China's Banks Prepare For Battle

With WTO entry looming, they're modernizing as fast as they can

Since Shanghai Pudong Development Bank listed on the Shanghai Stock Exchange in November, its expansion plans have been in high gear. Using some of the $482 million it raised, SPDB will add four branches to its nationwide network of seven by yearend. It is refocusing its lending strategy, too--to emphasize China's hot high-tech and housing industries more and traditional commercial real estate development less. It's also shrinking its bad-debt load as fast as it can.

China's banks are being forced to think big these days--for good reason. China's expected entry into the World Trade Organization later this year will put local lenders in head-on competition with foreign banks. "We will be confronted with fiercer competition for personnel and customers," warns Dai Xianglong, governor of the People's Bank of China. "This will put great pressure on Chinese banks."

TAX GLITCH. Dai aims to help the locals face competition with a raft of new measures. He wants to give banks freedom to set their own interest rates and let more of them follow SPDB onto the stock market. Central bank officials are also likely to raise foreign banks' tax rates to bring them more in line with local banks. Most foreign banks now pay half the 33% tax that local banks are charged on profits.

Beijing has a lot riding on such moves. The nation's banks must still lend heavily to fund massive infrastructure spending in order to reflate the economy--and the healthier they are, the easier that will be. Besides, better banking practices are crucial as China tries to weed out bad debts that many economists put at $250 billion--25% of outstanding loans. To succeed, banks will have to lend to profitable companies, especially in the fast-growing private sector. "Beijing has to liberalize," says Shawn Xu, director of research at China International Capital Corp., a joint venture bank between China Construction Bank and Morgan Stanley Dean Witter. "Otherwise, funds won't be allocated properly."

Letting more banks sell shares to the public will improve their balance sheets--and should make them better lenders. Before SPDB's November initial public offering, it answered only to the central bank, which has often been too busy with policy to watch small banks. Now, its operations are also monitored by the China Securities Regulatory Commission, the Shanghai stock exchange, and shareholders. When making loans and investments of more than $10 million, for example, shareholders must be notified--a radical change for China's banks.

The central bank has little time to waste in advancing these reforms. Last year, it formed four asset-management companies to swap bad loans for equity in debtor companies. But progress has been slow. Dai defends his pace, saying swaps totaling $42.3 billion were signed by yearend. But that is hardly enough to purge the system.

Entry into the World Trade Organization also weighs heavily on Beijing policymakers. Even before China eases restrictions on foreign banks, which it will have to do when it finally joins, foreign competition is already mounting. Local banking sources say that several foreign banks will soon be added to the 20 already licensed to do yuan business in Shanghai. An additional 10 or so banks, including the Shanghai branches of Bank of America Corp. and ABN Amro Holding, will soon be allowed to borrow from and lend to local banks--a privilege that is now limited to only nine banks.

Can China get its banks ready for global competition and still use them to stoke the economy by funding roads, dams, telecom networks, and other projects? Policymakers used to a command economy will have to negotiate this tricky new territory as China opens its doors.

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