major factor in Russia’s economic recovery but at the same time, is a cause for concern. In 2002, 85% of private sales of the top 64 Russian companies were by enterprises belonging to eight conglomerates, all of them based in commodities – mainly oil and metals. State owned firms (Gazprom and RAO UES) accounted for 43% of total sales. Russia’s economic recovery is therefore largely due to a few commodity based conglomerates.18
The situation in the banking sector improved in the post-crisis period. Between 1999 and 2003, bank assets, bank credit to the economy and household deposits more than doubled; and there was a fourfold increase in capital. Post-crisis, the central bank was criticised for its ad hoc approach to problem banks and its dealings with some of their managers – allowing them to continue even if the bank was failing. In 2001 the government and central bank announced a reform plan for the banking sector, including improved supervision by the central bank, the application of more sophisticated risk management techniques, greater corporate governance/transparency, setting up credit bureaux so all banks have access to credit histories, and a deposit insurance scheme for private banks. The main changes to date include the following.
17According to Barnard and Thomsen (2002), about half of household savings are held in US$ cash.
18Source: Barnard and Thomsen (2002), p. 4. They also note that the share of SMEs in GDP is about 10–15%, compared to 50% in other transition economies.
[ 299 ]
B A N K I N G I N E M E R G I N G E C O N O M I E S
žThe legal framework has been improved, with new laws on bank insolvency and restructuring. In the event of insolvency of a bank with retail deposits, ARCO (the restructuring agency) will act as liquidator. Amendments to the banking laws have been introduced to ensure secured creditors receive priority if a bank is declared bankrupt. Once in place, it should encourage more lending with collateral, which will help to raise the level of bank intermediation. The development of the legal system has some way to go.
žIn 2001, new amendments introduced more stringent ‘‘fit and proper’’ criteria for bank owners and management.
žA new anti-money laundering law was passed in 2001 and as a result, Russia was removed from the list of countries failing to undertake sufficient measures to stop international money laundering. Banks can refuse or close accounts if money laundering is suspected.
žThe banking sector was to adopt international accounting standards (IAS) by 2004, ahead of the 2005 date set for EU banks. Sberbank claims to have met these standards since 1996, publishing two sets of accounts – one according to Russian procedures and the other using IAS rules. The CBR asked all banks to publish two sets of accounts in 2005, and by 2006 it is hoped they can use the IAS accounts to show compliance with the Basel rules. It is reported that by the end of 2003, 120 banks (controlling 70% of the assets and capital of the sector) were preparing accounts according to IAS standards, and many are using foreign auditors to sign them off.19 However, there are a number of problems with its implementation. Russian civil law recognises Russian standards, and will have to be changed to accommodate IAS accounts and statements. A draft law is being prepared, but could take some time because of notable differences between Russian and IAS accounting rules. International audit standards are to be adopted. However, there are very few Russian accountants or auditors trained to prepare and inspect accounts using the IAS procedures. On the other hand, the greater transparency of Russian accounts will result in more reliable information on the banks’ financial positions, which is important for potential depositors, investors and supervisors. It is also likely to help encourage the acquisition of very small banks by domestic or foreign banks.
žIn 2002, corporate tax was lowered to 24%, for banks and all other firms. Prior to this, banks had paid a higher rate of tax. However, it is claimed that the elimination of tax relief on interest expenditure by corporations is causing them to use internal funds to finance expenditure, reducing the demand for corporate loans.
žA law ‘‘On Deposit Insurance’’ was passed in 2003. At the moment, only Sberbank’s retail deposits, and those of other state banks, are protected – the state guarantees the deposits of all banks where it has at least 50% of the voting shares. As this book goes to press, the Russian Duma is considering a change in deposit insurance. All banks would be required to pay a quarterly premium of 0.15% of eligible deposits to a fund.
In the event of bank failure, retail deposits of Rub 20 00020 would be 100% insured, with 75% coverage for deposits in excess of Rub 20 001 up to Rub 120 000. Thus the maximum amount any depositor could get back would be Rub 95 000 (or $3000). Banks will not be allowed to hold retail deposits unless they participate in the scheme. The
19World Savings Banks Institute and European Savings Banks Group (2003).
20About $700 at given the exchange rate in late 2003.
[ 300 ]
M O D E R N B A N K I N G
‘‘safer’’ banks are objecting to subsidising depositors at weak banks who will receive insurance if they collapse. This criticism is often made by the large dominant banks in countries (e.g. the UK) where all banks pay the same premium. The USA is notable in setting premia according to the risk rating of the bank (see Chapter 5). Concern about moral hazard problems has also been expressed, though a more serious problem could be the limited nature of coverage. In the event of another crisis, wholesale depositors and those holding more than $700 in their accounts will be the first to ‘‘run’’. However, 100% coverage could cause serious moral hazard problems unless there is much closer supervision of banks. The proposed changes would help to create a level playing field for private banks, which have had to pay a risk premia to attract deposits away from the state banks, especially Sberbank. It comes as no surprise that Sberbank and other state banks are objecting to the scheme because their depositors will be worse off.
Issues and problems in the Russian banking sector
The Russian banking system remains underdeveloped, even when measured against other emerging markets. Keeping in mind Russia’s fledgling bond and stock markets, the banking sector is central to financial intermediation. Table 6.3 shows monetisation and bank lending as a percentage of GDP is much lower than other transition economies. The bond market is
Table 6.3 Banking and Financial Market Indicators
|
M2 (%) |
Bonds |
Equity market |
Aggregate assets |
Loans to |
|
|
(%) |
capitalisation (%) |
(%) |
private sector (%) |
|
|
|
|
|
|
Russia |
24 |
3 |
27 |
35 |
17 |
China |
165 |
26 |
45 |
173 |
125 |
India |
63 |
36 |
43 |
50 |
29 |
Czech Republic |
71 |
15 |
16 |
94 |
36 |
Slovak Republic |
66 |
13 |
3 |
na |
na |
Hungary |
43 |
26 |
20 |
na |
na |
Poland |
43 |
20 |
15 |
51 |
21 |
Brazil |
29 |
na |
na |
67 |
35 |
Mexico |
45 |
na |
na |
37 |
13 |
S. Korea |
84 |
na |
na |
134 |
114 |
Turkey |
51 |
na |
na |
19 |
21 |
USA |
64 |
115 |
137 |
91 |
78 |
UK |
113 |
43 |
153 |
145 |
143 |
Japan |
123 |
107 |
92 |
153 |
102 |
Germany |
71 |
56 |
57 |
168 |
119 |
Note: All indicators expressed as a percentage of annual GDP.
Sources: Barnard and Thomsen (2002) for columns (1) to (3) – 2001 figures. World Savings Banks Institute and European Savings Banks Group (2003) for columns (4) and (5) – 2003 figures.
Columns (1), (2) and (3) for China come from Almanac of China’s Finance and Banking (2002).Columns (1), (2) and (3) for India come from Bhattacharya and Patel (2004).
[ 301 ]
B A N K I N G I N E M E R G I N G E C O N O M I E S
even smaller, and though the stock market looks relatively more important, the figure is due to privatisation in the 1990s, which created a few large concentrated firms. The banking sector is even less developed than the figures suggest because some banks are linked to a particular industry, so that much of the lending is connected, that is, within the group.
Just under 65% of corporate loans made by the large banks have a maturity of less than a year. The short-term nature of the lending is partly due to a civil code which requires all retail deposits to be available on demand,21 even though about 14% of deposits at large banks are for more than one year, and 57% are on deposit for six months or more. This rule leaves the banks highly liquid, as does a liquidity ratio of 7 – 10% of liabilities which banks are obliged to place with the CBR. There are calls to reduce this ratio or to exempt liabilities of a longer maturity. The limitations on long-term sources of finance are a problem – foreign banks, or very large corporate bond issues, are the only options for long-term finance.
The efficiency of Russian banks appears to be highly variable. Take Sberbank: its cost to income ratio (C:I) was in excess of 90% between 1999 and 2002, and in 2003 it dropped to 83%, with a ROA of 3.3%. These figures vary considerably from bank to bank. Vneshtorgbank reported one of the lowest cost to income ratios (39%) in 2003, with a ROA of 5.37%. Compare that to Citibank (Russia): its C:I ratio is 58% with a ROA of 4.6%. The spreads between loan and deposits rates are high. These variations are probably due to the different market niches of these banks. However, it is notable that Sberbank, which operates under such favourable conditions, has such high cost to income ratios, suggesting that protectionism breeds inefficiency.
The low level of market capitalisation of most banks is a cause for concern. According to Goryunov (2001), roughly 80% of the banks operating in Russia have (questionable) capital of less than $5 million, and about half of these have less than $1 million. Based on scale economy estimates (see Chapter 9), the figures suggest most of these banks are unable to benefit from scale economies because of their current size. Many question whether banks have as much capital as they claim. For example, banks can borrow from another bank and treat the loan as a capital injection. The CBR has recently imposed rules to stop this activity, but there is a general feeling that capital is over-reported by most Russian banks.
It was noted earlier that Russia lacks IAS trained auditors and accountants, which highlights a more general problem. Russia continues to be deficient in trained and experienced banking staff, both in the private and state (central bank) sectors. Few staff have experience in credit or other forms of risk analysis because so little of it was practised in the 1990s, where connected or named lending was the norm, up to and during the crisis. The absence of restrictions on the operation of foreign banks should help to alleviate the problem more quickly.
A major obstacle to the further growth of Russian banking has been the failure of the banks to instil confidence among potential and existing customers. This lack of trust is not surprising, given the events of the early 1990s and during the 1998 crisis. Recall, for example, the failure of the central bank to shut down failed banks, and the favouritism it showed some bank managers at the expense of depositors, investors and creditors. In the early
21 According to this civil code, depositors withdrawing the deposit before the term is up are entitled to the interest paid on a call deposit.
[ 302 ]
M O D E R N B A N K I N G
1990s, investment funds were introduced, but these became vehicles for criminals to steal assets. Pyramid funds advertising extremely high rates of return attracted unsophisticated investors, and proved extremely popular, even after they began to collapse when some clients attempted to cash in on their investment. They continue to exist in a variety of forms, even though many originators of funds launched in 1995 have been tried for fraud and other crimes.
In the summer of 2004, the central bank revoked the licence of Sodbiznesbank following an investigation into money laundering. Less than a month later a run on another Moscow bank, Credittrust, forced it to suspend business and negotiate with the RCB how to meet its debt obligations. One analyst claims that only 30 of 1200 banks in Russia are financially stable, and if the crackdown on money laundering persists, there will be more bank runs.22 Once the banking system rids itself of the problem banks, greater stability should improve confidence in the system, though it could take many years. If and when the banks do overcome this lack of trust, the growth potential for household deposits at banks is considerable. Russian retail bank savings as a percentage of GDP is just under 11%, compared with 30% in Poland and 43% in the Czech Republic. It exceeds 50% in Western Europe and 40% in the USA.
There is also a lack of trust between Russian banks (which may explain the tiny interbank market) and foreign banks do not have much confidence in Russian borrowers; foreign banks account for about 12% of US dollar loans to Russian corporates, while their share of the rouble market is just 1.3%. However, many of the financially viable Russian corporates borrow from the head offices of foreign banks, which is classified as cross-border lending. In 2002 it accounted for about 30% of total corporate lending in Russia. This substantial (dollar) loan market is largely due to cash flows arising from imports and exports. Loans to individual customers are a very small part of the market. In 2003, they accounted for just under 3% of total bank assets.23
The CBR is criticised by banks and observers for focusing on adherence to form rather than substance in their supervision of banks. The number and length of forms banks are required to complete for the CBR and other federal agencies is estimated to take up 10 – 15% of bank time. All would benefit from a reduction in the duplication of forms and the number of agencies banks must report to. If the CBR were in sole charge of bank supervision and adopted the practices of western regulators, supervision would improve, which in turn should help build trust.
There is also concern about whether the authorities will be able to implement many of the planned reforms effectively. The major banks are part of powerful industrial groups. Their close connection with big conglomerates and/or business people with political clout could lead to pressure on the CBR to, for example, keeping failing banks open. Since the crisis, there has been no major test of the new system and reforms. The CBR answers to the Duma (parliament), depending on it for adequate supervisory powers. Yet when the Duma was considering amendments to CBR law in 2003, it actually reduced the number
22Nick Holdsworth, ‘‘Russian Bank Falls Victim to Crime Fears’’, The Daily Telegraph, 5.6.04, p. 34.
23The figures cited in this paragraph are from the World Savings Banks Institute and European Savings Banks Group (2003).
[ 303 ]
B A N K I N G I N E M E R G I N G E C O N O M I E S
of inspections the central bank is allowed. Also, having recently introduced restrictions on single large credit exposures, the CBR, under political pressure, exempted both Sberbank and VTB.24 Another vulnerable point is deposit insurance. If and when the new system is introduced, the CBR must be given the power to refuse entry by weak banks into the scheme, and there must be strict, transparent criteria for admission to the scheme itself. The amendments also include changes in the way the National Banking Council (which oversees the CBR) members are appointed – half will be appointed by the Duma or the Kremlin, which again makes the CBR vulnerable to political interference. Nor do members of the Duma have time to manage the fine details of the CBR’s supervisory functions, which makes them highly susceptible to the influence (and money) of the powerful banks. Likewise, the low-paid staff of the CBR may easily be persuaded by the same banks to engage in regulatory forbearance should a bank or banks get into trouble.
The state still owns a considerable number of banks, including Sberbank. Sberbank’s special privileges give it unfair advantages, which should be phased out. It appears that some of them (e.g. guarantees of retail deposits) will be in the near future. The position of Sberbank must be dealt with very carefully because it is the one bank that depositors do trust, and it would be unwise to create panic among householders. The CBR has decided Sberbank’s status should be left unchanged until other banks erode its dominant position. This should be possible if the new deposit scheme is introduced, and its other privileges are gradually removed. The other state banks are more of a problem. The proposed reforms say nothing about privatising them but there is little interest in taking them over because they are saddled with the bad debt of former state owned enterprises. This problem must be resolved by the state, but it requires dealing with politically sensitive, but unprofitable, sectors.
To conclude this section, how has Russia fared in terms of reducing financial repression? After nearly 70 years of a communist regime, where a central bank reallocated funds between sectors according to a centralised economic plan, Russia has come a long way in a short period. There are now virtually no controls on interest rates or capital. Russia has sensibly allowed foreign banks to enter the market with few restrictions. Banks have a free hand over the direction of credit, though this is stifled by the expectation that banks be able to repay all retail deposits on demand, regardless of their maturity. In the absence of such a requirement, reserve ratios of 7 – 10% would not be unreasonable, but with it they are on the high side.
Despite the 2002 – 3 financial sector reforms, a number of problems remain.
žPolitical interference in the banking sector – for example, the central bank’s supervisory authority can be undermined by members on the National Banking Council.
žThe oligopolistic power of the bank/financial conglomerates, and their close political connections.
žState ownership of a considerable share of the banking sector.
žThe potential for a large number of bank failures, if analysts’ assessments about the viability of most of the banks prove correct.
24 It has since instructed them to reduce their exposures to the permitted limits.
[ 304 ]
M O D E R N B A N K I N G
žConnected or named, as opposed to analytical, lending, which has grown because of close connections between individual banks and financial conglomerates. It reduces the available capital for small innovative firms.
žHuman resource problems – the need to train staff in risk management techniques, IAS accounting and auditing. The expertise brought by the foreign banks should help, as will the good educational system.
Amendments to the Russian Civil Code are slowly changing the banking landscape, enabling the CBR to more effectively supervise banks, subject to the constraints noted above. However, Russia has some way to go before its financial system can support a forward-looking, growing economy. As this book goes to press, the CBR and government are expected to announce a new strategy for the banking sector.
Performance of the transition economies
How does banking in the other ex-communist countries compare? Space constraints prevent a detailed review, but a few points are worth making. The figures in Table 6.3 indicate some are doing considerably better than Russia, especially in terms of monetisation, aggregate assets and private lending. Countries such as the Czech Republic, Hungary and Poland, which joined the European Union in 2004, have made great progress very quickly. An investigation by the World Bank (2002) considers the effect of liberalisation on economic growth between 1990 and 1999 in the Eastern European states and Russia. This study assessed the extent to which the initial conditions or changes in economic policy affected annual rates of growth. The authors used the World Bank’s liberalisation index, which quantifies progress from a transition to market economy. They found that initial economic conditions were the most important factor explaining the decline in output in the period 1990 – 94, though the liberalisation index was also significant in this early period. Also, certain distortions (such as the absence of pre-transition reforms, high repressed inflation and high black market exchange rates) were found to be more significant than other indicators in explaining most of the early decline in output. As transition progresses, policies begin to take over as the principal explanation for the growth in output. The overall conclusion is that market reform helps to cushion the effects of transition on the fall in output in the early period, and over the medium term (1995 – 99) contributed to a faster rate of recovery and promoted growth.
Grigorian and Manole (2002) used data envelope analysis (DEA) to estimate an efficiency frontier, and to identify how close banks are to that frontier. This is not the appropriate place to explain DEA in detail,25 but it involves using linear programming techniques to identify efficient production units, and constructing a piecewise linear efficiency frontier. The most efficient bank is on the frontier and less efficient ones will be inside it. Using data from BankScope, these authors look at the period 1995 – 98 for 15 Central and East European countries, including Russia, the Czech Republic, Slovakia, Hungary, Poland and the Ukraine. Looking at the results by region, the Central European countries were, on
25 See Chapter 9 for a more detailed explanation of DEA.
[ 305 ]
B A N K I N G I N E M E R G I N G E C O N O M I E S
average, closest to the efficiency frontier. Banks in the Czech Republic came closest to the efficiency frontier – 79% efficient, followed closely by Slovenia (77%). Banks in Hungary (68%) and Poland (69%) were roughly 10% less efficient. Slovakia (61%) was found the least efficient, i.e. Slovakian banks would have to improve their efficiency by 39% to reach the frontier. Among the Commonwealth Independent States, Kazakhstan (59%) and Belarus (52%) do best. Russian banks were found to be 49% efficient. Then there is a large gap with Armenia (34%), the Ukraine (29%) and Moldova (27%) coming at the bottom. Moldova’s banks would have to become 73% more efficient to reach the frontier. Banks in the Baltic region and South Eastern European countries ranged between 51% (Romania) and 71% (Bulgaria), with an average score of 59%.
Grigorian and Manole (2002) used these measures of output efficiency as the dependent variable to test a number of explanatory variables. Since the dependent variable varies between 0 and 1, they used a Tobit26 model rather than ordinary least squares. They find well capitalised banks are relatively more efficient, as are banks with a larger share of the market. The authors suggest that the latter finding indicates a high concentration may lead to greater efficiency in transition economies. Once the economy is stronger, greater competition among banks might be encouraged, without an efficiency loss. Foreign controlled banks were found to be more efficient than domestically owned banks (private or state), which is consistent with the argument that these banks bring with them superior technology, risk management, management and operational techniques. Also, because of the perception that they are likely to be backed by their parent, they can pay a lower deposit rate than domestic banks, making their funding cheaper.
Certain prudential regulations (e.g. capital adequacy rules) were found to affect efficiency, but not others. Also banks in countries with less stringent foreign exchange exposure rules were more efficient, possibly because in transition economies, foreign exchange business and earnings are a big component of banks’ non-interest income. GDP per capita was the only macroeconomic variable found to influence bank efficiency, probably because the high income countries attract more deposits, contributing to a higher level of intermediation.
6.3.2. China27
As a communist country, China operated an economic and financial system similar to the USSR. The People’s Bank of China (PBC) not only issued currency, but was the financial hub of each State Economic Plan. All funds were channelled to the PBC, which, taking its cue from the state, allocated the funds in accordance with each plan. The PBC controlled currency in circulation, managed foreign exchange reserves, set interest rates, collected all deposits (via 15 000 branches and sub-branches) and made loans, almost exclusively to state owned enterprises. In addition, there were three specialised banks. The Bank of China28 became a subsidiary of the PBC, responsible for all foreign exchange and international
26Tobit is similar to the logit model, but rather than the outcome being binary (0 or 1), it is specified to be any number between 0 and 1. See section 6.5 and Chapter 7 for more detail on the logit model.
27Special thanks to Xiaoqing Fu for her assistance with this section.
28Originally established as a private bank in 1912.
[ 306 ]
M O D E R N B A N K I N G
transactions. The Agricultural Bank of China (ABC), set up in 1951, operated under the PBC, dealing with the agricultural side of the economy. Rural credit cooperatives, which pre-dated the PBC, provided basic banking services for their members – mainly peasant farmers. These coops became units of the ABC after it was formed, collecting deposits in rural areas and confining lending to farmers. In 1954, the China Construction Bank (CCB) was established as a fiscal agent for the Ministry of Finance, with control over the administration of funds for major construction projects, in line with the relevant economic plan.
Chinese bank reforms: 1979 – 92
In 1978, China opted for major economic reforms with the objective of increasing economic efficiency and improving resource allocation. Emphasis was placed on decentralisation and the gradual introduction of a market based economy to replace the old system. Unlike the USSR there has been no political disintegration, and the plan is to create a market-like economy operating within a communist political system.
The banking system is to be reformed, with banks acting as intermediaries between savers and borrowers, together with the provision of a payments system to ensure the transfer of funds between economic units. To date, two stages of reform have been undertaken, from 1979 to 1992 and 1993 to present. Stage one began with the creation of a ‘‘two-tier’’ banking system. Between 1979 and 1984 the specialised banks were separated from the direct control of the PBC/Ministry of Finance and became state owned, national commercial banks, each specialising in a certain sector of the economy, which effectively ruled out any competition between them. For example, the CCB was now independent of the Finance Ministry, and acted as banker to state construction firms, as well as managing the fixed assets of all state enterprises.29 In 1984, the Industrial and Commercial Bank of China (ICBC) was established, to assume the PBC’s deposit taking function as well as granting loans to state owned industrial and commercial enterprises in urban areas.
Gradually the lines of demarcation that separated these banks were removed, reducing the amount of functional segmentation. In 1985, in addition to the ICBC, the ABC, BOC and CCB were allowed to accept deposits and make loans to households and corporates (mainly SOEs), via nation-wide branches.30 As universal banks, by 1986, most had expanded to include trust, securities and insurance affiliates.
In 1984, the People’s Bank of China officially became the central bank. It was assigned the tasks of formulating monetary policy and supervising all financial institutions. Though responsible for monetary policy and supervision, it differed from its western counterparts because of its continued role in economic development. Under a credit quota system, the PBC imposed credit ceilings on the state and so-called independent commercial banks, though they could exceed their limits by borrowing from the PBC. The length of the
29The Ministry of Finance had allocated funds for physical plant and equipment to state owned enterprises so when the banks were separated the CCB assumed this role for all fixed assets.
30At the end of 1992, each bank had an average of about 30 000 branches and sub-branches, though there were large variations. The ABC had over 56 000 and at the other extreme the Bank of China had 1352. The ICBC had just under 32 000.
[ 307 ]
B A N K I N G I N E M E R G I N G E C O N O M I E S
loans could be for days, months, or up to 1 – 2 years. Wu (1998) argues that the PBC’s role in economic development took precedence over monetary policy until 1995. For example, in 1992 it loaned 678 billion renminbi to other banks, making up 26% of the total bank lending.
Between 1985 and 1992, to promote more competition, the Chinese government permitted the establishment of new ‘‘small and medium-sized’’ commercial banks, which initially offered universal banking services to households and firms, mainly in the regions and cities.31 Total loans cannot exceed total deposits, and they are allowed to borrow short-term funds from the PBC. This group included the Shenzhen and Guangdong Development Banks, the CITIC Industrial Bank, Bank of Communications, China Merchants Bank, China Everbright Bank and Hua Xia Bank. Many are joint stock, i.e. shareholder owned – but the state is a key player in their operations, because either central or local governments and/or state owned enterprises are major shareholders. For example, the respective provincial governments own shares in Shenzhen and Guangdong Development Banks and China Everbright Group Limited, a SOE, owned China Everbright Bank. Between 60% and 70% of these banks’ shares are either owned directly by the state (or indirectly via SOEs) and cannot be publicly traded. Thus, when the Shenzhen Development Bank became the first bank to list its shares on the Shenzhen Stock Exchange in 1991, only a minority were listed. Likewise for the three other banks that listed their shares in 1999.
Rural credit cooperatives have a long history of offering basic banking services in their respective agricultural communities. Since 1979 they had been required to place a certain percentage of their deposits with the Agricultural Bank of China, which provided clearing services to them. The ABC also acted as supervisor until 1996, when this responsibility was transferred to the PBC. City based urban credit cooperatives were introduced in 1979, but most were established after 1987. The idea is to offer banking services to households, urban collectives and small firms. Though these cooperatives raise some equity capital, local government owns most of the shares. Unlike the west, where members of coops or mutual organisations each have one vote independent of the size of their deposits and loans, in China the state, as majority shareholder, has much more power and influence over the way the cooperatives are run than individual customers.
The attitude towards foreign bank operations remained quite restrictive in this period. In 1979, the authorities allowed Japan’s Export and Import Bank to establish a representative office in Beijing, and in 1982, a Hong Kong bank was allowed a subsidiary, but was restricted to offering foreign exchange services to firms and individuals in Shenzhen, one of the special economic zones China had established.
This first stage of banking reform led to a rapid growth in the banking sector’s assets and liabilities. Deposits increased by 25 times; there was a 15-fold increase in loans. However by 1992 the market share of the state owned banks was still very high: 84% of loans and 78% of deposits. The rural credit cooperatives had higher deposit (13%) and loan (9%) shares than the small/medium-sized commercial banks, with, respectively, 6% and 4% of the deposit and loan markets. Foreign banks had no deposits, and just 1% of the loan market.
31 Later, two of these banks expanded beyond their regions, with nation-wide branches.