Updated: May 20, 2022
As creators of credit, banks are in a very privileged position. To create a loan, the equivalent of making a sale for other companies, banks just need to type a number into a computer and hit 'enter'. This is a licence that frequently gets abused if banks throw caution to the wind.
"The idea of a bank going under in China was utterly anathema"
Thus these 'companies' (the banks and the state-owned enterprises) constituted China's early corporate sector and since none of them were run for profit nor took their own decisions, it is little wonder that a poor corporate culture evolved.
Under vice premier Zu Rongji in the early 2000s, an attempt was made to clean up the banks prior to them being listed in Hong Kong. Bad debt was exchanged for the bonds of asset management companies into which it had been transferred. But more importantly, Western-style credit assessment processes were established within the banks themselves, superseding the previous system of state-directed lending.
It was looking as if the banks had a chance of evolving into proper banks run with shareholders in mind and I must confess to getting just a little excited. Although we would need to wait to see how the banks managed themselves through difficult times and treated minority shareholders, the prospect of investing at some point in a sector that I conceptually like, in the fastest growing and potentially largest economy in the world was mouth-watering indeed.
All was progressing well until Lehman Brothers collapsed, an event which came as a huge shock to China's communist party cadre. Not only must, they thought, there be a problem with the Western banking model that they were adopting but also a problem with the US government and thus its securities which China had been rapidly accumulating - the idea of a bank going under in China was utterly anathema and would only occur if the government was too weak to save it.
So, in late 2008, China's banks reverted to their old ways. They were instructed to extend loans to the thousands of infrastructure projects that were being hastily rubber-stamped by the National Development and Reform Commission Lending growth rates hit 40%.
No doubt many of these loans will go bad and no doubt they will subsequently get cleaned up, perhaps without any of us being any the wiser. It is not a banking crisis that I worry about; it is the impact that a regression to a primitive past will have on China's corporate culture. I suspect I will have to wait a while longer for those banks.
Published in Professional Investor
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.