The Chinese Banking System:Structure, Potential Risks, and Reforms

Professor Jun Qian (QJ)Fanhai International School of Finance, Fudan University

July 22, 2020Peterson Institute Online Forum

Outlinel Structure of the Chinese banking system: a three-tier system

l Comparing the largest banks around the globel Different features of ownership and governance of banksl Case study of Baoshang Bank

l The growth of fintech lending:l Examples of “ecosystems” of fintech platforms with multiple functionsl What is special about fintech lending in China?

l Shadow banking sector: l Growth of banks’ wealth management products (WMPs)l Restructuring of the shadow banking sector

Total Social Fundraising and GDP Growth (2006-2019)

Sources: PBoC, WIND

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Undiscounted BA Bank Loans Trust Loans BondEquity ABS Others Real GDP Growth(%)

Trillion RMB

lA three-tier structure:Ø “Big Four” banks (ICBC, BOC, CCB, and ABC), plus Bank of Communications and the

Postal Savings Bank; among the largest banks in the world; and policy banks

Ø Stockholding banks (most of these are listed): e.g., China Merchants Bank （招商银行）

Ø Regional, small & medium sized banks (SMBs); credit cooperatives; non-bank inst

Ø Support old growth model: absorbing social savings => (low cost) loans (investment) to key industries

lKey reforms in the recent two decades: IPOs of state-owned banksØ See, e.g., Allen, Gu and Qian (2017), for more details

lBanks’ business and risks: on- and off-balance sheet activitiesØ China’s shadow banking: formation, growth, roles and risks

Overview of China’s Banking System

Largest Banks in the World (assets) (Source: Bloomberg, latest filings as of Dec. 2019)

Rank Bank Name HQ Country Total Assets ($trillion)

1 IND & COMM BK OF CHINA China 4.32

2 CHINA CONSTRUCTION BANK China 3.65

3 AGRICULTURAL BANK OF CHINA China 3.57

4 BANK OF CHINA LTD China 3.26

5 MITSUBISHI UFJ FINANCIAL GRO Japan 3.07

6 HSBC HOLDINGS PLC United Kingdom 2.72

7 JPMORGAN CHASE & CO United States 2.69

8 BANK OF AMERICA CORP United States 2.43

9 BNP PARIBAS France 2.16

10 CITIGROUP INC United States 1.95

Largest Banks in the World (market cap)(Source: Bloomberg, latest filings as of Dec. 2019)

Rank Bank Name HQ Country Market Cap ($billion)

1 JPMORGAN CHASE & CO United States 429.91

2 BANK OF AMERICA CORP United States 311.21

3 IND & COMM BK OF CHINA China 294.12

4 WELLS FARGO & CO United States 222.43

5 CHINA CONSTRUCTION BANK China 217.70

6 AGRICULTURAL BANK OF CHINA China 182.40

7 CITIGROUP INC United States 168.90

8 HSBC HOLDINGS PLC United Kingdom 161.26

9 BANK OF CHINA LTD China 147.24

10 ROYAL BANK OF CANADA Canada 113.26

Largest Banks in the World: ROA in 2019

Source: Wind

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3.00%

3.50%

IND &

COMM BANK OF C

HINA

CHINA CONSTRUCTIO

N BANK

AGRICULTURAL BANK OF CHIN

A

BANK OF CHINA

MITSUBISHI U

FJ FIN

ANCIAL G

RO

JPMORGAN CHASE

HSBC H

OLDINGS

BANK OF AMERIC

A

CITI GROUP

Data Source: WIND

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0.90

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1.10

2019-12-31 2020-01-31 2020-02-29 2020-03-31 2020-04-30 2020-05-31 2020-06-30

Top 10 Banks’ (by Total Assets) Stock Performance 2019.12.31 to 2020.07.16

IND & COMM BK OF CHINA-A

CHINA CONSTRUCTION BANK-A

AGRICULTURAL BANK OF CHINA-A

BANK OF CHINA LTD-A

MITSUBISHI UFJ FINANCIAL GRO

JPMORGAN CHASE & CO

HSBC HOLDINGS PLC

BNP PARIBAS

BANK OF AMERICA CORP

CITIGROUP INC

IICCBBCC’’ss OOwwnneerrsshhiipp SSttrruuccttuurree ((aass ooff MMaarr..3311tthh,, 22002200))

Huijin, 34.99%

MOF, 31.14%

SSF, 5.89%

Ping An, 4.44%Temasek, 2.05%

CSF, 0.68%

Other H Shareholders,

16.46%

Other A Shareholders, 4.35%

Data Source: WIND

CChhiinnaa MMeerrcchhaannttss BBaannkk’’ss OOwwnneerrsshhiipp SSttrruuccttuurree ((aass ooff MMaarr..3311tthh,, 22002200))

China Merchants Steam Navigation Company (Central

SOE), 13.04%China Ocean Shipping

Company (Central SOE), 6.24%

Hexie, 4.99%

Anbang, 4.99%

Shenzhen Yanqing, 4.99%

Shenzhen Zhaorong, 4.55%

Shenzhen Chuyuan, 3.74%CSF, 2.99%

Other H Shareholders,

18.20%

Other A Shareholders, 36.27%

Data Source: WIND

lRole of government ownership stakes:Ø For profit goals and non-profit goals, including financial stability of the financial system

and implementation of macro-prudential policies

lRole of foreign institutional investors:Ø Improving operating efficiency and shareholder governance (serving on the board)

lWhat is the optimal structure of the banking sector:Ø For emerging markets, the optimal structure should perhaps include both public/state

large and private/smaller banks; or including government ownership stakes in some large institutions

Ø Competition and comparison among these banks can ensure public banks are efficiently run, and private banks do not take too much risk

Ø See Allen, Qian, Shan and Zhao (2011) for more details

Ownership and Governance of Large Banks

lTaken over by CBRC on May 24, 2019:o Due to its credit risk, China Banking Regulatory Commission (CBRC) decided to

take over for one year, starting May 24, 2019

o On Apr. 30, 2020, Mengshan Bank（蒙商银行） was founded, and took all the assets and liabilities of Baoshang Bank in the region of Inner Mongolia

l Factors leading up to the failure of Baoshang Bank:o Capital was occupied/tunneled by it’s (ultimate) controlling shareholder

o Poor quality of assets: low capital adequacy ratios and provision coverage; lack ofhigh-quality of major loan customers

o Problematic regional economic development : low GDP growth rates; high leverage of local government; net outflow of population

Case Study: Baoshang Bank (包商银行)

lOther banks that got in trouble:o Hainan Development Bank: took over by ICBC in 1998o Bank of Jinzhou (锦州银行, in Liaoning Province): reformed and

restructured in 2019o Some credit cooperatives went bankrupt due to different reasons

lRegional banks’ activities and capital flows typically concentratein a few cities/one or two regions:o Thus no strong contagion risks.

Case Study (cont’d): Baoshang Bank

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2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

USAJapanIndiaChina

%

Data Source: World Bank

Performance of Listed Banks in China: NPLs (over GDP) and ROA(Dec 2008 to Dec 2020Q1)

Data Source: WIND

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0.80%

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2008

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NPLs/GDP ROA (Right Axis)

Digital Economy and Financial Services: China’s Business Model

Source: Goldman Sachs ( 2018)

Case Study: Ant (Financial) Technology

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§History …

§Ownership

What is special about platform lending?

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n Fintech vs. traditional banking：

n Informational advantages

n Platforms as cheap distribution channel

n Platform recycles funds (“closed loop”)

n Enforcement mechanisms

SalesPerformance

ServiceQuality

CreditHistory

Non-salesPerformance

Credit Usage

OwnerCharacters

l A broad definition of ‘shadow banking’:l All investment products off-the-balance sheet of (deposit-taking) banks

l Theoretical work on the role of shadow banking: Wang et al., (2016)—can be welfare enhancing

l Wealth management products (WMPs) issued by banks:l Acharya, Qian, Su and Yang (2019): understand the growth and risks of the WMPs

l Loans issued by non-bank institutions:l Chen, Ren and Zha (2018): monetary policies & issuance of entrusted loans; Allen, Qian, Tu and Yu (2018):

Properties of entrusted loans; Du, Li and Wang (2016): Non-financial firms as financial intermediaries

l Trust industry: Product level analysis: Allen, Gu, Qian and Qian (2018)

l Other credit/lending channels:

l Informal/private credit agencies: Allen, Qian and Xie (2019); Internet platforms (P2P, crowd-funding)

Related Work on China’s Shadow Banking

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Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15

New Bank Loan as a Percentage of 2004 GDP

New Bank Loan/2004 GDP GDP (trillion RMB)

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4 trillion stimulus

Banks’ Wealth Management Products: Principal-floating WMPs/Netassets (Acharya, Qian, Su, and Yang, 2019; largest 25 banks; 2008-2014)

l After a series of reforms, large Chinese banks have become stalwarts of the financial system

l On-balance sheet activities: NPLs under controll Off-balance sheet activities: fast growth since the stimulus;

rollover risks; l Reforming the banking and shadow banking sectors:

Ø Liberalization of interest rates, Ø Downsizing of the risky part of the shadow banking sector Ø New regulations on asset managementØ Banks’ establishment of new asset/wealth management companies

Summary: Banks and Financial Institutions

Thank You