The Chinese Banking Syndrome

There’s nothing as representative of capitalism as the financial services industry. There’s nothing as representative of communism as China. And when those forces meet whether to collaborate or collide—it can be fascinating to watch.

The most visible symbol of that dichotomy right now is the high-profile trial of former high-ranking politician Bo Xilai. It’s technically not directly related to financial services, though he was previously Minister of Commerce and the charges he’s facing have mostly to do with bribery and corruption. The more interesting connection is between free markets—a basic tenet of capitalism—and the stranglehold the Chinese government has on every aspect of business life.

In fact, Bo racked up an impressive economic record during his stints in public office. He aggressively pursued foreign investment by lowering income taxes and his efforts are credited with leading to a much higher GDP in his districts than the national rate. (It was also tagged as ‘red GDP,’ indicating heavy government subsidies.) None of this is likely to help in his trial, however—according to a U.S. State Department report, the conviction rate for criminal trials and their appeals reached 99.9% in 2010. The tight Communist party control over police, prosecution and the courts is apparently quite effective.

Stepping back a little, the broader financial picture is just as conflicted, and getting more so. As the Wall Street Journal pointed out recently, there was a time when it was much easier to track the economy. All China-watchers had to do was monitor the volume of loans issued by banks every month. Those days are certainly gone.

In the past few years, with serpentine maneuvering that would make Wall Street veterans envious, banking industry executives have employ increasingly complex tactics to spread the wealth around without public scrutiny. Along the way, in scenarios that mirror battles being fought by free-market counterparts, they’ve run headfirst into Chinese regulatory agencies.

As covered on this blog previously, the problems stem partly from the Chinese government’s decision to place stringent restrictions on loans to SMBs, which led to the rapid growth of a ‘shadow banking’ market. These trust companies and short-term financing arrangements naturally feature significantly higher interest rates than traditional modes of lending—a potential recipe for corruption and even violence. The more recent problems, however, go much deeper.

As these alternative financial models became increasingly common, larger banks got involved, in the process keeping their true credit records off the books. By 2011 the China Banking Regulatory Commission (CBRC) had cracked down, forcing banks to go back on the record about their true credit histories. So the banks switched gears, opting for wealth-management products involving bonds, index futures and so on. These were, as the name suggests, designed specifically for high-net-worth individuals. When the CRBC stepped in here as well, financial institutions deployed even more byzantine strategies to stay undercover, such as categorizing corporate loans as interbank loans.

It’s unclear just how much there is floating around out there precisely because it’s all in the shadows. But it’s important to stay abreast of this imbroglio because China is so important to the global economy right now, and so many Western banking institutions are looking for greater access to the market.

There are major potential downsides here—just this month, news leaked that Wall Street conglomerate JP Morgan Chase is being investigated by the U.S. Securities and Exchange Commission for hiring ‘princelings,’ the children of high-ranking Chinese government officials, to sweeten their bid for a share of the massive China market. It’s also by no means the only institution to face these challenges. Sure, outright bribery is expressly prohibited by the Foreign Corrupt Practices Act, but is favoritism of this kind illegal?

We don’t have all the answers yet, and it’s going to be a long time before we do. But some essential truths are inescapable: China is a huge business market, currently holds a great deal of U.S. debt, and will maintain a defiantly socialist posture while allowing (some) free-market policies. Somewhere inside that tangled web there is the potential for real reform and economic growth. Companies that can learn to walk that fine line will reap tremendous benefits.

Written by Staff