By Tianlun Jian
Currently, the Chinese mainland banking sector is still dominated by four state-owned banks (Bank of China, Industrial and Commercial Bank of China, Agricultural Bank of China and Construction Bank). China is such a big country, the second largest economy in the world with a population of 1.3 billion, yet it has only a few dozen banks, which coupled with foreign bank branches total one hundred banks at most. In contrast, the U.S. has 300 million people, yet more than 7,000 banks. Among the one hundred banks in China, four state-owned banks control more than 80% of the business.
Bank profits in China are raining from the sky, thanks to the nature of China’s banking system and its interest rate policy. People in the banking industry make far more money than in other sectors. Why? China's interest rate is set by the government, and rates on deposits and loans are highly regulated by its policies. Banks have little freedom in setting interest rates. Under such circumstances, the four major banks essentially monopolize the Chinese banking sector and its profits. For example, the current rate for one-year term deposits is 3.5%, yet the lending rate on one-to-three year loans is 6.56%, meaning that as long as banks loan out their deposits, the one-year interest differential is three percentage points. A 3% gain on loans is thus guaranteed.
Due to the regulations on interest rates on deposits and loans, the Bank of China Chairman Xiao Gang wrote: “[N]et interest margins on yuan loans are almost double of that on foreign currency loans in the international market. In such an environment, which bank wouldn’t want to increase its lending? The more banks lend, the more profits they earn. Simple.”
Net interest income accounts for more than 70% of the total income in China's banking industry. In other countries, net interest income share is about 50% to 60%. So obviously the Chinese banking sector relies heavily on the spread to survive. They profit because of the government’s interest policy. The state-owned banks are in a monopoly position, so they always make money. There is no competition.
How much money did the China's banking sector earn last year? It was more than one trillion yuan in 2011, 2.2% of China’s GDP. Its GDP share was more than double that of the US banks. According to FDIC statistics, net income of US banks was $119.5 billion, accounting for 0.8% of the U.S. GDP in 2011. Even prior to the financial crisis when banking was in a boom period, bank earnings accounted only 1.1% of the US GDP in 2006.
However, how much is the banks' profit margin then? The remark of Minsheng Bank President Hong Qi is vivid and true: "Corporate profits are so low, but bank profits are so high that we felt we had made too much money and were too embarrassed to announce." The Minsheng Bank's profit margins are too high to be announced. In 2011, its net profit rose 58.8%. Its ROE (return on equity), a key measure of profitability, was 22%, whereas the average ROE for American banks in the last 28 years was 10%. All the four state-owned banks had ROEs between 17% and 22% in 2011, well above the norms of banks in the western world. China's banking industry’s net profit increased from 185 billion RMB in 2005 to 1,0412 trillion RMB in 2011, a compound annual growth rate of 28.96%.
With regard to the income of bank employees, the annual bonus for a general staff member, not even an officer, is 100,000 RMB which is four times a Chinese urban resident’s annual income of 23,929 RM. We all know about China’s oil industry monopoly, but revenue and profit in the banking industry are even higher than those of the oil industry. In reality, even people in the banking industry feel their profits are too high and are embarrassed to mention them. This is unreasonable and is causing grievances from average people.
In other words, once you are in the banking industry, you will make more money than others.
Once you are in the banking sector, your personal income will be above the upper middle class. Obviously, we can imagine that the leaders of the banking sectors are millionaires. The monopoly banking industry contributes to the widening of the income gap between the rich and poor in China.
Monopoly Breeds Corruption
Mainland China National Radio reported on April 3, that when Wen Jiabao investigated business conditions in Guangxi and Fujian Provinces, he appealed for reform of the financial system to break the monopoly of state-owned banks. Why does the financial system need to reform? Actually in China, because of the long-term monopoly in the banking sector, the small enterprises lack of funds, or do not get the funding when they need it. These state-owned banks are holding the lifelines of small businesses. They give you money only when they want to. Without this funding, small businesses have to shut down. When orders come, without funding, small businesses cannot operate. What can be done then? Under that situation, many illegal underground banks and loan companies have appeared all over China.
This illegal phenomenon results from several factors. On the one hand, financial activities due to monopoly in the banking sector cannot meet the needs of the national economy; on the other hand, the state-owned banks use their power to reap huge profits.
Often these underground banks and loan companies obtain the money from branches of state-owned banks by paying commissions to the staff of the banks. Then they can loan it out charging 30%, 50%,70%, or even 100% annual interest rates. In this way, they earn high profits by channeling the money to companies that badly need it. The high cost of money pushes up the total cost of small and medium enterprises.
Prospects for Banking Reform
To break the monopoly of the state-owned banks is to get rid of state-owned enterprises, state-owned companies and large state-owned banks -- residues of China's planned economy. This is a general trend. Why did Premier Wen Jiabao release information calling for banking reform at this time? I believe that it is due to China's economic slowdown. If the financial system is not able to fully play its role of building a bridge between savings and companies needing the funding, money cannot be fully utilized and thus cannot promote economic growth. Therefore, the government needs to break the monopoly in the banking sector and approve some loan companies or private banks, such as small banks, regional banks and community banks. In fact, in the United States or other countries, small to medium banks make business loans to small enterprises and help to promote economic development.
Economic slowdown is another factor behind the timing of the reform. The monopoly in the banking industry results in high profits due to unfair competition. This not only causes social discontent, but also raises the cost of capital. At the present time, small and medium enterprises produce 65 per cent of China’s GDP. Yet, they are the companies that cannot obtain the funding they need. Breaking the financial monopoly is beneficial for the development of these companies and for the promotion of economic health at the same time.
In 2011, the per capita profit of the banking sector amounted to almost 400,000 RMB. It was 10 times more than that of industrial enterprises (less than 40,000 RMB). Therefore, people in the existing banking system and bank interest groups are likely to do everything possible to obstruct the reform. On the other hand, the local government that gives approval to these banks and regulators of the banking system may make a ton of money due to the reform. Even so, I think breaking the monopoly of banks should be popular, so people from top to bottom will still support it. The result may not be as good as expected, but it should take place. What would happen to financial reform after the political changes? I believe that if the Chinese Communist party steps down, the financial reform will certainly be carried out.
But from current reports, we see that only some of the existing township loan companies and underground banks are reformed, namely those aiming to set up private banks or financial services companies. So at best, it only supplements the existing financial system--there is no real plan to privatize the state-owned banks yet.
Who will benefit?
What concerns me most is if financial reform will result in more corruption. Because of the Communist Party dictatorship, it is hard to believe that they would use the power in their hands to further their personal interest. In the past, the reform of state-owned enterprises and the joint-stock system only filled the pockets of corrupt officials and state-owned assets became their private property.
If privatization of these state-owned banks is the goal of the next economic reform, then prevention of assets from being carved up into individual hands of the rich and powerful must be seen to. Otherwise, China’s economic reform may become negative and will lead to more deterioration of China’s economic development and a more uneven distribution of wealth.
In general, the difficulties exist in two aspects: one is that people involved in the state-owned banks will not easily give up profits; and second is that officials may do their best to make money.
Since the four large state-owned banks account for a large share of China's banking industry, breaking the monopoly is equivalent to taking away the meat from their mouths. Of course they will try to find a way to prevent it. Another thing is that the small banks and loan companies need to be audited. To approve or disapprove their bank status is at the will of the officials in charge. They are probably thinking about how to transform their power into personal property. Nowadays in China this has become a popular way to obtain more personal income.
All these issues can hinder the reform to some degree. In addition, lack of integrity is also an issue. How to recover the loans and reduce bad debts become important factors for consideration. Therefore, under the existing political system, the financial reform may not be smooth.