By Zhang Chenghui

I. The current situation of the Chinese policy financial institutions The state decided to set up China Import & Export Bank, China Agricultural Development Bank and National Development Bank in 1994 as a major move to reform the financial system. These banks are charged with the responsibilities of providing policy-oriented loans for the import and export of complete sets of electromechanical equipment, for grain and oil storage, the purchase of major farm produce and byproducts, and agricultural development, and loans and discount business for financing the key state projects. At the same time, the policy-oriented functions of the former four state-owned banks were separated to sever their association between basic currency with policies and to create conditions to speed up their commercialization and establish the independent status of the central bank. In the past four years, the three policy banks witnessed rapid development in their business and played an important role in implementing state industrial policies, backing regional economic development and stabilizing the agricultural sector. They also helped the development of China’s financial sector and the reform of financial system.

Table 1 Credit receipts and Payments of Policy Banks (in RMB 100 million yuan)

National Development Bank	Import & Export Bank	Agricultur al Development Bank	Total	Percentage in All Financial Institutions
Sources of Fund	3637.19	301.65	7480.88	11419.72	11.5%
Among which: Deposits	7.18	0.17	155.10	162.45	0.18%
Financial: Bonds	3261.96	262.26	360.99	3855.21	98.5%
Re-loan of the People’s Bank			6759.66	6759.66	49.2%
Owners’ Equity	472.39	26.95	128.17	627.51	14.6%
All loans	3580.17	245.50	7165.12	10990.78	14.2%
Among which: Short-term Loans		5.14	7074.77	7079.91	12.7%
Medium and Long-term loans	3566.70	232.29	90.35	3889.34	24.1%

Source: Monthly Report of Monetary Credit Receipt and Payment of Chinese Financial Institutions, May 1998

According to the above table, less than four years after their founding, the policy financial institutions had occupied an important position in the financial system. On the credi market in particular, they accounted for 12.7 percent of the short-term loan market shares and 24.1 percent of the medium and long-term loan market shares.

The three banks also played an important role in their respective domains if viewed form the results of their business operations. Since its founding, The National Development Bank had provided funds for over 3,000 projects, with key projects accounting for 70 percent of all the important profects. The banks effectively supported the implementation of the state industrial policies and the regional development strategy and played and active role in the realignment of economic structuring. China Import & Export Bank is the state policy financial institution to bolster the export of such capital good as electromechanical products and complete sets of equipment. It made full use of such export financing methods such as export credit, export credit insurance and external guarantee to support the export of large quantities of high-tech and high value-added electronmechanical and products and equipment with good economic result and , which have broad export prospect on the international market and can bring in a large amount of foreign exchange at low production cost. Up to the end of 1997, it approved export seller’s credit totaling over RMB 40 billion yuan, buyer’s credit of 93.77 million U.S. dollars and undertook export credit insurance of 1.116 billion U.S. dollars. China Agricultural Development Bank is mainly charged with the task to ensure the fund for purchasing farm produce and byproducts. It effectively pursued the state policy in the purchase and sell of grains and oil products, providing the guarantee for stabilizing agricultural production and raising peasants’ income through the elimination of IOY in the purchasing. The table shows the business performance of the three banks.

II. Problems confronting China’s policy financial institutions

After their founding, these policd banks did play a prominent role in implementing state industrial policies and promoting economic development and they themselves developed rapidly. However, with the present situation in view, they are confronting increasingly outstanding problems which show in the following aspects.

Table 2 Assets, Liabilities, Losses and Gains of the Policy Banks in 1997

(in 100 million RMB yuan)

 

Items National Import & Agricultural Development Export Development Bank Bank Bank

Total assets 3811.48 313.17 9233.00

Total liabilitres 3354.43 278.28 9111.2

Ownere quity 457.04 34.89 121.80

Of Which: Paid-in Capital 442.33 33.19 139.96

Operating income 3720.59 25.83 654.87

Operating expenses 294.30 24.75 717.76

Net profit 8.16 0.71 -25.3

Source: 1997 Annual Reports of National Development Bank, China Import & Export Bank and Agricultural Development Bank

1.Uncertain legal status and unclear functions

Viewed from their nature of owrenship, policy banks are set up for a special purpose by the government to implement state industrial policies and the regional development strategies. This is the base point in the relations between the banks and the government. But in practice, such a nature has not been recognized by law and their functions and status and relations with the government are far from clear. Up to now, there exists neither law on the establishment of the three banks, nor any special regulations on the administratin of them. Such a situation not only does not conform to the prevailing international practice, and will affect the business guideline, objectives and internal management mechanism of the banks and their relations with the ministries of the central government.

2. Inborn deficiency in system design

The deficiency manifests in the followings:

First, the functions of these banks are in distortion. Policy banks assume both financial and monetary characters, but the two characters do not stand side by side and on an equal basis, their prominent and foremost charater should be their financial character. Otherwise, the necessary precondition for setting up the banks would not exist. Their monetary character shall serve their financial purpose. The reason why the policy banks must operate as a bank is because their major purpose is to ensure the recovery and turnover of their fund to increase the efficiency in using fund. Now, at the decision making level or the management level, or even inside the policy banks, the relation between the primary and secondary characters are not clear. The two characters are often put on the same par with each other and over emphasis is even laid on the monetary character. As the result, the tendency to weaken the policy nature and reinforce the commercial nature of the policy banks appeared in practical operation, and their interest rates on loms are basically at par with that of the commercial banks. The business scope of the policy banks comes into competition with the commercial banks, thus hampering the full play of the superiority and functions of the policy banks. The management system the policy banks is also fallen into a wrong path, for they just follow the management system as that of the commercial banks.

Second. Distortion in the management system of the policy banks. As the nature of ownership of the policy bank is not clearly defined, these banks are put under the management of the central bank. But in foreign countries, the business management of almost all their policy banks are under the finance ministry instead of the central bank. For instance, in Japan the ""Two National Banks and Nine State Trasuries are under the administration of the ministry of Finance and "" maintain business contacts only with the Ministry of Finance, the Ministry of International Trade and Industry and the Economic Planning Agency in stead of the central bank. But the situation in China is exceptional. Apart from its responsibility of maintaining the stability of the currency, the central bank also oversees the business activities of the financial institutions. Under such circumstances It is logical for the central bank, the People’s Bank, to administer the business of the policy banks from the perspective of financial supervision. But the problem is that the People’s Bank in fact plays the role of ""the final loan provider"", the result of which is adverse for the bank to implement an independent monetary policy and for policy banks to establish an compensation financing mechanism.

Thirdly. Irrationality in the designe of the source of fund of the policy banks. At present, the fund of the policy banks comes mainly from two sources: the issuance of financial bonds and suploan from the People’s Bank. But the fund-raising cost through the two channels is too high. After the People’s Bank lowered the interest rates in December 1998, the interest rates on subloan for half-year and one-year terms fell to 5.04 percent and 5.13 percent respectively, 1.7 percent and 1.3 percentage points higher than the interest rate for term deposit in the corresponding periods. As the commercial banks all hold a large quantity of current deposits, and over two thirds of the enterprises’ deposits are current deposits, calculated from the interest rates after their fall in December 1998, the average interest rates of deposit of the commercial banks are less than 3 percent, while the interest rates of both of the subloan and policy financial bonds topped the interest rales of banks’ deposit by two to three percentage points.

After 1998, the Development banks and the Import & Export Bank have tried the market practices of organizing underwriting groups and inviting bidding in issuing bonds and achieved satisfactory results in lowering the fund-raising cost. But such results were achieved at the time when the economy was still at its bottom and most of the commercial banks were cautious about the economic situation. Therefore, the availability of long-term, stable and low cost funds for the policy banks remains a problem to be tackled from the root.

3. Immense potential business risks

Business risks of the policy banks concentrate in the National Development Bank and the Agricultural Development Bank. Now the two banks have accumulated a large amount of bad assets or potentially bad assets which are still on the rise year by year. A report of Agricultural Development Bank shows that bad loans accounted for 20 percent of its total loan at the end of 1995, 26 percent at the end of 1996 and 27 percent by February. Even worse, the risk has been further increased by the misappropriation of large quantities of agricultural policy fund. At the end of 1996, the balance of its loans to buy grains, cotton and oil crops stood at RMB 51.77 yuan, while the stock of grains, cotton and oil crops were valued at only RMB 28.61 million yuan of which Irrational loans amounted to RMB 17.37 million yuan, accounting for 33.55 percent of the balance. At the end of 1997, enterprise deficit left on account plus misappropriated fund reached nearly RMB 200 million yuan, and the deficit left on account increased by another RMB 27 billion yuan (""Agricultural Development and Finance"", 3rd and 4th issues, 1997). Bad assets of National Development Bank are also on the increase year by year, with bad debts having broken the record of zero. Bad assets involve not only the coal, military and textile industries, but also the electric, electronic and auto industries whose performance had always been good. With a history of only four years and most of the loans are long-term loans with a term of at least five years, so one can say that the potential risk for the bank has hat yet fully manifest itself.

The financial situation of the banks is not optimistic either. The deficit incurred by Agricultural Development Bank has been increasing year by year with the amount for 1998 expected to exceed RMB 16 billion yuan (excluding subsidies). Payment of Interests in arrears by the enterprises who have maintained an account with the Bank, are also rising. The large sum of interests due but not paid by the enterprises lands the banks in a situation in which they not only obtain revenue from the loan but receive no fund, but also have to advance money to pay business taxes and surcharges. Although all the financial indexes of the Development Bank reached those as stipulated in the Basel Agreement, the potential financial risks are still grave. The risks exhibited themselves in the long period of ongoing fimd, heavy interest losses and the gradual increase of interest due but unpaid year by year. In addition, the prevailing interest rate differential subsidies are calculated on the basis of the deficit plan which is checked and ratified under the principle of maintaining break-even condition and making scanty profit. But constrained by the financial budget, the plan to check and ratify deficit is so tightly controlled that the subsidies cannot be appropriated and put in ploce as schedualed, thus affecting the business of the policy banks and magnifying their losses.

4. The internal control mechanism of the policy banks is not perfect and their ability to guard off risks is weak.

Experience of foreign countries shows that the internal control of the successful policy financial institutions must be stricter than that of the commercial banks with strong ability in appraising, selecting and supervising projects and perfect internal control. But China tells a different story. Because of various reasons, the perfection of the system, the administration ability and the ability of research and forecast, information gathering and analysis and the overall ability to guard against risks of the policy banks all come below the commercial banks with good performences. The quality of their staff varies much. This cannot be ruled out as one of the important reasons for their business risks.

III. Proposals for nurturing and perfecting the policy financial system in China

For China, a country confronting with urgent demand for economic and social development and an onerous task of restructuring, policy finance shall play an important role in a long period to come. The building up and perfecting of the policy finance shall directly influence the reform of the banking system and the financial system. Therefore, it is imperative to nurture the Chinese policy financial system and to improve the business mechanism of the policy financial institutions.

1. Promulgate related laws as soon as possible to further define the legal status of the policy financial institutions

As mentioned above, before setting up policy financial institutions, countries in the world had all explicitly defined and stipulated the legal status and the business activities of the policy financial institutions through legislation. But in China no law concerning policy bank has been drawn up four years after the establishment of the three banks. The lag in legislation shall not benefit the perfection of the business mechanism of the policy banks, and the creation of a fine external environment for the banks’ business. At present, we should quicken the pace of formulating the ""Regulations on China Agricultural Development Bank"", ""Regulations on National Development Bank"" and ""Regulations on China Import & Export Bank"" and prepare for the formulation of related laws. Such moves shall further define the status, role, rights and functions of the policy banks, standardize their business operations and smooth out their internal and external relations.

2. Smooth out supervision system and modify related rules

The existing management system of the policy banks is the major cause for the constrain of their business mechanism and the growing risks. Putting the business of the policy banks under the control of the central bank shall not help the central bank carry out an independent monetary policy, nor shall it benefit the healthy growth of the policy banks. I propose to hand over the administration of the policy banks to the Ministry of Finance and to include their annual business plan into the ministry’s fund-raising plan in reference to the practice prevailing in foreign countries. On such major matters as the total amount of loans, the orientation of the loans, sources of the fund, the interest rates of the loan and the subsidize interest rates, the Ministry of Finance shall play the leading role in making the decisions by consulting the People’s Bank and other ministries concerned after taking into all factors into consideration. The formation of a board of directors shall also be considered to take charge of making decisions on the major business matters of the policy banks. The board shall be composed by consist of officials from the Ministry of Finance, the People’s Bank, the State Development and Planning Commission and other ministries concerned.

It is both practicle and feasible to put the policy banks under the control of the Ministry of Finance. First, the main function of the central bank is to formulate and implement the monetary policy with the stress of supervision laid on commercial financial institutions. The business of the policy banks falls into the sphere of the government’s firancial business rather than the macro control area of the central bank. In addition, in no foreign countries does the fund of the policy banks come from the capital funds and long-term fund of the central bank. Otherwise, the central bank shall have to be landed in a passive position as it is unable to control the fund needed for special governmental projects. Secondly, the policy banks need a special control system and management measures as they differ from the commercial banks in the sources and employment of fund, in internal management and risk control. But it is not possible for the central bank to set up two sets of management system and method. Thirdly, the handover of the policy banks to the control of the Ministry of Finance shall be conducive to the setting up of a stable interests compensation mechanism. The policy banks are established and owned exclusively by the government to implement its industrial policies and other policies. Therefore, the government shall give compensation to make up for the deficit incurred by the policy banks to maintain their normal operation. But under the present system, the government just passively provides compensation to the poliey banks. As the government finance is not of an active nature, it puts up too many restrictions on the deficit plan of the policy banks, the deficit subsidies are insufficient to cover their actual losses, and the income from the refund of business tax designated for supplementing their capital fund cannot be in place as scheduled.

From the experiences of other countries, none of their policy banks maintains direct or indirect association with the central bank. However, no direct association does not mean no control. The central bank can provide the policy banks with necessary guidance and support through indirect means. It can supply temporary source of fund to help the policy banks to solve their difficulty in fund turnover. Its representatives can join the decision making body or board of directors of the policy banks to strengthen the coordination and cooperation between the central bank and the policy bank.

3. Broaden fund-raising channels to create long stable and low cost source of fund for the policy banks Practices have proved that long stable fund-raising source constitutes the necessary precondition to guarantee the stable development of the business of the policy banks. In view of the special character of the policy banks, their source of fund shall be selected in light of the following principles: A. Their source of fund should not come from the basic currency (基础货币). Otherwise, policy financial institutions shall become the credit creatin bodies and its business shall hare a direct impact on the central bank, making it impossible for the central bank to devise and implcment an independent monetary policy.

B. The fund-raising activities of the policy banks shall not come into competition with the commercial banks as both of them have their respective scope of activities and the business activities of the policy banks are limited and subject to the government protection. The policy banks shall not directly compete with the commercial banks in fund employment, nor shall it in the source of fund. Otherwise, there would be no guarantee for the equity and fairness of market competition.

C. The source of fund of the policy banks shall be in long terms and at low cost. As most of their loans are in long terms and at low cost, their source of fund and the employment of fund shall match these features to prevent their business from withering.

I suggest that, according to the above-mentimed principles, the financing framework of the three policy banks shall be adjusted so as to open new financing channels through postal savings, insurance funds and external debts.

4. Establish and improve an interests compensation mechanism and a system to secure the fund recovery for the policy banks.

First, the existing interests compensation mechanism shall be further improved simultaneously with the effort to adjust the system. Although the state has undertaken the duty to give compensation for discount and the deficit of the policy banks, the compensations are often not given as scheduled and in place. The government do not provide the fund as compensation for dicount directly to the development bank but the compensations to the projects financed by the loans of the bank. In view of the existing maladies, I propose that in the future all the government fund designated for the bank discount shall be earmarked to the National Development Bank as subsides for the differential of interest rate resulting from the application of preferential interest rates to hard loans. At the same time, the government shall return to the policy banks the reimbursements of income tax and business tax to be used as subsidies for the differentice interest rate when the capita funds are in place. The subsidies for deficit shall also be checked and ratified rationally.

Secondly, an effective system to secure the recovery of loans shall be set up. At present, the following two methods can be adopted. (1), granting the policy banks the right to make their own decisions for the operation of the business projects so as to allow them to determine projects in the framework of the state industrial policy and local policies. In this way, they could fully play their role in supervising and managing the projects as the creditor. It should be considered that they could be even granted the rights of the preferred creditor. (2), a local fund-raising and investment system shall be established to intensify the local governments’ support to projects. The practice of the World Bank to link its loans with the credit standing of a nation’s finance should serve us as an example to providing special loan guarantee to the policy banks and other policy financial institutions. Meanwhile, penalties shall be given to the local governments or the departments which exceed the time limit in making repayment of the principal of loans.

Thirdly, the rate for the provision for bad debts shall be raised in view of the high business risk of the policy banks. The high debt cost and low asset quality of the banks deprive them the ability to establish a benign business mechanism and bring them to the risk of unable to pay bond interests and principals. But the present rate for provision of bad debts set at the same level as that of the commercial banks is difficult for the policy banks to be equipped with the ability to fend off the high risk. The rate of retention from the provisions for bad debts shall be increased step by step in line with the enduring ability of the government finance to allow the policy banks to guard against risks.