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China’s incremental moves toward private banks

This has been a particularly tedious gestation period, but may finally see the light of day. Although on a trial basis, China will allow the establishment of private banks.

The decision comes after a few years of customary Chinese caution. In 2010, the idea to encourage private banks was mooted and, in 2012, the China Banking Regulatory Commission started issuing norms for the entry of private capital, on an equal footing, into the banking industry.

This week, regulatory bodies went a step further and asked provincial governments to make detailed plans for the establishment of private banks and take the process forward at the regional level. Following a more decentralised planning approach, provincial departments are in charge of designing and implementing plans for privately-owned Chinese banks.

The strong and urgent demand to establish private banks has come from the industrial belt of East China where thousands of small and micro enterprises remain desperate for funding and credit.

The central government has long urged large banks to support small and medium-sized enterprises, but with minimal results. In the end, it was left with no choice but to support private banks.

State-owned banks routinely ignore the needs of smaller enterprises. Since they do not lack customers and tend to pick up only low-risk, high-profit projects associated with the government, this gives them little incentive to invest in small and medium-sized enterprises that are more vulnerable to default.

Even if some state-owned and state-held banks are willing to provide loans to SMEs, the terms of loans remain punishing. For instance, China Everbright Bank defines SMEs as companies with registered capital of at least 5 million yuan and annual sales in excess of 20 million yuan. This is an exceedingly high limit and, as a result, an overwhelming majority of China’s private businesses do not get access to bank credit and are forced to rely on black market capital, at usurious rates of interest.

In fact, various studies by state agencies indicate that private lending had hit 3.38 trillion yuan nationwide by May 2011, with an average interest rate of 15.6 per cent.

At this juncture, it would be more palatable for the Chinese financial system to give space to private banking. Private lenders would bring underground financial activities out in the open and provide a legal channel for investment and credit. This would also strengthen risk prevention.

Thus, pressure on the government to relax restrictions and support the establishment of private banks has mounted in recent months. By September, at least 27 listed companies or their major shareholders submitted applications to establish private banks, or at least announced their plans to do so. In fact, relevant authorities have approved at least nine names for prospective private banks for trial.

The two most high-profile contenders for private banks are home appliance retailers Suning Commerce Group and Gree Electric Appliances, both listed in Shenzhen stock exchange. The market obviously sees potential in the private banking story, as share value of the two companies have surged up to 80 per cent since the buzz started.

The extensive retail distribution channel of the two companies has given them the confidence to launch banks due to a thorough knowledge of unmet financial requirements of people at the grassroots level.

Also, the lure of high profits in the banking sector is a major attraction for private companies to get into banking. The four biggest state-owned banks were listed as the most profitable companies across industries in China this year. In 2012, the nation’s banks realized combined post-tax profits of 1.51 trillion yuan, an increase of 20.7 per cent year-on-year.

Due to the staid and risk-free nature of Chinese banking, profits come from a steady source. Nearly 65 per cent of the Chinese banking industry’s income comes from net interest margin – which is the difference between interest rates for savings and loans, The net interest margin for Chinese state-owned banks is 3-3.5 per cent, approximately 10 times higher than the international rate, according to the banking regulatory commission.

— The writer is a freelance journalist based in China.