The Chinese Banking System: Structure, Potential Risks, and Reforms

Professor Jun Qian (QJ) Fanhai International School of Finance, Fudan University

July 22, 2020 Peterson Institute Online Forum Outline l Structure of the Chinese banking system: a three-tier system l Comparing the largest banks around the globe l Different features of ownership and governance of banks l Case study of Baoshang Bank l The growth of fintech lending: l Examples of “ecosystems” of fintech platforms with multiple functions l What is special about fintech lending in China? l Shadow banking sector: l Growth of banks’ wealth management products (WMPs) l Restructuring of the shadow banking sector Total Social Fundraising and GDP Growth (2006-2019)

30 Trillion RMB 16

25 14

12 20 10 15 8 10 6 5 4

0 2 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 (5) 0 Undiscounted BA Bank Loans Trust Loans Bond Equity ABS Others Real GDP Growth(%)

Sources: PBoC, WIND Overview of China’s Banking System l A three-tier structure: Ø “Big Four” banks (ICBC, BOC, CCB, and ABC), plus Bank of Communications and the Postal Savings Bank; among the largest banks in the world; and policy banks Ø Stockholding banks (most of these are listed): e.g., China Merchants Bank （招商银行） Ø Regional, small & medium sized banks (SMBs); credit cooperatives; non-bank inst Ø Support old growth model: absorbing social savings => (low cost) loans (investment) to key industries l Key reforms in the recent two decades: IPOs of state-owned banks Ø See, e.g., Allen, Gu and Qian (2017), for more details l Banks’ business and risks: on- and off-balance sheet activities Ø China’s shadow banking: formation, growth, roles and risks Largest Banks in the World (assets) (Source: Bloomberg, latest filings as of Dec. 2019)

Rank Bank Name HQ Country Total Assets ($trillion)

1 IND & COMM BK OF CHINA China 4.32

2 CHINA CONSTRUCTION BANK China 3.65

3 AGRICULTURAL BANK OF CHINA China 3.57

4 BANK OF CHINA LTD China 3.26

5 MITSUBISHI UFJ FINANCIAL GRO Japan 3.07

6 HSBC HOLDINGS PLC United Kingdom 2.72

7 JPMORGAN CHASE & CO United States 2.69

8 BANK OF AMERICA CORP United States 2.43

9 BNP PARIBAS France 2.16

10 CITIGROUP INC United States 1.95 Largest Banks in the World (market cap) (Source: Bloomberg, latest filings as of Dec. 2019)

Rank Bank Name HQ Country Market Cap ($billion)

1 JPMORGAN CHASE & CO United States 429.91

2 BANK OF AMERICA CORP United States 311.21

3 IND & COMM BK OF CHINA China 294.12

4 WELLS FARGO & CO United States 222.43

5 CHINA CONSTRUCTION BANK China 217.70

6 AGRICULTURAL BANK OF CHINA China 182.40

7 CITIGROUP INC United States 168.90

8 HSBC HOLDINGS PLC United Kingdom 161.26

9 BANK OF CHINA LTD China 147.24

10 ROYAL BANK OF CANADA Canada 113.26 Largest Banks in the World: ROA in 2019

3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00%

CITI GROUP

BANK OF CHINA HSBC HOLDINGS JPMORGAN CHASE BANK OF AMERICA

IND & COMM BANKCHINA OF CHINA CONSTRUCTION BANK AGRICULTURAL BANK OF CHINA MITSUBISHI UFJ FINANCIAL GRO

Source: Wind Top 10 Banks’ (by Total Assets) Stock Performance 2019.12.31 to 2020.07.16 1.10

1.00 IND & COMM BK OF CHINA-A

0.90 CHINA CONSTRUCTION BANK-A

AGRICULTURAL BANK OF CHINA-A 0.80 BANK OF CHINA LTD-A

MITSUBISHI UFJ FINANCIAL GRO 0.70 JPMORGAN CHASE & CO

HSBC HOLDINGS PLC 0.60 BNP PARIBAS

0.50 BANK OF AMERICA CORP CITIGROUP INC 0.40 2019-12-31 2020-01-31 2020-02-29 2020-03-31 2020-04-30 2020-05-31 2020-06-30

Data Source: WIND ICBC’s Ownership Structure (as of Mar.31th, 2020)

Other A Shareholders, 4.35% Huijin, 34.99%

Other H Shareholders, 16.46%

CSF, 0.68% MOF, 31.14% Temasek, 2.05% Ping An, 4.44%

SSF, 5.89%

Data Source: WIND China Merchants Bank’s Ownership Structure (as of Mar.31th, 2020)

China Merchants Steam Navigation Company (Central SOE), 13.04% China Ocean Shipping Company (Central SOE), 6.24% Hexie, 4.99% Other A Shareholders, 36.27% Anbang, 4.99%

Shenzhen Yanqing, 4.99% Other H Shareholders, Shenzhen Zhaorong, 18.20% 4.55% Shenzhen Chuyuan, CSF, 2.99% 3.74% Data Source: WIND Ownership and Governance of Large Banks l Role of government ownership stakes: Ø For profit goals and non-profit goals, including financial stability of the financial system and implementation of macro-prudential policies l Role of foreign institutional investors: Ø Improving operating efficiency and shareholder governance (serving on the board) l What is the optimal structure of the banking sector: Ø For emerging markets, the optimal structure should perhaps include both public/state large and private/smaller banks; or including government ownership stakes in some large institutions Ø Competition and comparison among these banks can ensure public banks are efficiently run, and private banks do not take too much risk Ø See Allen, Qian, Shan and Zhao (2011) for more details Case Study: Baoshang Bank (包商银行) l Taken over by CBRC on May 24, 2019: o Due to its credit risk, China Banking Regulatory Commission (CBRC) decided to take over for one year, starting May 24, 2019 o On Apr. 30, 2020, Mengshan Bank（蒙商银行） was founded, and took all the assets and liabilities of Baoshang Bank in the region of Inner Mongolia l Factors leading up to the failure of Baoshang Bank:

o Capital was occupied/tunneled by it’s (ultimate) controlling shareholder o Poor quality of assets: low capital adequacy ratios and provision coverage; lack of high-quality of major loan customers

o Problematic regional economic development : low GDP growth rates; high leverage of local government; net outflow of population Case Study (cont’d): Baoshang Bank lOther banks that got in trouble: o Hainan Development Bank: took over by ICBC in 1998 o Bank of Jinzhou (锦州银行, in Liaoning Province): reformed and restructured in 2019 o Some credit cooperatives went bankrupt due to different reasons lRegional banks’ activities and capital flows typically concentrate in a few cities/one or two regions: o Thus no strong contagion risks. NPLs (over loans) of Japan, India, China and the US

12.00 %

10.00

8.00 USA 6.00 Japan India 4.00 China

2.00

0.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Data Source: World Bank Performance of Listed Banks in China: NPLs (over GDP) and ROA (Dec 2008 to Dec 2020Q1)

14.00% 1.60%

12.00% 1.40% 1.20% 10.00% 1.00% 8.00% 0.80% 6.00% 0.60% 4.00% 0.40% 2.00% 0.20% 0.00% 0.00% 2008-12 2009-06 2009-12 2010-06 2010-12 2011-06 2011-12 2012-06 2012-12 2013-06 2013-12 2014-06 2014-12 2015-06 2015-12 2016-06 2016-12 2017-06 2017-12 2018-06 2018-12 2019-06 2019-12 NPLs/GDP ROA (Right Axis)

Data Source: WIND Digital Economy and Financial Services: China’s Business Model

Source: Goldman Sachs ( 2018) Case Study: Ant (Financial) Technology

§History …

§Ownership

17 What is special about platform lending?

n ： Fintech vs. traditional banking Sales Performance

n Informational advantages Owner Service Characters Quality

n Platforms as cheap distribution channel

n Platform recycles funds (“closed loop”) Credit Usage Credit History

n Enforcement mechanisms Non-sales Performance

18 Related Work on China’s Shadow Banking l A broad definition of ‘shadow banking’: l All investment products off-the-balance sheet of (deposit-taking) banks l Theoretical work on the role of shadow banking: Wang et al., (2016)—can be welfare enhancing l Wealth management products (WMPs) issued by banks: l Acharya, Qian, Su and Yang (2019): understand the growth and risks of the WMPs l Loans issued by non-bank institutions: l Chen, Ren and Zha (2018): monetary policies & issuance of entrusted loans; Allen, Qian, Tu and Yu (2018): Properties of entrusted loans; Du, Li and Wang (2016): Non-financial firms as financial intermediaries

l Trust industry: Product level analysis: Allen, Gu, Qian and Qian (2018) l Other credit/lending channels: l Informal/private credit agencies: Allen, Qian and Xie (2019); Internet platforms (P2P, crowd-funding) RMB 4-trillion Stimulus and Credit Expansion (newly issued bank loans and GDP growth; 2004-2015) New Bank Loan as a Percentage of 2004 GDP 80.0% 80.0

70.0% 70.0

60.0% 4 trillion stimulus 60.0

50.0% 50.0

40.0% 40.0

30.0% 30.0

20.0% 20.0

10.0% 10.0

0.0% 0.0 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 New Bank Loan/2004 GDP GDP (trillion RMB) Banks’ Wealth Management Products: Principal-floating WMPs/Net assets (Acharya, Qian, Su, and Yang, 2019; largest 25 banks; 2008-2014) Summary: Banks and Financial Institutions l After a series of reforms, large Chinese banks have become stalwarts of the financial system l On-balance sheet activities: NPLs under control l Off-balance sheet activities: fast growth since the stimulus; rollover risks; l Reforming the banking and shadow banking sectors: Ø Liberalization of interest rates, Ø Downsizing of the risky part of the shadow banking sector Ø New regulations on asset management Ø Banks’ establishment of new asset/wealth management companies Thank You