Coloring on the Walls of China
bank reformation: secondary and tertiary effects
by Jonathan Gregg

So after a couple weeks of ignoring emails and slacking on my part (hey, it was the holidays -- there was drinking to be done!), I finally got back to our wonderful neighborhood editor at The Network, and she told me: “Yeah, you have about three days to get me an article, and that’s only because I like you.” The message was clear: “Hurry the heck up you bum!”

As for the subject, I’m supposed to work on “ a solid business article... something that tangentially touches upon finance.” How’s that for clear? I mean Lordy, why not just tell me to write “something cool that doesn’t suck”? (Incidentally, that’s what I told my wife back in the day when she asked me what I wanted to do that night for a date … and that was before I got married and didn’t have to be my insanely “charming” self any more!)

So I started to go through my bookmarks looking for inspiration. I went to all my favorite websites, www.fool.com (the Berkshire discussion board is awesome!), the Business Week MBA site, Damodaran's site over at NYU, and finally ended up at a piece I had read a couple weeks ago on China by Stephen Roach over at Morgan Stanley.

The piece said, in part:
The public listing of China's policy banks changes the very character of the nation's financing architecture. Charged with delivering profitability and shareholder value, publicly listed banks are bringing the days of open-ended policy lending to a close in China. Credit allocation must now follow the best practices of international commercial lending standards. ...."

As a senior Chinese banker put it to me over lunch in Beijing a couple of weeks ago, "Policy lending is out. Profitability and shareholder value are in."

Now, I don’t know about you, but when I see a headline every other day or so about how some western bank just dropped another gazillion or two (that’s a real word, I promise!) to buy into some Chinese bank, this may just be worth thinking about. So, I asked myself, is this change any more credible than the last time I promised “just food is out, and rabbit food is in”? At first I would tend to say no, because the political costs could just be too high, even in a non-democratic government. One of the reasons for this is that during my time in Beijing, I definitely got the impression that much of the government's legitimacy, such as it is, stems from economic growth. This was made especially apparent when I asked one of my new Chinese friends: "Why are there so many pictures of Chairman Mao around, and why is he so revered, when so many horrible things happened during his watch?" She replied: "Well, some bad things did happen, but he made our country strong and got the economy going." Wow.

On the other hand, later in my trip I met with a contact that works for a large state-owned company in Beijing. I asked him why I saw a competing American firm's products in so many state-owned companies (as opposed to his firm's products). I thought, after all, the government is your largest shareholder, so how could they buy from an outsider? He told me that the government really was serious about changing, and he felt that sometimes they even went so far as to discriminate against local firms! (He also told me to take a shot of the strongest liquor I have tasted in my life, and was tickled pink at my shock when I did and then thought my throat was on fire … but that’s a different story.)

Think about that one for a second, the government is the single largest shareholder in this firm, by far, and yet they are buying from an American firm, and placing these products out where an uninformed person like me can see them! Maybe they are serious? If so, this could be a huge opportunity for all of us pursuing an MBA!

The article went on to say:
Between them, the three policy banks still have over 46,000 branches offices throughout China. Historically, these branches have had great autonomy -- closely tied to local governments and their local employment imperatives. Now that they are publicly listed companies, however, branch autonomy is now giving way to an increasingly centralized system of tight internal controls -- necessary not only for consolidated banking system efficiency but also essential for the efficacy of Chinese monetary policy.

When I told my son that he can’t color on the table any more, want to guess what he did? (Besides yell “ewwwwww” at the mess he had made?) That’s right, he went and colored on the walls! Point being? You can’t change an existing behavior only by imposing rules; you HAVE to change the underlying culture. If you don’t fix that, the behavior will just find another outlet. So, in light of this, do we think the culture shift the Chinese are trying to do is realistic? Let's think about this like my son would, i.e. if they really are centralizing the banking and taking things out of the local government's sphere of influence, how will that impact the local government's actions in other areas? (Any walls handy to color on, maybe?)

The reason this is important is because we know that central government relies to a substantial degree on the provinces and local governments to enforce the rules, generate economic growth, etc. (Even though they are "centrally planned/communist," the Chinese delegate many economic choices to the local level.) If the ability to direct banking at the local level is taken away, that will take away some of the local administration's political clout (the ability to dole out financing/loans equals power), and I can't imagine they will be too happy about this. So, after this, might they then be less than helpful in some other areas in their dealings with Beijing?

Additionally, if they take away this form of patronage that the local governments are used to being able to dole out, what kind of spillover effects might that have on other forms of corruption? I mean, unless there really is a culture shift toward market economies, rule of law, etc. at all levels, taking away one method might just make two new ones spring up. It seems to me that considering the Chinese population's perception that corruption is high as it is, and the chances that this may force it higher (or make things more visible), coupled with the stressful economic adjustments this new policy will cause, this might be a recipe for some really upset people! As any parent knows, there are some second and third order effects that derive from any rule, and I think these need to be examined carefully!

In short, China’s market, and its banking system in particular, are a huge opportunity for anyone getting an MBA these days. However, while the payoff may be huge, there are also huge risks involved which need to be examined before taking the plunge.

Comments