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China (PRC) and Its China (PRC) and Its “Long March” Toward a “Long March” Toward a

Modern Banking SystemModern Banking System

Prof. Joseph NortonProf. Joseph NortonSJD., DPhil., LLD SJD., DPhil., LLD

Dedman School of LawDedman School of LawSouthern Methodist UniversitySouthern Methodist University

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I. Primary Points To Be MadeI. Primary Points To Be Made China in fact has had a long experience with China in fact has had a long experience with

banking, albeit in differing and largely banking, albeit in differing and largely underdeveloped contexts.underdeveloped contexts.

China well-recognizes that its move toward a robust China well-recognizes that its move toward a robust “socialist market economy” on a sustainable basis “socialist market economy” on a sustainable basis will require a modern international banking system.will require a modern international banking system.

A modern international banking system requires A modern international banking system requires substantial compliance with evolving and substantial compliance with evolving and heightened international prudential, operational, heightened international prudential, operational, and anti-money laundering/terrorism financial and anti-money laundering/terrorism financial standards, along with the liberalization/openness standards, along with the liberalization/openness engendered by the move toward a more market-engendered by the move toward a more market-oriented economy and the embrace of the oriented economy and the embrace of the WTO/GATS requirements.WTO/GATS requirements.

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I. Primary Points To Be Made (Cont.)I. Primary Points To Be Made (Cont.) The quest for a robust and open, but safe and The quest for a robust and open, but safe and

stable banking system inherently entails various stable banking system inherently entails various substantial tensions and possible conflicts that will substantial tensions and possible conflicts that will challenge China’s policymakers, lawmakers, challenge China’s policymakers, lawmakers, enforcers and market participants.enforcers and market participants.

Additional substantial pressures will be brought by Additional substantial pressures will be brought by China’s historic, ongoing (but fragile) economic China’s historic, ongoing (but fragile) economic growth rates; by the inevitable evolution of the growth rates; by the inevitable evolution of the Chinese Yuan into a major international currency; Chinese Yuan into a major international currency; and by increasingly complex developmental and by increasingly complex developmental demands and disparities.demands and disparities.

China’s overall approach has been incremental and China’s overall approach has been incremental and measured, but also forward-looking and measured, but also forward-looking and internationally-oriented.internationally-oriented.

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II. Brief History of China Banking SystemII. Brief History of China Banking System

1845 - 18961845 - 1896 A Foreign Dominated Banking A Foreign Dominated Banking SystemSystem

1896 - 19491896 - 1949 A Mixed But Undeveloped A Mixed But Undeveloped Modern Modern Banking SystemBanking System

1949 - 19781949 - 1978 A Typical Socialist Banking A Typical Socialist Banking SystemSystem

1978 - Present1978 - Present A Gradually Reforming BankingA Gradually Reforming BankingSystem Influenced By System Influenced By

International International StandardsStandards

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1845 – 18961845 – 1896 A Foreign Dominated Banking A Foreign Dominated Banking SystemSystem

The Oriental Bank Corporation, which was a British The Oriental Bank Corporation, which was a British bank, opened its Canton branch in 1845. It is the bank, opened its Canton branch in 1845. It is the first modern banking institution in China. first modern banking institution in China.

Since then, European and American Banks had set Since then, European and American Banks had set up branches in China. Some Western banks even up branches in China. Some Western banks even started business directly in China. started business directly in China.

- For example, Hong Kong Shanghai Banking - For example, Hong Kong Shanghai Banking Corporation Corporation (HSBC) was established in 1865 to (HSBC) was established in 1865 to finance the growing finance the growing trade between China and Europe. trade between China and Europe. Recently has moved its Recently has moved its headquarters back to London from headquarters back to London from Hong Kong.Hong Kong.

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1896 – 19491896 – 1949 A Mixed But Undeveloped A Mixed But Undeveloped Modern Banking SystemModern Banking System

In 1896 the China Merchants Bank, the first In 1896 the China Merchants Bank, the first Chinese modern bank, was established in Chinese modern bank, was established in Shanghai by China Merchants Group which Shanghai by China Merchants Group which was a governmental business entity. was a governmental business entity.

From that time, a mixed modern banking From that time, a mixed modern banking system began to develop. This system was system began to develop. This system was composed of state-owned banks, private composed of state-owned banks, private banks and foreign banks.banks and foreign banks.

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1949 -19781949 -1978 A Typical Socialist Banking A Typical Socialist Banking SystemSystem

During this period, only three state-owned banks existed in During this period, only three state-owned banks existed in the whole country, namely, People’s Bank of China, China the whole country, namely, People’s Bank of China, China Construction Bank, and Bank of China.Construction Bank, and Bank of China.

In the centrally planned economy, there is no demarcation In the centrally planned economy, there is no demarcation between the central bank and commercial banks. All the thbetween the central bank and commercial banks. All the three banks were tools for the implementation of economic aree banks were tools for the implementation of economic and monetary policies/planning. nd monetary policies/planning.

These banks were also vehicles for the deposit of domestic These banks were also vehicles for the deposit of domestic sav- ings.sav- ings.

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1978 – Present1978 – Present A Gradually Reforming Banking A Gradually Reforming Banking SystemSystem

Under background of the “reformation and Under background of the “reformation and opening” policy, China banking system has opening” policy, China banking system has undertaken significant changes since 1978. undertaken significant changes since 1978.

Besides the restructuring of the state-owned Besides the restructuring of the state-owned banking sector, main measures in the banking banking sector, main measures in the banking reform process include: reconstruction of the reform process include: reconstruction of the central bank; cultivating a range of banking central bank; cultivating a range of banking institutions to activate the banking sector; and, institutions to activate the banking sector; and, gradually opening the domestic banking gradually opening the domestic banking market to foreign competitors.market to foreign competitors.

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III. Reform Process of the Banking SystemIII. Reform Process of the Banking System

A.A. Reconstruction of the Central BankReconstruction of the Central Bank

B.B. Emergence of Different Types of BanksEmergence of Different Types of Banks

C.C. Opening the Domestic Banking Market Opening the Domestic Banking Market to to Foreign CompetitorsForeign Competitors

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A.A. Reconstruction of the Central BankReconstruction of the Central Bank Since 1949, the People’s Bank of China (PBC) has been Since 1949, the People’s Bank of China (PBC) has been

the central bank. But before 1984, PBC also took depositthe central bank. But before 1984, PBC also took deposits and granted loans. The reform of PBC started at the ens and granted loans. The reform of PBC started at the end of 1970s and was completed by three main steps:d of 1970s and was completed by three main steps:-- In 1979, part of PBC became Agricultural Bank of In 1979, part of PBC became Agricultural Bank of

China, a govt-owned commercial bank serving thChina, a govt-owned commercial bank serving the e rural areas. rural areas. -- In 1984, the rest commercial banking sector of PBIn 1984, the rest commercial banking sector of PBC C became the govt-owned Industrial and Commercibecame the govt-owned Industrial and Commercial al Bank of China.Bank of China.-- In 2003, the China Banking Regulatory CommissioIn 2003, the China Banking Regulatory Commission n was established to take charge of the banking was established to take charge of the banking

regulation: bank supervision/regulation was movregulation: bank supervision/regulation was moved ed from the central bank. from the central bank.

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B.B. Emergence of Different Types of BanksEmergence of Different Types of Banks Current Structure of China Banking SystemCurrent Structure of China Banking System

-- 4 State-owned Commercial Banks, 1 of which got 4 State-owned Commercial Banks, 1 of which got listed in HK.listed in HK.

-- 3 State Policy Banks3 State Policy Banks

-- 12 Share-holding Commercial Banks, 6 got 12 Share-holding Commercial Banks, 6 got listedlisted

-- 120 Urban Commercial Banks120 Urban Commercial Banks

-- 11 Rural Commercial Banks11 Rural Commercial Banks

-- 48 Rural Cooperative Banks48 Rural Cooperative Banks

-- Thousands of Urban and Rural Credit CooperativesThousands of Urban and Rural Credit Cooperatives

-- Other Banking Institutions (12 financial leasing Other Banking Institutions (12 financial leasing companies, 59 trust and investment companies, 74 companies, 59 trust and investment companies, 74 finance finance

companies, etc.)companies, etc.)

-- Foreign BanksForeign Banks

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C.C. Opening the Domestic Banking Market to Opening the Domestic Banking Market to Foreign CompetitorsForeign Competitors

According to the commitment China made According to the commitment China made when it acceded into WTO in November 2001, when it acceded into WTO in November 2001, foreign banking institutions are to enjoy the foreign banking institutions are to enjoy the full access to the Chinese banking market by full access to the Chinese banking market by the end of 2006. the end of 2006.

Now there are 238 subsidiaries or branches of Now there are 238 subsidiaries or branches of 71 banks from 20 countries; 238 71 banks from 20 countries; 238 representative offices of 173 banks from 40 representative offices of 173 banks from 40 countries.countries.

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Foreign Investment in Chinese Banks (Some Foreign Investment in Chinese Banks (Some Examples)Examples)

Chinese Commercial Chinese Commercial Bank Bank

Foreign Bank Foreign Bank Share Share PercentagePercentage

China Construction BankChina Construction Bank Bank of AmericaBank of AmericaTemasek HoldingTemasek Holding

9%9%

5.1%5.1%

Bank of ChinaBank of China Consortium led by Consortium led by Royal of ScotlandRoyal of Scotland

10%10%

Bank of Communications Bank of Communications HSBCHSBC 19.9%19.9%

Shanghai Pudong DevelopmShanghai Pudong Development Bankent Bank

CitibankCitibank 19.9%19.9%

Bank of ShanghaiBank of Shanghai HSBCHSBC

IFCIFC8%8%

7%7%

Bank of BeijingBank of Beijing ING GroupING Group 19.9%19.9%

Xi’an City Commercial BanXi’an City Commercial Bankk

Note: See also recent CitiGroNote: See also recent CitiGroup consortiumup consortium

Bank of Nova Bank of Nova ScotiaScotia

IFCIFC

85% takeover of 85% takeover of GuangdongGuangdong

2.5%2.5%

2.5%2.5%

Development Development BankBank

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IV. Restructuring of State-owned Commercial BanksIV. Restructuring of State-owned Commercial Banks

A.A. Brief Introduction of the “Big Four”Brief Introduction of the “Big Four”

B.B. Influence of Evolving International Influence of Evolving International StandardsStandards

C.C. Optimization of Capital StructureOptimization of Capital Structure

D.D. Reformation of the OwnershipReformation of the Ownership

E.E. Public Listing in Overseas Stock MarketPublic Listing in Overseas Stock Market

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A. Brief Introduction of the “Big Four”A. Brief Introduction of the “Big Four”

Bank of China Bank of China

Advantage: overseas network and international Advantage: overseas network and international experiences experiences

Industrial and Commercial Bank of ChinaIndustrial and Commercial Bank of China

Advantage: the largest scale of financial assets and Advantage: the largest scale of financial assets and domestic RMB business domestic RMB business

Agricultural Bank of China Agricultural Bank of China

Advantage: the most extensive rural networkAdvantage: the most extensive rural network China Construction Bank China Construction Bank

Advantage: the first “Big Four” bank publicly listed Advantage: the first “Big Four” bank publicly listed overseas overseas

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B. Influence of Evolving International StandardsB. Influence of Evolving International Standards

Modern international banking standards, Modern international banking standards, especially those issued by the Basel especially those issued by the Basel Committee, have great influence on China’s Committee, have great influence on China’s banking reforms. This is purely a voluntary banking reforms. This is purely a voluntary commitment of the PRC government.commitment of the PRC government.

One of the reasons to restructure the “Big One of the reasons to restructure the “Big Four” is to make them satisfy the 8% capital Four” is to make them satisfy the 8% capital adequacy requirement in Basel Accord I. adequacy requirement in Basel Accord I.

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C. Optimization of Capital StructureC. Optimization of Capital Structure Striping Off the NPL From the “Big Four” Striping Off the NPL From the “Big Four”

-- In 1999, four asset management companies were In 1999, four asset management companies were established to take over the non-performing loans established to take over the non-performing loans

from from the “Big Four”. the “Big Four”.

-- Since 1999, over 1,400 billion RMB non-Since 1999, over 1,400 billion RMB non-performing performing loans have been stripped off from the “Big loans have been stripped off from the “Big Four”.Four”.

Capital Injection From the Foreign Exchange Capital Injection From the Foreign Exchange ReservesReserves

-- In December 2003, 22.5 billion U.S. dollars were In December 2003, 22.5 billion U.S. dollars were injected to injected to the capital funds of China Construction the capital funds of China Construction Bank and another Bank and another 22.5 billion to that of Bank of China.22.5 billion to that of Bank of China.

-- In April 2005, 15 billion U.S. dollars were injected In April 2005, 15 billion U.S. dollars were injected to to Industrial and Commercial Bank of China. Industrial and Commercial Bank of China.

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D. Reformation of the OwnershipD. Reformation of the Ownership China Construction Bank (CCB)China Construction Bank (CCB)

-- In 2004, the original 100% state-owned CCB was In 2004, the original 100% state-owned CCB was restrrestructured into a share-holding corporation. Huijin, a uctured into a share-holding corporation. Huijin, a specispecial-purpose government entity, became the al-purpose government entity, became the controlling controlling shareholder with an 85.23% stake. shareholder with an 85.23% stake. -- Foreign strategic investors are introduced. In 2005, Foreign strategic investors are introduced. In 2005,

Bank of Bank of America paid 3 billion U.S. dollars to purAmerica paid 3 billion U.S. dollars to purchase 9% stake in chase 9% stake in CCB. Temasek Holdings acquired 5.1%.CCB. Temasek Holdings acquired 5.1%.

Bank of China (BOC)Bank of China (BOC)-- In 2004, the old BOC was restructured into a share-In 2004, the old BOC was restructured into a share-

holding holding corporation also controlled by Huijin. corporation also controlled by Huijin. -- In 2005, A consortium led by Royal Bank of Scotland In 2005, A consortium led by Royal Bank of Scotland

got approval to buy a 10% stake in BOC.got approval to buy a 10% stake in BOC.

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E. Public Listing in Overseas Stock MarketE. Public Listing in Overseas Stock Market

On October 27 2005, China Construction Bank On October 27 2005, China Construction Bank Share-Holding Corporation got listed on Hong Share-Holding Corporation got listed on Hong Kong Stock Exchange. It was the first “Big Four” Kong Stock Exchange. It was the first “Big Four” bank listed overseas.bank listed overseas.

According to the ambitious schedule of the According to the ambitious schedule of the Chinese government, Bank of China will be Chinese government, Bank of China will be listed in 2006 and Industrial and Commercial listed in 2006 and Industrial and Commercial Bank of China and Agricultural Bank of China in Bank of China and Agricultural Bank of China in 2007 or 2008. 2007 or 2008.

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V. The Banking Regulatory SystemV. The Banking Regulatory System

A.A. Three Pillars of the Legal FrameworkThree Pillars of the Legal Framework B. B. Division of CBRC and PBC's ResponsibilitiesDivision of CBRC and PBC's Responsibilities C. C. Coordination between CBRC and PBC Coordination between CBRC and PBC D. D. Strengthened Regulation of Commercial BankStrengthened Regulation of Commercial Bank

ss

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A. Three Pillars of the Legal FrameworkA. Three Pillars of the Legal Framework

Law of People’s Republic of China on People’s Bank Law of People’s Republic of China on People’s Bank of China (promulgated in 1995, amended in 2003)of China (promulgated in 1995, amended in 2003)

Law of People’s Republic of China on Banking Law of People’s Republic of China on Banking Regulation and Supervision (promulgated in 2003) Regulation and Supervision (promulgated in 2003)

Law of People’s Republic of China on Commercial Law of People’s Republic of China on Commercial Banking (promulgated in 1995, amended in 2003)Banking (promulgated in 1995, amended in 2003)

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B. Division of CBRC and PBC's ResponsibilitiesB. Division of CBRC and PBC's Responsibilities

Responsibilities of China Banking Regulatory Responsibilities of China Banking Regulatory Commission (CBRC)Commission (CBRC)

-- Examining and approving the establishment, Examining and approving the establishment, dissolution, business scope and any change in dissolution, business scope and any change in

the the constitution of banking institutions.constitution of banking institutions.

-- Regulating business activities of these Regulating business activities of these institutions institutions and verifying the sources of funds and and verifying the sources of funds and credibility of credibility of major shareholders.major shareholders.

-- Supervising banking financial institutions and Supervising banking financial institutions and imposing sanctions for non-compliance.imposing sanctions for non-compliance.

-- Examining financial and accounting records.Examining financial and accounting records.

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B. Division of CBRC and PBC's Responsibilities (CB. Division of CBRC and PBC's Responsibilities (Cont.)ont.)

Responsibilities of People’s Bank of China (PBC)Responsibilities of People’s Bank of China (PBC)

-- Formulating and implementing monetary Formulating and implementing monetary policies and policies and taking measures to avoid and taking measures to avoid and minimize risks in the minimize risks in the financial market and to financial market and to stabilize RMB.stabilize RMB.

-- Overseeing and promoting the development of Overseeing and promoting the development of the the financial markets from a macro perspective.financial markets from a macro perspective.

-- Regulating the inter-bank lending market, the Regulating the inter-bank lending market, the inter-inter- bank bond market, the inter-bank foreign bank bond market, the inter-bank foreign exchange exchange market, the gold market, and directing market, the gold market, and directing and deploying and deploying anti-money laundering measures.anti-money laundering measures.

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C. Coordination between CBRC and PBC C. Coordination between CBRC and PBC

PBC may recommend CBRC to inspect and supervise PBC may recommend CBRC to inspect and supervise banking financial institutions to ensure their banking financial institutions to ensure their operations are in line with monetary policies.operations are in line with monetary policies.

The amended Commercial Banking Law distinguishes The amended Commercial Banking Law distinguishes situations where each PBC and CBRC may penalize situations where each PBC and CBRC may penalize commercial banks who have acted in violation of commercial banks who have acted in violation of laws.laws.

The State Council will establish a financial The State Council will establish a financial supervisory and reconciliation mechanism to supervisory and reconciliation mechanism to facilitate the information sharing between the two facilitate the information sharing between the two regulatory agencies.regulatory agencies.

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D. Strengthened Regulation of Commercial BanksD. Strengthened Regulation of Commercial Banks

The amended Commercial Banking Law has The amended Commercial Banking Law has strengthened regulation of commercial banks by: strengthened regulation of commercial banks by:

-- Requiring commercial banks to establish a Requiring commercial banks to establish a sound sound risk management and internal control risk management and internal control systemsystem

-- Adjusting certain requirements relating to the Adjusting certain requirements relating to the operation of commercial banksoperation of commercial banks

-- Extending the time requirement on commercial Extending the time requirement on commercial banks banks with their disposal of immovable with their disposal of immovable

properties or equity properties or equity interests obtained through interests obtained through enforcementenforcement

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D. Strengthened Regulation of Commercial Banks D. Strengthened Regulation of Commercial Banks (Cont.)(Cont.)

-- Clarifying the establishment of procedures Clarifying the establishment of procedures and and organizational structure of commercial banks, organizational structure of commercial banks, the the protection mechanism for depositors as well protection mechanism for depositors as well as as some basic lending principles some basic lending principles

-- Outlining rules on finance and accounting, Outlining rules on finance and accounting, takeover and termination of commercial takeover and termination of commercial

banks banks

-- Removing the wholly state-owned banks’ Removing the wholly state-owned banks’ obligation to obligation to provide loans to projects provide loans to projects specifically approved by the specifically approved by the State Council State Council

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VI. Challenges in the Banking ReformVI. Challenges in the Banking Reform

A.A. Non-performing Loans Non-performing Loans B.B. Lack of Deposit Insurance SystemLack of Deposit Insurance System C.C. Management of On-going Internationalization Management of On-going Internationalization

and and Openness under WTO/GATSOpenness under WTO/GATS D.D. Regulation of Financial ConglomeratesRegulation of Financial Conglomerates E.E. Reconciliation of Modern Commercialization Reconciliation of Modern Commercialization

with with Significant Development NeedsSignificant Development Needs F.F. Accommodation of An Impending Major Accommodation of An Impending Major

International Currency International Currency and One of World’s Largest and One of World’s Largest Economies with Global Trading & Economies with Global Trading & Investment Investment Links ( US, Canada, EU, Latin America, SE Asia, Links ( US, Canada, EU, Latin America, SE Asia, Indian Subcontinent, Africa, ME)Indian Subcontinent, Africa, ME)