China's Banks Become the Government's Foot Soldiers

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Adrian Bradshaw / EPA / Corbis

Pedestrians passes by the headquarters of Bank of China

In virtually every country now struggling to cope with the global economic downturn — with only one notable exception — there remains a single overriding priority: fixing what a senior official at the U.S. Federal Reserve Board earlier this year called "the transmission belt of the global economy" — the financial system that disperses capital, the raw fuel of economic growth.

The exception is China, where the country's major banks, all of which are state owned, are playing a critical role warding off the effects of what Beijing sees as an economic crisis wholly made in the U.S.A. China has, measured by market capitalization, the three largest banks in the world, and they along with their smaller rivals are now frantically pumping loans into the world's third largest economy. In December of last year, new renminbi loans in China totaled 772 billion, or $115.5 billion. In January that sum more than doubled to the equivalent of another $235 billion, and in February the banks pumped an additional $157 billion into the economy. (See pictures of Chinese business in Africa.)

In China, in other words, the 'transmission belt' is working just fine, at least for now. And that fact, most economists believe, means that Beijing will be able to cope better with the vicious decline in global economic activity than most of its western counterparts. Earlier this week, the World Bank lowered its official forecast for GDP growth this year from 8% to 6.5%. And though that's a meaningful decline in an economy that has been growing at around 10 per cent annually, "it could be a lot worse," says She Min Hua, bank analyst at Citic China Securities.

Because they are owned by the government, China's banks have in effect been deputized to fight in the war against the global slowdown. Last November China announced a stimulus package worth about $565 billion, and analysts estimate that as much as half of that will be funneled through the banks that Beijing owns. That means the banks don't waste much time asking questions — doing due diligence on the potential creditworthiness of borrowers; they just salute and move the money on to other state-owned companies who are getting the huge infrastructure contracts Beijing is now in the process of doling out. In January, for example, nearly 90 per cent of the $235 billion in new bank loans went to state-owned companies. "It is impossible for the private sector to penetrate these walls," Bao Yujun, chairman of the China Private Economy Research Center complained to the Economic Observer, a popular Chinese business publication.

There are risks, economists acknowledge, in both the overall surge in lending, and to where it's going. Though Chinese officials now tend to congratulate each other that their financial system is in so much better shape than the West's, the fact is, that's more a function of timing, not regulatory or managerial competence. At the beginning of this decade, China had to massively recapitalize its own banking system, because the major institutions were swamped with nonperforming loans. A big part of the reason for their problems: they tended to wave through loans to politically connected borrowers, whether they were building apartments in Shanghai or new cement factories in Shandong province.

What's happening now? Banks, again, are frantically doling out loans where the government wants them to go. Are they, in the midst of the current slowdown, laying the seeds for the next banking crisis in China, as some economists worry? Optimists point out, reasonably enough, that under the current circumstances, they could hardly be expected to do anything else; sure, some of the money doled out now might be wasted; but when throwing a lifeline to a drowning man, style points don't count. Zhou Xiaochuan, the chairman of the People's Bank of China, said recently that there are already "signs of stabilization and recovery" in the economy. Moreover, bank regulators, mindful of the last crisis, are forcing banks to raise capital, and increase their loan loss provisions. (Bad loans, according to the PBOC, amount to just which 2.5 per cent of total bank assets now.)

The question is, will that be enough protection when some of the current lending binge turns sour, as it almost inevitably will? Michael Pettis, a professor of Finance at Peking University's Guanghua School of Management, acknowledges that it's "very prudent" for the authorities to be forcing banks to increase protection against future losses, but nonetheless believes "skepticism about the quality of bank portfolios is still very much in order. I think it's extremely unlikely that we won't see a surge in [bad loans] over the next two years." Perhaps so. But Beijing has made it clear that the choice between an increase in bad loans down the road and propping up a flagging economy now is, in effect, no choice at all. Let the money flow.

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