Reference no: EM133155489

Question - As of 2006, China's banks were estimated to hold $900 billion in bad loans, or 40% of the nation's annual GDP-and this after China had already spent the equivalent of 25 to 30% of GDP in previous bank bailouts. This lending disaster makes China the home of the world's largest potential banking crisis. Faulty corporate governance is at the heart of this ticking time bomb. A history of low pay, lax supervision, and politicized lending has resulted in loans being made that were doomed from the outset. Beyond the ever-present corruption that plagues the banking system, the biggest problem is the role that Communist Party officials continue to play in lending decisions. Because they are government owned, China's banks report to party bosses rather than to independent boards of directors or to shareholders. The result is a lack of accountability and transparency. Moreover, as tools for government-directed lending, China's banks have little expertise in assessing risk or pricing capital. State-owned enterprises (SOEs), which tend to be far less efficient than foreign-funded enterprises, account for more than 50% of outstanding bank credit. This figure reflects the fact that banks in China traditionally were required to finance the operations of SOEs, regardless of their profitability or risk. Owing to various obstacles, such as barriers to laying off workers, SOEs find it difficult to reduce their costs. At the same time, because they employ millions of workers, banks face enormous pressure to continue lending to SOEs. Although the government is unlikely to permit the banking sector to collapse, a healthy banking industry is critical to achieve Beijing's goal of maintaining strong, but more efficient, economic growth. One answer that Beijing has come up with to reform the banking sector is to have its largest state-owned banks launch initial public offerings (IPOs). Beijing's main goal in listing these banks is not to raise cash but rather to subject them to the discipline and scrutiny of financial markets and international regulators that accompany a public listing. According to Fred Hu of Goldman Sachs in Hong Kong, ''Given all the political interference, it is very hard to run the banks on a commercial basis. The first step is to change their ownership, and IPOs are a way to achieve that.''10 Similarly, Beijing has made overseas listings a key component of state-owned industrial enterprise reform because they provide companies with pressure from public shareholders to pursue profits and wean themselves from government handouts.

Required -

1. Would you expect loans to SOEs to be safer or riskier than other Chinese bank loans? Explain.

2. How can IPOs improve the sorry performance of Chinese banks?

3. What difficulties will China face in preparing their state-owned banks for IPOs?

4. What other steps can the Chinese government take to improve the performance of their banks?

5. How would a more efficient banking system benefit China?

6. What is the downside of introducing market forces into China's banking system?