China’s Financial Reform and Economic Development during the 12th Five-year Period  

- Speech by CBRC Chairman LIU Mingkang at Lujiazui Forum

(May 20, 2011)

Party Secretary Yu, distinguished guests, ladies and gentlemen,

Good morning.

This year marks the beginning of the 12th Five-year Period. Over the past three decades, China has witnessed glorious achievements in its reform and development. I feel that at this new starting point, we are faced with arduous tasks of adjusting the economic structure, boosting the transformation of growth mode, and pursing development in a scientific manner. These tasks are by no means less difficult or complicated that what we were faced 30 years ago. China needs to not only build a strong and robust financial system, but also improve its overarching design and strengthen various works in economic and social administration. Now, I want to share with your the following observations.

1. China’s banking sector has undergone profound changes in the course of reform and development

In recent years, as a result of vigorous facilitation by the Central Government, the financial reform and opening-up has got in full swing. Thanks to over 8 years of prudential guidance, the banking sector has withstood the impact and test of the international financial crisis that rarely occurs in everything 100 years. Remarkable changes have taken place in internal mechanisms and external image. In particular, the operating mechanisms and managerial efficiency have seen some delightful changes, which is not easy to achieve.

First, operating efficiency has been drastically improved. As of end-2010, the amount of loans extended by banking institutions reached 4 times that of 2003, and the average profitability has grown by 10 times, comparable to that of well-managed international banks. One source of such profitability is effective cost control. One famous example is that the Industrial and Commercial Bank of China, which boasts the world’s largest capitalization, has lowered its cost to revenue ratio from over 60% in 2000 to around 30% in 2010.   

Second, the banks’ ability to fend off risks has been significantly enhanced. The amount and proportion of major commercial banks’ NPLs dropped respectively from RMB 2.28 trillion and 23.61% (on the basis of 4-category loan classification) at the end of 2002 to RMB 364.6 billion and 1.15% (on the basis of more stringent 5-category loan classification) at the end of 2010. The banks’ consolidated weighted average capital adequacy ratio rose from -2.98% at the end of 2003 to 12.2% at the end of 2010, with the capital adequacy ratio of each and every commercial bank exceeding the required 8%. More importantly, the banks have developed the awareness of capital constraints and the internal dynamism for continued capital supplementation. As a result, the banks’ provisioning coverage rose from 6.7% at the end of 2002 to 218.25% at the end of 2010, and the ratio of loan loss provisioning reached 2.41%. To make sufficient provisions for withstanding risks has become a consensus shared by bank shareholders, directors and senior officers.

Third, the sources of revenue have become increasingly diversified. In 2010, the net amount of listed banks’ service fee and commission revenues grew by 30% over 2009, hitting a growth rate 7 percentage points than that of 2009. As for China Construction Bank and other banks, the contribution of the net revenue from service fees and commissions to their operating revenues has grown from 4% in 2002 to 20% in 2010. The model of making profit mainly from difference in interest rates is experiencing unnoticeable changes. What is delightful is that the growth in service fee and commission revenue comes from the development of new business activities. As of end-2010, commercial banks issued 200 million valid credit cards, which mean that one out of every 6 people owns a credit card. Besides, the average overdraft limit rose by around 40% over 2009. In addition, the wealth management sector has also seen a sharp growth. In 2010, the wealth management products sold by the ICBC only totaled RMB 4.5 trillion.

Nevertheless, we must look at the existing issues of China’s banking sector in an objective manner. As Mr. Deng Xiaoping pointed out in 1993, the issues we are facing after development are no fewer than those before development. Facts have proven that he was right.

2. To strategically facilitate the banking sector to transform the development mode

President Hu Jintao stressed that it is of necessity to accelerate the transformation of development mode so as to adapt to major changes in global demand structure and match the new characteristics of China’s socio-economic development. The banking sector in China must remain cool-headed, adopt a broader vision and think more proactively, and strategically accelerate the transformation of development mode.  

Firstly, continued efforts must be made to boost business innovation. In 2010, One fourth of funds raised by non-financial corporate sector in China came from direct financing in the stock and debt markets. Diversification of the financing structure has become an inevitable trend. Of course, there are still many issues. Given the decreased potential of conventional banking business model, banks must make efforts in the following three regards. First is to focus more on financial services for small and micro-enterprises. With the rapid growth of the direct financing market, large and high-quality enterprises are walking away from credit funds. Commercial banks must break the conventional practice of extending loans to large borrowers while firmly sticking to minimum requirements on loan concentration. In recent years, commercial banks have started to make explorations in this regard and have made some preliminary results. In some banks, retail loans contributed to 30% to 40% of all loans extended in 2010. Their practices have fully demonstrated that supporting small companies would lead to increased risk diversification and marginal benefit, and flexible risk pricing would add up to the competitive edge of those banks that are better at serving small companies. Second is to focus more on financial services for individuals. The provision of private financial services tailored to individual needs is a new opportunity for profit growth. The areas worth expecting include: to provide simple, convenient and credible financing products providing long-term positive risk-adjusted return in response to China’s ageing trend; to offer more diversified portfolios of global asset management products in response to the growing number of middle-class population; and to offer innovative financial products in support of the production and consumption of spiritual products, such as culture and tourism, while enriching the offering of financial products to support the production and consumption of material products, in response to the need to boost consumption. Third is to focus more on capturing the strategic opportunity in the fast-growing direct financing market. Banks should work hard to improve the delivery of settlement, clearing and custody services at home and abroad, and become premium retail distributors and managers of related financial products, by leveraging on their physical outlets across the country and convenient e-networks and tapping into their abundant professional human resources.  

Secondly, the banks must improve the capability of performing due diligence and selecting quality clients. China’s economy is, on the whole, embracing both growth opportunities and challenges. Some of the clients have made progress in terms of business ethics and corporate governance, while others have slipped back in this regard. Particularly at a time when China is fighting against inflation and exercising controls over the economic aggregate, the banks need to draw on modern methods of selecting clients and perform due diligence checks. From a development perspective, it is a must to select clients and such a practice also embodies the spirit of making specific analysis to address a specific issue.

Thirdly, the banks must continue to promote their capability of pricing products on a reasonable and equitable basis. Banking institutions should be able to accurately calculate their own costs, expenses and risks, and “calculate before doing other than do before calculating”. First is to improve the funds transfer pricing mechanism. Some leading international banks have been able to amortize over 90% of all costs to every product and transaction via funds transfer pricing. Commercial banks in China must step up the efforts to establish the FTP system, accurately calculate the costs associated with deposited funds and returns on lent funds in light of mid to long-term risk-cost calculations and supply-and-demand situation in the money market, and improve their capability of pricing lending and intermediary businesses.

Second is to accelerate the collection of risk data and development of managerial infrastructure. The banks should improve the system platform and dynamic modules from data tracking analysis and scientific assessment, strengthen the measurements and calculations of various risks, and adopt cost-plus pricing to make sure that return is sufficient to cover costs and maturity-matched risks. Third is to give the clients the right of choice. The banks should inform the consumers of available options concerning services and fee charges in an understandable and acceptable way, and provide the clients with instructions and options to choose from. Fourth is to establish sound appraisal rules. The banks should, in light of the actual situations and in the spirit of sustainable development, define the scope and objectives in relation to appraisal of various business activities, and have in place reasonable incentive and disciplinary measures. They should implement the scientific approach to development throughout their organizations in a consistent manner.

Fourthly, the banks must promote the “problem solving” culture. With the support of sound corporate culture, systems and policies are useless. As banks are service providers, “solving problems for the clients” is a fundamental requirement. First, the banks should strictly follow the prioritized order of safety, liquidity and profitability, and pursue growth on the basis of robust operation. Every employee must work hard towards that and solve the problems for the clients. Second, the banks should promote the “problem solving” culture and enhance the employees’ sense of responsibility. Every employee working with the clients or in the market represents a bank’s image, so they should improve their ability to work alone and collaboratively. In fact, what China lacks is horizontally-integrated management. Status prejudice and low synergy result in internal conflicts. The banking sector is no exception. Therefore, we need to make persistent efforts to foster such a culture so as to improve China’s soft competitiveness.  

3. To strengthen overarching design and create a supervisory environment to support sound economic growth

Firstly, the banking sector should positively interact with the new countryside development and urbanization programs. In this regard, the banking sector covered all unbanked townships/towns with basic financial services at the end of 2010, and accomplished for two successive years the goal of “making sure that the growth rate of agro-related and SME loans is not lower than the average growth rate of all loans and the amount of new agro-related and SME loans extended is not smaller than that of previous year”. In this year, efforts will be made to set up banking outlets in 500 under-banked townships/towns. What is crucial is that efforts must be made to promote the equalization of public services at the grass-roots level. That is to say, besides basic financial services, efforts should be strengthened to improve the delivery of public services, such as housing, employment, education, social security and medical insurance, in a coordinated manner, to have in place well-designed systems and mechanisms, to define short-term and mid-to-long-term goals, and to ensure the implementation in a consistent way.

Secondly, the banking sector’s development and deepened SOE reform should promote each other. The scientific development and careful management of the banking sector will help to boost the deepening of corporate reforms, particularly with regard to SOEs, hence promoting the quality of socio-economic development at both macro and micro levels. On the other hand, the substantial socio-economic progress at both macro and micro levels will safeguard the sound development of banking sector. At present, a very important task is to play down the nature and size of companies,. The banks should, in the spirit of promoting sound and rapid development, make sure that various resources, including bank credits, are accessible through equal competition, thus optimizing the configuration of social resources.

Thirdly, we should effectively boost the transformation of development mode. Currently, given the impact of domestic and international factors, many links of China’s development are quite tensed. From a scientific point of view, the socio-economic development of China needs to focus more on the optimization of demand-side management. We should draw on the lessons learned to meticulously accelerate the optimization and upgrading of industrial structure other than regional migration. Rapid but unsound growth is not what we are pursuing. Growth in terms of quantity over quality will bring in piles of hidden dangers and disputes at home and abroad, and such kind of growth is not sustainable and therefore not advisable. In addition, we need to take a scientific perspective when looking at such a view that the scien-tech content of demand side should be increased. The key is whether China’s share of added value will hit a sharp rise and whether our efficiency will see remarkable improvements; otherwise, we will always be encountered with structural puzzles on the supply side. The use of administrative measures to control and cope with individual conflicts, e.g. the CPI issue, will only result in temporary effect, which will never last long.

Fourthly, the development of the banking sector needs fundamental supports from public policies. First, public policies should be conducive to the sustainable development of economy and finance. Currently, China’s economy is very dependent on land finance and foreign capital, which has brought in enormous problems. Therefore, efforts should be made to, in the spirit of matching fiscal power with administrative power, rationalize the fiscal allocation relationship among governments at various levels, and improve local fiscal and taxation systems. In addition, local finance department should develop local balance sheets to improve the transparency of assets and liabilities on and off-sheet, and set up a direct financing mechanism accordingly. By dosing so, such problems as intentional failure to implement policies, policies being implemented at central level but overlooked at local levels, or failure to implement policies due to objective reasons, will be eliminated. The 12-Five Year Plan and the central economic work conference have set forth requirements for us to press ahead with various works. Second, we should fend off the negative impact that may be caused by the “rushing in and out” of international speculative capital. Some countries have adopted the unremunerated reserve requirement, and some have begun to levy inward investment income tax or financial transaction tax. These methods and measures are good example for us to draw on if we are to live more secure in the globalized world. Third, we should accelerate the effort to foster a competition environment that values integrity, equity and orderliness. It is therefore important to promote the development of credit system, strengthen credit supervision and punishment against bad faith, reduce the moral hazards facing various sectors, and build a highly democratic, civilized, modernized country under the rule of law. In deed, credit culture is the most important element of cultural building, which requires vision and systematic development.

Ladies and gentlemen, at a time when everybody is eyeing on Asia and China, I feel that we should remain more cool-headed and sober-minded than ever in history. The coming 5 to 10 years is crucial for China in the international competition. As a member of the financial supervisors, I feel heavy responsibilities on my shoulder. I hope that all of us had shared commitment and concerns so that we would work hard together to live up to everyone’s expectations.

Thank you.

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Copyright: China Banking Regulatory Commission
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