Reforming China's Banking System: How Much Can Foreign Strategic Investment Help?

Type:
SCID Working Paper 276

Author(s):

Published:
04/1/06

Region:
China

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Abstract:
The problems of the Chinese financial system are well documented and the Government has been endeavoring to reform the system, especially the banks, for a decade or more. China’s entry into the World Trade Organization and the associated opening of financial services to unfettered foreign competition has made banking reform an even more urgent priority. Increasingly, the Chinese Government and Chinese banks have turned to strategic partnerships with foreign investors to improve domestic banks’ performance. Foreign participation offers domestic banks the prospect of more effective restructuring, especially of management practices; attractive opportunities for business cooperation; enhancement of their reputations in global and local capital markets; and injections of equity capital. The rapidly growing Chinese financial services markets and distributional advantages of associating with established Chinese banks create prospects for handsome profits for foreign investors. But the problematic situations of many of the larger Chinese banks, with concerns about poor asset quality, dysfunctional corporate governance, and under-developed capacity to manage risk, as well as the unfavorable legal and regulatory environment in which they operate, present a less rosy picture. Nevertheless, on balance, if the Chinese Government acts to mitigate some of the potential obstacles, in particular by establishing a legal system that supports banks more effectively, by limiting official intervention in the activities of the banks, and by ceding more voice to foreign interests in bank operations, foreign investment in China’s banking sector has the potential markedly to improve the performance of China’s financial system.