Jun 27, 2012 01:44 PM

Is the Financial System to Blame?

Starting from the more developed, east coast, banks in China are now experiencing or will soon experience a significant growth of non-performing loans.

I boldly predict that in the coming half year, the Chinese banking industry will encounter the following three problems. First, the overall annual profit growth rate of the banking system will drop by ten percentage points or more due to the effects of non-performing assets on their capital and lending ability. Second, following the emergence of risk on local government fundraising platforms in 2011 and problems in private guarantee and finance institutions in 2012, banks will inevitably run short on desirable clients. This will further exaggerate credit concentration and make banks even more stingy in making loans. Third, China is about to experience credit crunches and deflation just as it did after 1999.

If we again place all the blame on the imperfections of banks' internal management systems, it is possible we are not being fair. That is because our current financing problems have come to be fundamentally the same as those experienced by Western nations during the crisis. It's hard for us to say that Bernard Madoff and other runaway entrepreneurs in the West represent something fundamentally different from what we have here. On an even more pessimistic note, finance reforms alone will not be enough to end the crisis. Even if we continue to roll out new capital supervision regulations, we can expect more crises to come.

So what's the root problem?

First, there are problems in the economic environment.

On the surface, it would seem that inherent weaknesses in corporate joint-guaranteed loans and private small and medium-sized enterprises that are to blame. But if we look deeper, we find that the risk is caused by unpredictable economic prospects and financing costs. To put it more precisely, by disbursing 7.8 trillion yuan in loans during the first half of 2009 as a response to the downturn, we sealed our fate of having to pay the price for a decade to follow. Systemic risks are the cost.

There was clear evidence that non-performing assets were either already on the books or soon to arrive at banking institutions everywhere, from the state-owned banks such as Bank of China and the China Construction Bank, to the joint-stock banks including Pudong Development Bank and the Guangdong Development Bank, from urban commercial banks to rural credit cooperatives, even from commercial banks to trusts. If every single institution without exception experienced worsening operations, we would be deceiving ourselves to lay the blame on malfunctioning internal controls of one or two institutions alone.

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