By Wei Jianing 　

In the reform of the past 20 years, the lag in the banking reform left the banks a considerable amount of bad assets which were accumulated when the banks replaced the government finance as the wickets of releasing the government fund. From 1992 to 1993 in particular, the economic overheating goaded the bond and security market and the property market to inflate like bubbles and bad bank assets to rocket. The bad assets could go into latency by repaying old debts with new borrowings while the money market was still expanding. However, they will come to the light once credit deflates. According to figures of the People’s Bank of China, bad assets of China's banking system have amounted to roughly 25 percent of GNP with unrecoverable bad debts making up about 8 percent of GNP. The accumulation of a large quantity of bad assets not only hinders normal bank deposit and lending business, but also poses a grave threat to the stable development of the national economy. First of all it will create among domestic and foreign investors ill expectations on China’s investment environment and prospects for economic growth. It will damp their enthusiasm for investment, leading to an economic slowdown which will cut the government tax revenue, forcing the government to raise taxes and tax collection intensity. The continuation of such a trend will produce a vicious cycle of economic downturn. To prevent such an economic disaster it is necessary to resolutely get rid of the bad bank assets. In view of the grave accumulation of the large quantity of bad assets in Chinese banks the State Council decided at the beginning of the year to set up asset management corporations to restructure the assets of the state-owned banks (see appendix: Asset Management Corporations for Ridding of Bad Bank Assets). Our investigation and study show that the following questions call for attention in order to ensure fulfill-ment of the job assigned to the asset management corporations.

I. Stick to the principle of treating the problem by looking into both its symptoms and root cause

The amount of the bad assets is enormous, whereas the resource-the financial revenue that can be, used to tackle them, is relatively meagre. But with the growing national strength built up in the process of the reform and opening up, it is entirely possible for us to deal with the bad assets by writing them off after verification and putting new investment into the banks'assets. The question lies in the fact that in the final analysis, the bad bank assets were generated by the inefficient system of the state-owned enterprises (SOE) and banks. As now we are in the process of the shift from the planned economy toward a market economy, the aim and behavior of the banks and SOEs fall far short of those of the enterprises operating in the market economy. Moreover, the defects in the legal system and the intensity of law-enforcement further aggravate the problem. So long as these problems are still in place, new bad assets will re-emerge after the old bad assets have been cleaned up at tremendous cost, landing the authorities in a passive situation. Such a circumstance determines that the cleaning up operation must be carried out through curing both its symptoms and the root cause, with the emphasis laid on the root cause. In another word, the operation should focus its attention on the prevention of the emergence of new bad assets, combine the cleaning up drive with the reform of establishing a modern enterprise system and commercializing the banks. In the operation, restrictions on the finance and budget of industrial and commercial enterprises and banks should be reinforced and their business mechanism must be transformed. The asset management corporations should aim at recovering the value of bad assets to the largest possible extent so that they can effectively deal with the existing bad bank assets. Different from the ordinary commercial banks in functions and business operations, the corporations focus more on the asset sales like the investment banks, on debt restructuring and enterprise regrouping. They will also engage in turning the debts into shares and holding shares for a certain period, shifting the assets into bonds and equities, managing consultation and participating in the supervision and management of enterprises. It should be stressed that in achieving these objectives, the corporations must strive to prompt industrial and commercial enterprises and state-owned banks to effectively put their management structure in order, strengthen their business management and improve the quality of their assets on the basis of reforming the asset ownership system.

II. To do a good job in determining the bad assets and prevent the practice of taking the opportunity to evade and abrogate debt obligations

To prevent bad morality in risking debt evasion and abrogation in the handling of bad assets and to ensure the objectivenees and scientific approach in determining bad assets, bad bank assets should not be determined by commercial banks themselves nor by the central bank which has the responsibility of supervision. They should be defined and determined by objective, neutral and authoritative credit rating bodies or other intermediate organizations. The determination of bad assets and credit rating should become the regular system which serves to strengthen external supervision over enterprises and facilitate the prevention and early warning against financial risks. When determining bad bank assets, the amount and composition of bad assets, the causes for their formation and the persons chiefly responsible for them must be verified and dealt with according to different circumstances. Minor errors should be recorded in the dossier of the responsible persons, and, in the case of serious offenders, the administrative and legal responsibilities must be looked into. No matter who should share and bear the losses, the relevant plan should not be made public too early. It should be determined by all parties concerned after consultations or by the market in order to avoid artificially minimizing or magnifying the scale of bad assets as a result of ill expectations.

III. Adopt various ways to tackle bad bank assets in accordance with different circumstances

Bad bank assets were tackled in the past few years largely through government-presided bankruptcy and amalgamation of enterprises. A progress compared with the "blood transfusion" into the ill-managed enterprises or those having no value for existence, but this approach cannot prevent debt evasion and abrogation when they are backed by bodies in charge of the enterprises concerned, thus bringing about excessive losses of bank assets. Moreover, the move to auction the bad assets or to write them off after verification is beyond the bearing ability of the state finance. Under the circumstances, the turning of the creditor’s rights of the bank to the bad assets into the stockholder’s equity to the shares of the indebted enterprises may provide an option which can preserve to a large extent bank assets and enable both banks and enterprises to survive. Generally speaking, indebted enterprises can be classified into the following types: enterprises with grave problems in both net assets accumulated in history and their current operations. This type of enterprises should be declared bankrupt, their assets cleared up and the creditor’s rights canceled after verification. The second-type enterprises are those incurring losses in their current operations but still having positive assets. If they apply for bankruptcy, they should be suspected of the evil intention of evading debt obligations. The last type of enterprises fare not bad and hold promise for development, but are tormented by heavy debt burden and financial problems. They are most eligible for turning their debts into shares. Asset management corporations should employ varied ways to tackle the bad bank assets when they take over according to different circumstances. Which enterprise that is eligible for the method of turning debts into shares should be determined by state asset management authorities and asset management corporations rather than by government administrative bodies. Now, many SOEs are facing the problem of choosing the proper way for their shutting down in stead of keeping their operation going, because the decisions to build such projects were the product of the official will without commercial expounding. Now, we should rectify the past mistakes and decide the way out for the enterprises in accordance with the principle of the market economy. The shift of debts to shares means that banks and enterprises will share the responsibility for asset losses.

Compared with bankruptcy and amalgamation, it poses higher requirements to both enterprises and asset management corporations. It means that the latter, as the shareholder, must urge enterprises to change their business mechanism with their soft budget restraints replaced by hard budget restraints. Nevertheless, a fairly complete legal system and judicial environment constitutes the needed precondition for the normal operation of the asset management corporations. Corresponding changes should be made as soon as possible on existing regulations which are not applicable to the asset management corporations in dealing with bad assets. For example, the commercial bank law prohibits commercial banks to invest in enterprises. In this case, the law should be revised and limitation on the investment ratio should be defined.

IV. Carry out bank reform in earnest and ward off a re-emergence of bad assets

Now the state-owned banks still occupy the dominant position. The great amount of residents’ savings keep them away from a payment crisis in the near future, but the danger of lower asset quality engendered from poor efficiency in their business mechanism should not be taken lightly. The key to solve the problem lies in the thorough reform of the business system in the large state-owned commercial banks and the development of medium and small non-state owned financial institutions to frame a sound banking system.

1. Set up a modern banking system in large state-owned commercial banks

At present, China’s state-owned banks have yet to set up a market system to meet the demand of the market economy. Now the large state-owned banks grudge granting loans as they focus on the preservation of their capital. Superficially, this practice might seem to be a progress than their past irresponsible and discretional lending, but in nature, it reflects the same problem. That is, banks are still to a large extent subordinate to leading administrative bodies and have not become independent enterprises. They therefore are bereft of the basic functions of commercial banks, that is, to optimize the deployment of their capital through raising fund for projects of high economic efficiency. When the leading administrative authorities emphasize the banks' responsibility for lending safety, the banks would put the preservation of their capital as the fundamental objective of their business. They will not strive to heighten their risk control ability by looking for appropriate lending objects, and refrain from lending if the borrowers are unable to use their assets as mortgage, or request credit guarantee companies to provide full guarantee including that on the interests. Once the leading authorities ask the banks to contribute to expanding domestic demand and pushing up economic growth through lending activities, they would readily fall into the rut of indiscriminate lending. In the market economy, the banks should be encouraged to engage in lending activities which contain some risk. We must carry out reform to vest the banks with motives to seek profit through increasing lending, and enhance their awareness and ability to guard against financial risks. Only through this way can they become true commercial banks at an early date. First, state-owned commercial banks should be transformed into corporations and pushed onto the market. This will help them to diminish their existing bad assets and establish modern enterprise system so that they can become commercial banks in the true sense. Before they are transformed into corporations, their bad assets should be transferred to asset management corporations and then using part of the fund recalled from the market to offset the bad assets. Such a move can cut down the financial input by the state when tackling the bad assets. In the course of transforming the state-owned banks, part of their shares should be sold to non state-owned undertakings and individuals to promote pluralistic participation and increase the transparency of the enterprises operation. This move will benefit the banks in setting up an effective corporate governing structure to prevent occurrence of new bad assets.

Second, we should adhere to the guideline of opening up.

While gradually raising the competitiveness of the domestic banks, we should steadily enable foreign banks to widen their business scope of running RMB currency, introdu a brand new business mode and effective competition. This will give impetus to the reform of Chinese banks and create a situation in which reform and opening up promote each other. 2. Develop non state-owned financial undertakings for medium and small enterprises Now in China the deposit and lending business of the banks concentrates in a small number of big state-owned banks, leaving quite big risks to the state. At the same time, there are only few medium and small financial institutions of poor quality which would be able to meet the demand of medium and small enterprises, causing difficulty in fund-raising by these enterprises. This is a prominent problem facing China’s banking system. Business of lending to medium and small enterprises usually involves big volume of work but small amount of fund and high operation cost. Large banks often fail to adapt themselves to these particularities. In many countries, small financial bodies with a flexible system and compact structure, which can disperse risks, are vested with the special functions of raising fund for medium and small enterprises. Under the circumstances, China must vigorously develop medium and small financial organizations. In the recent past, many such non state-owned bodies were under disorder in management and accumulated bad assets. As a result, a large numbers of them went bankrupt in some of the areas, causing many depositors to lose all their principal funds. It is entirely necessary to straighten out and reorganize these financial bodies. But we should point out the causes for the grave problems in these organizations: A. Such financial institutions are often the "backyard enterprises" of local governments or administrative authorities which master the power of examining and approving the setting up of such bodies or have other background. They serve as the ready source for the authorities to accumulate wealth by unfair means. B. Due to the shielding and connivance from power authorities, the supervision over these financial institutions becomes nominal. Nationally, apart from these problem-ridden financial bodies, there also exist some earnest and efficient models which have played a good part in promoting the development of the local economy. In the drive of straightening up and reorganization, we should guard against coping with all the problems in the same way in disregard of the circumstances. We should support the standardized urban credit cooperatives and other non state-owned medium and small financial institutions. In opening the Chinese financial market, we should not only permit major foreign-owned banks to run business in China, but also consider allowing a group of powerful financial institutions from Hong Kong, Macao and Taiwan or those owned by overseas Chinese to buy shares or the medium and small financial bodies whose business mechanism is not at all perfect. This can help reduce the impact on China’s state-owned large financial institutions brought about by foreign financial organizations, as well as to disperse the burden of guarding off financial risks.

V. Activate capital stock of banks and promote the rearrangement of state-owned economy and enterprise reform

As Chinese banks are the major creditors of state-owned industrial and commercial enterprises, the restructuring of bad assets provides a good opportunity to promote the SOE reform and the rearrangement of the state-owned economy. The practice to turn the debts into shares allows the asset management corporations to become the shareholders of indebted enterprises in a certain period. Special departments must be set up in the asset management corporations to guarantee the effectiveness of the restructured enterprises and the improvement of enterprise operation. They should be capable of managing the industrial and commercial business and granted with the power and responsibility to supervise and guide the enterprises through the board of directors. Now, large numbers of laid off SOE workers are looking for reemployment, while a great quantity of bad bank assets need to be restructured. In some countries, the bad bank assets are sold to small investors at discounted prices. If we follow this practice by selling bad assets to laid off workers at preferential prices to help them set up their own undertakings, the state, banks, enterprises and the workers will be benefited one and all. In addition, we can also carry out plans like "let everybody have his own house" and "let all business persons have their own shops" to broaden the market space for digesting the bad assets and bring about a prosperous national economy.

Appendix: Asset Management Corporations for Ridding of Bad Bank Assets

Since the 80s, global bank crises triggered off by huge bad bank assets have happened more than once. In these crises, countries affected usually set asset management corporations to deal with the bad assets. The corporations are independent of commercial banks and specialized in dealing with the bad assets. They employ two modes to conduct their business. One is to deal with the assets en bloc. Corporations using this mode are usually managed directly by the government and supervised by the central bank or the parliament. They check and cancel the asset losses of the banks in a one-off operation and replenish bank principal capital by making use of financial resources. This move can quickly contain the spread of the crises, but is restrained by two factors. One is the amount of the financial resources which can be employed, and the other is the fostering of the banks’ dependence on the government and the risk to their business ethics which could delay the improvement of the their business mechanism. The other mode is the mode of diversity, by which asset management corporations will be set up as a specialized body in the banks and the government gives them indirect support through providing fund-raising guarantee, sharing capital losses and cancel bad assets after verification by stages. In the process of recovering debts, the corporations can supervise the indebted enterprises and help them with short-term funds. This will help enterprises restructure themselves under the protection of bankruptcy and improve their business under the creditors’ supervision through debt rescheduling. The possible sources of the fund in tackling the bad assets include: (1).The government cancels bad assets with cash, uses treasury bonds to replace bad assets or compensates asset losses with deposit insurance fund. (2). The banks offset the bad assets with their future profit by increasing lending and absorbing deposits to supplement their circulating fund. (3). To turn the bad assets into bonds and securities through auctioning the debts, or lower the banks real interest rates by employing inflation and devalue their debts. (4). To obtain loans from the World Bank or other international financial institutions and sell the bad assets to overseas private investors.

"Reform and Development of SOEs" Research Group

Development Research Center, the State Council

Group leaders: Chen Qingtai, Wu Jinglian

Coordinator: Xie Fuzhan

Author: Wei Jianing