China's Banks Cling to Old Ways

The announcement this week of details of the planned initial public offering of the [Industrial and Commercial Bank of China] — potentially the largest offering in financial history, topping $21 billion — has foreign investors in a frenzied clamor to get a toehold in the booming Chinese financial market. Apparently, Chinese banking, like Chinese manufacturing before it, has arrived.

But according to the work of the economists Anil Kashyap at the University of Chicago Graduate School of Business and Wendy Dobson at the University of Toronto, banks in the new China may look modern on the outside, but they are not so far from their traditional roots. Their behavior seems closer to the 1990's crony capitalism of neighbors like Indonesia and Thailand, which engendered financial panics, than to that of international financial centers like London and New York….

The basic problem, they say, is that the Chinese government owns the banks and will continue to control them after the public offerings. The government has always exercised ultimate authority over the banks' lending decisions and, historically, has forced them to lend to corrupt and inefficient state-owned enterprises. That leaves the banks with a large share of loans that, effectively, default. Despite the recent reforms, that basic interference continues.…

…the government desperately wants to prevent a breakdown of regional stability and an overwhelming mass migration of workers out of rural areas (especially before it stages the Olympics in 2008). One major way it does that is by using bank loans to keep afloat the major employers in those remote areas: state-owned enterprises. Those are the same employers that failed to pay back the previous loans. Lending them money another time will, of course, mean that a large fraction of the bank's loans will again go sour. By that point, though, the bank's initial public offering will be long completed.