Walter Hutchens’ Blog

China Construction Bank, the Bank of China and now ICBC have successfully listed in Hong Kong (and in ICBC’s case, also in Shanghai).

The shares of each bank are trading above the issuance price. For those that got in early, grabbing shares in mainland China’s listed banks has so far been a great move.

Is this a sign that China has successfully restructured its financial sector, deftly steering around what many regarded as a critical weak spot in its transformation? Or is this irrational exuberance? Will these banks perform well over time?

On the one hand, China has done a lot to restructure these banks. They’ve made them into companies and given them boards with outside directors, including representatives of foreign strategic investors (leading global financial institutions); pumped billions of new capital into them; taken billions of bad loans off their books; installed new computer control systems; and now subjected them to the discipline of the listing process and consequently future monitoring by overseas analysts, regulators and investors. More generally, these banks are huge players in one of the world’s biggest, most stable and fastest growing economies. There’s a lot to like here.

On the other hand, there are reasons to be cautious about the longer term. There are at least two clusters of underlying concerns:

1) Will the overhaul of the banks “take?” Will the new controls work? In essence, will the trappings of privatization be just that?

2) Will the formal separation of the government from these enterprises sufficiently matter? The banks now have independent legal personality—zheng qi fen kai, a well-worn slogan—but the PRC government remains the overlord of these banks. Will the government act like a controlling shareholder seeking to maximize the value of its shares (with interests thereby aligned with other shareholders) or will it act like a government with broader policy, political or personal agendas (which might not be aligned with those of shareholders)? In particular, will the Party that controls the government that controls the banks do things that are good for public shareholders? The Party may be communist in name only, but it is Leninist (authoritarian) to its core—it aims for stability and development (good for business) but it also intends to maintain its monopoly on political power (often in ways people from liberal democracies find repulsive) and thus is subject to the opacity, distortions and factionalism typical of Leninist parties (these are issues in all political systems, but China’s may have less capacity to deal with them because it lacks a truly free press, elections, independent courts and strong civil society). China wouldn’t be better off with a democracy like the one my country has “given” Iraq, but even if you don’t favor a destabilizing regime change in China (and I certainly don’t), it is a fact that China’s current political arrangements have costs as well as benefits. Specifically, for instance, Huijin, the entity that owns most of the shares in these listed banks on behalf of the PRC government, holds shares in all these listed banks. Thus it might not seek to unleash the competitive forces that discipline foreign banks. Would you get Citibank vs Chase or Morgan Stanley vs Goldman Sachs if a single entity owned all of them? It seems that the creative destruction of markets is in dynamic tension with the imperatives for political monopoly and stability that drive the CCP. Too much instability in China will be bad for investors; but too much control could be, too.

These concerns are highlighted by comments and analysis in this good FT article reprinted in The Australian. It notes:

It was only two years ago that bad loans at ICBC represented 21 percent of the portfolio. Only gigantic re-capitalizations and loan write-offs by the state have enabled the large banks to become solvent.

. . . Investors are betting that banks’ internal risk management culture and systems have, overnight, become sophisticated enough to stop poor lending or downright fraud.

In the words of Hong Kong governance activist David Webb, China has taken out the bad loans but has it taken out the bad lenders?

. . .

While the banks have indeed been listed, the state retains about 80 per cent of the stock in each company. Will the state be a passive or active investor?

The Government wants banks to cool lending to prevent over-investment. But what if the banks have a commercial desire to create shareholder value by expanding lending?

The article also notes that criminal malfeasance, i.e., looting, has been a problem in China’s banks.

All this will lead some to think that the people who have made paper windfalls by buying into PRC banks early can best realize those profits by also selling early. At the very least, it will be prudent to hedge and diversify (as the early institutional investors no doubt have).

Incidentally, I don’t read The Australian every day. I found this piece through Google Alerts, a free service that culls stories based on search terms and emails them to me. I often find—and have noticed other bloggers sometimes find—interesting items this way, frequently from sources like English papers in India that I’d otherwise overlook. Google’s net isn’t cast wide enough to be one’s only clipping service (they don’t harvest stuff from some key sources), but it’s a helpful tool to have in the mix.

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