Banking Sector Current Condition in China - Essay Example

of the of the Table of Contents Introduction …………………………………………………………………….3 Banking sectorcurrent condition ………………………………………………3 Need for reform …………………………………………………………………4 Understanding issue using AS-AD model ……………………………………..5 State-owned bank & pol-economy …………………………………………….6 Dichotomy in Chinese banking system ………………………………………..7 Banking & forex ……………………………………………………………….9 Review Loans: step for reform ………………………………………………10 References Appendix Introduction China economic condition has become a subject of economists discourse as its central bank decided to refrained from circulating funds to fuel blood to its market operation, thus, sagging bit the inter-bank funding costs. Such happened after the People’s Bank of China (PBOC) permeated 36 billion yuan (or HK$45.2 billion) to be fed to its banking system via bills and forward bond repurchase agreements which motivated short term loans in the market that was scaled up last month (Reuters, 2013, p. 1; The Economist, 2013, p. 1). Banking sector current condition While they are hopeful that the money market rates will be normalized by July, but economists began to note that the bond repurchase in seven days slumped to 69 bps to 4.76 % since June, the zenith period for liquidity squeeze (Reuters, 2013, p. 1). The overnight repossession rate dropped 63 bps to 3.79 % and the 14-day rate lurched nearly 100 bps to 5.09% based on reports (Reuters, 2013, p. 1; The Economist, 2013, p. 1). Reports bared that Chinese government permitted the short-term borrowing to reach 30% that could risk banks fiscal condition notwithstanding reassurance from lawmakers of such ample liquid cash within its financial system to silence concern of domestic economists that lending will further slump a slowing economy (Reuters, 2013, p. 1; The Economist, 2013, p. 1). Economists recorded that banking shares in Shanghai sank lower albeit the traders discourse about positive impact of lending to small business entrepreneurs and to agriculture by 12 billion yuan (Reuters, 2013, p. 1; The Economist, 2013, p. 1). Critics pointed that China lacked the capacity exercise the standard monetary policy and governance pointing the lack of better stimulus packages that is best exercised by the Japanese government (The Economist, 2013, p. 1). It is most poised for deleveraging its system noting how its credit system grows expediently than its annual growth domestic product (GDP) (The Economist, 2013, p. 1). The total social financing lowered its ratio hence, affecting its interbank fiscal condition with the cash at critical situation. Need for reform Some critics recommended that structural reform should be undertaken for Chinese banking system, suggesting the need to undertake initiatives to liberalize the interest rates and to raising prices of utilities. The problem is further exacerbated by the heavy public spending and tax cuts (Dobson & Kashyap, 2006, pp. 103-108). Its economy is likewise heavily dependent on exports and its government needs to grapple with its high level economic issues with its neighbours and with countries with which they have trading relations (Dobson et al., 2006, pp. 103-108). The credit ratio of the country also scaled up, higher than what they have from its monetary conditions in the past. While it’s admitted that increasing credits for domestic entrepreneurs of China could help improve the resource needs of these small businesses but the returns remained undertrained, and so is the payment (Dobson et al., 2006, pp. 103-108). It is not likewise certain if these entrepreneurs possessed such credit worthiness that would warrant fast and expedient repayment of loans and interests, especially so that most of those engaged on business in China are less transparent of their financial standing or are secretive of their business operations (Dobson et al., 2006, pp. 103-108; Akerlof & Romer, 1993, pp. 1-73; Anderson, 2006, pp. 1-5). This indeed has serious implications to the macroeconomic and microeconomic standing of the country too (Dobson et al., 2006, pp. 103-108). Understanding issue using AS-AD model From the theoretical vantage of the AD-AS model, monetary policy is one of the macroeconomic tools to control aggregate economy and is governed by the central bank of Chinese government. It has a major influence in the economy by the amount of the supply of money and the availability of funds through credit institution (Gali, 2008, pp. 1-78) . It differ to fiscal policy in a sense that such refer to the power of the government to control its flow. Two of the effects of monetary policy on macro policy model are the shift of the AD curve to the right when it’s shifted by expansionary monetary policy and when the AD curve to the left to indicate the shift brought about by contractionary policy shift (Gali, 2008, p. 1-78). Expert posited that the effect of the monetary policy on the AD/AS model are expressed by the equilibrium income and the price level that are obviously reliant on the inflationary pressures at a given situation (Gali, 2008, p. 1-78). The other effect could also be viewed on how the economy levels to the potential income. At the macro level, the effect of monetary policy are demonstrated if the expansionary monetary policy increases the nominal income and the real income correlates to how price levels responded (Gali, 2008, p. 1-78). Economist explained that in Keynesian range, the real income will rise with the expansionary monetary policy and decline with contradictory monetary policy (Gali, 2008, p. 1-78). Albeit the situation, the level of prices remained unaffected (Gali, 2008, p. 1-78). State-owned bank & pol-economy Unlike other countries where central bank operates independently outside the structure of the government, China’s bank is obviously under the control of its state (Asian Development Bank, 2006, pp. 117). The relation of its structure to the governing leaders, on how they manage the monetary and fiscal resources, will certainly affect stability of price of the prime commodities and its potential inflation rates (Saxon, 2007, p. 81). Of course, it has also direct correlation on the design and implementation of the monetary policy viz the international considerations (Saxon, 2007, p. 81). Such will certainly determine the strength of yen in the foreign exchange rates in economic trading (Saxon, 2007, p. 81). Economists defined exchange rate as the expression of the currency of a state and its value against the dollar (Saxon, 2007, p. 81). The exchange rate is essential because international trade is a significant part of the economic relations of China. In relation thereto, the monetary policy of Chinese government will also influence the international trade relation through the changes and exchanges of the supply of money (Saxon, 2007, p. 81). Theoretically, those exchange rates depended on how much of the Chinese money is set for circulation and ergo, the monetary policy of China cannot be laid without considering the international issues and risks (Saxon, 2007, p. 81). As such, it is therefore the duty of both the Chinese government and its bank to enforce protective monetary policy; deliver its services, issue bank notes and administer well their public debt because all these influence the supply and circulation of money and credit in its economy (Dobson et al., 2006, pp. 103-108). It must also look into how its government regulate and supervise its financial institutions and provide banking services to its government. Decision-making on the disposition of resources viz its monetary policy should be made wisely and with knowledge of the potential risks and market vulnerability (Dobson et al., 2006, pp. 103-108). Very crucial in this present situation is the fluctuation of overnight financing rates and the cash management operations because this control and manages the electronic funds every day and also determine if there are surplus values or balances that can be maximized for loans and credit for those situated in financial deficits overnight. Banking experts contended that this changes in the overnight financing rate also affect the contractual terms of the structure of interest rates and its yields (in time for maturity). Dichotomy in Chinese banking system At the outset, China’s banking system (Allen,Qian, & Qian, 2006, p. 24) can best be understood by undertaking significant changes owing the influence of western financial institution and hence, the system is being dichotomized as banking remained controlled by the state or the government but is influenced by the western practices. In the previous years, China’s banking system limited their expansion in undeveloped western areas of the country to accordingly protect local banks in from bank law liberalization in 2006 (Saxon, 2007, p. 81). This development led to strong competition in banking, insurance, and industries owned by Chinese and of superpower foreign companies that are great at leveraging in market conditions. The Chinese state wasn’t just as ready as that when it decided to embrace a liberalized economy and banking system. To reckon, China’s central bank, the People’s Bank of China (PBOC) was tasked to regulate the commercial banks operation covering four state-owned banks: 1. The Bank of China (BOC) which specialized in foreign exchange relations and trade financing with 59% share of China’s trade-finance business (Saxon, 2007, p. 82); 2. The China Construction Bank (CCB) that accord infrastructural financing for projects and urban house developments (Saxon, 2007, p. 82); 3. The Agriculture Bank of China (ABC) that offer financing to agriculture sector, including those engaged in retain banking services to farmers, township and village enterprises (TVEs) as well as, those rural institutions (Saxon, 2007, p. 82); 4. The Industrial and Commerce Bank of China (ICBC) as provider of financing for urban and manufacturing developments (Saxon, 2007, p. 82). 5. The smaller banks that comprised Bank of Communication, China Everbright Bank, CITIC Industrial Bank, Shanghai Pudong Development Bank, Shenzhen Development Bank, Guangdong Development Bank, Minsheing Bank and Hua Xia Bank. Those considered as the second-tier banks are healthier in asset and profit management with lower non-performing loan ratios. They were encouraged to operate with diversified portfolios and personal credit rating system to advance its consumer credit industry (Saxon, 2007, p. 83). They were also encouraged to raised capital by maximizing bonds or stock issues. In maximizing the banking industry, the Chinese central government allocate the foreign exchange for their approved import but they also bridge relation with for financial support from Export-Import Bank of the United States (Ex-Im Bank), an independent financial agency that supports the US-based exporters for offshore markets (Saxon, 2007, p. 84). It also guaranteed repayment of loans and made loans to international purchasers of US goods and services as well as extended export credit insurance to exporters to protect them from vulnerability of non-repayment for political and commercial causes (Saxon, 2007, p. 84). Banking & forex China also regulated the conversion and transfer of foreign exchange policies and to all foreign-invested enterprises (FIEs) while large state-owned enterprises (SOEs) receive primarily the biggest chunk of commercial bank lending and of local financing (Saxon, 2007, p. 84). The foreign enterprise operating within the mainland and those that are requiring working capital, either in forex or local currency attained short-term loans from state-owned commercial banks (Saxon, 2007, p. 84). While relative financial stability was attained in some banks, here are still those who need to improve their banking management, customer relation, transactional relations and corporate leveraging which can only be attained if rigorous investment will be poured by the state too to improve and harness the capacity of bankers’ core competence in strategizing banking and finance. The government also needs to improve its banking policies to fit and reform it with the international quality banking standards. Some of its policies tend to be too broad than those under the Organization for Economic Cooperation and Development Countries (OECD) (Dobson et al., 2006, pp. 103-108). This general stroke of laws permeate such vagueness to simmer in the application of its system and its flexibility could certainly accord inconsistencies in the interpretation and enforcement—and therefore very ambivalent in dealing with crucial issues such as those matters pertaining to financial crisis (Dobson et al., 2006, pp. 103-108). Thus, monetary policies should be reviewed and evaluated to determine if these remained congruent to the targets and strategies of banking institutions (Dobson et al., 2006, pp. 103-108). Further, the China government also needs to improve their accounting practices since a lot of its creditors or those who availed loans are potentially not transparent in dealing with their financial management. These entrepreneurial borrowers should be required to submit financial documents and those foreign entrepreneurs should work well with Chinese accountants or with joint venture accounting firms for their services (Dobson et al., 2006, pp. 103-108). Review Loans: step for reform Moreover, Chinese government need to review loans granted to small entrepreneurs and its trading relations and restudy how they are going to protect their forex from the rapidly changing course of the market. For loans granted, it is apt to understand that the government is maximizing the banking institution to fuel the ailing domestic market and improve it to accommodate the increasing number of unemployed Chinese--- which include new graduates, rural migrants, and those laid off from state-owned enterprises. However, this policy on lending must be based on the political criteria and creditworthiness of the clienteles, otherwise, return of investment might be nil. It is likewise pointed by critics that the dependence of China’s government affiliated firm on state banks for capital meant that the banking institutions are compelled to support contradictory aims of financially supporting efforts to curb unemployment and in attaining social stability by transforming these creditors to become effective corporate institutions. Critics contended too that the Chinese government failed to consider these contradictions that may have a long-term impact to financial condition of the country. It’s therefore possible that with these realities, the government intentions might imperil bank reform and such weaknesses will affect the role of the banks in trading relations and in foreign exchange dynamisms. While the government is publicly declaring positivism that they could resolve the financial slump faced this month, there remained a lot of strategies, structural and policy-based, to be undertaken by Chinese leadership to ascertain that its problems of the banking institution will not ruin the national economy. References Akerlof, G. A. & Romer, P. M. (1993). Looting: The Economic Underworld of Bankruptcy for Pro?t. BPEA, no. 2, pp. 1–73. Allen, F., Qian, J. & Qian, M. (2006). China’s Financial System: Past, Present and Future. Philadelphia: Wharton Financial Institutions Center. Anderson, J. (2006). How Real Is China’s Bank Clean-up? UBS Investment Research Asian Focus, pp. 1-5. Asian Development Bank (2006). People’s Republic of China. In: Asian Development Outlook Manila: Asian Development Bank, pp. 117–24. Dobson, W. & Kashyap, A. K. (2006). The Contradiction in China’s Gadualists Banking Reforms, Brookings Papers on Economic Activity, vol. 2, pp. 103-160. Gali, J. (2008). Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework. Princeton, NJ: Princeton University Press, 2008. Reuters (2013). China money rates tumble as central bank cash flow in, South China Morning Post, p. 1 Retrieved: http://www.scmp.com/business/economy/article/1273872/pboc-sounds-warning-over-local-government-loans Saxon, M. (2007). An American’s Guide to Doing Business in China, USA: Adam’s Media, pp. 81-92. The Economist (2013). Stimulus v reform in China—Likonomics: what’s not to like. US: Economist.com, p. 1. Retrieved: http://www.economist.com/blogs/freeexchange/2013/07/stimulus-v-reform-china?fsrc=scn/tw/te/bl/likonomics Appendix 1: Copy of the Story Stimulus v reform in China Likonomics: what's not to like Jul 1st 2013, 9:52 by S.C. | HONG KONG JAPAN is still enjoying the effects of Abenomics, a campaign to reflate the economy named after Shinzo Abe, the prime minister. (The campaign stopped consumer prices, excluding fresh food, falling in the year to May.) China, on the other hand, is now enduring the effects of something called "Likonomics". Pronounced lee-conomics, the term has nothing to do with Facebook's economy of endorsements. It refers instead to the emerging doctrine of Li Keqiang, China's prime minister, who has overseen the country's economy since March. The term was coined on June 27th by three economists at Barclays Capital: Yiping Huang, Jian Chang and Joey Chew. Like the three "arrows" of Abenomics, Mr Li's strategy comprises three parts, they argue. Unlike the arrows of Abenomics, however, all of them hurt. Likonomics stands for: 1. No stimulus. Whereas Abenomics embraces both monetary and fiscal stimulus, Likonomics champions neither. In a bracing speech to officials on May 13th, Mr Li argued that China had little scope for stimulus or government-directed investment. In China, like the United States, stimulus is now a dirty word. But it fell into disrepute for opposite reasons. In America, stimulus failed to win favour because it was too small. In China the post-crisis stimulus was discredited because it was too big. 2. Deleveraging. In China, credit, broadly defined, has been growing much faster than GDP. The stock of "total-social financing", an eclectic measure of loans, corporate bonds and a bit of equity financing, is now about 190% of GDP. Mr Li is committed to lowering this ratio, according to the Barclays economists, who cite last month's alarming cash crunch in the interbank market as evidence.  3. Structural reform. Mr Li talks a lot about the need for structural reform. "Reform is 'the biggest dividend' for China," he has said. At a May meeting of the State Council, China's cabinet, he outlined many worthwhile initiatives, from liberalising interest rates to raising utility prices. The hope is that he will flesh out these proposals at a big communist-party meeting in the autumn (the third plenum of the central committee of the Chinese Communist Party). There is a lot to like about Likonomics, especially its third arrow. But I have some qualms about it. In particular, I worry that it reflects the growing influence of China's "pain caucus". The aversion to stimulus is an obvious example. China may have little room for stimulus spending in the form of further heavy public investment. But if the economy weakens further, it could still benefit from stimulus of a different kind. Tax cuts are one example. Higher social spending is another. To his credit, Mr Li has espoused both. But too many economists in China now think that stimulus is antonymous with reform, as if microeconomic evolution requires macroeconomic pain. It doesn't. China can change the composition of spending, even while maintaining a healthy growth in spending. Its economy can change in shape, even as it continues to expand in size. Its own recent history proves this. China's critics use to lambast the economy for being overly dependent on exports. But in the past five years, it has managed to reduce the share of exports from over 38% of GDP to less than 26%, even as the economy grew by over 9% a year on average. What about leverage? The Likonomists are right to worry that China's credit ratio is increasing too fast. When this ratio drifts too far above its historical trend, trouble often follows, as economists at the BIS have demonstrated. They define the credit "gap" as the difference between credit, as a percentage of GDP, and its long-term trend. By this definition, China's credit gap is about 14% of GDP, according to my calculations based on BIS data. Historically, a gap bigger than 10% has served as a reliable early-warning indicator of a crisis within the next three years, with only a 15% chance of a false alarm, according to a study of 39 countries by Mathias Drehmann of the BIS. Mr Li is right to heed this alarm. But there are two sides to every ratio: top and bottom. If credit is rising so much faster than nominal GDP, the extra loans cannot be adding much to the economy. Thus it should, in theory, be possible to curtail them without subtracting too heavily from it. Richard Werner of Southampton University has pointed out that loans for consumption or capital expenditure would all add to nominal GDP, if only through higher product prices. But a third kind of credit--namely lending for the purchase of existing assets, such as land or real estate--does not add directly to GDP, because GDP measures only freshly produced output. If he's smart, Mr Li will try to curtail this third kind of credit without crushing the first two. Amid all the recent talk about China's excesses, it can be easy to forget one simple fact: China is not a country living beyond its means. The country still runs a sizeable current-account surplus, which shows that it spends less than it earns--its domestic demand falls short of its supply. And consumer-price inflation remains low, which shows that domestic and foreign demand combined are not putting undue pressure on its productive resources. China does not need to spend less. It just needs to spend differently. The three Barclays economists argue that Likonomics will be good for China over the long run, helping it to sustain a growth rate of 6-8% over the next decade. But Likonomics also poses some short-term risks, they argue. The combination of rebalancing and deleveraging could temporarily drag quarterly growth down to 3% or below at some point over the next three years. If so, Likonomics will feel more like Lakonomics. Read More