Report Warns of Risks to China’s Bank System
The article titled, “Report warns of risks to China’s bank system,” was published in New York Times on July, 15, 2010 (nytimes.com, 2010). It unleashes an interesting aspect about Chinese banking system and the emerging risks associated with its operations. It is highlighting the fact that Chinese banks are involved in aggressive lending operations which increases the probability of piling up non- performing loans and getting exposed to high financial risk. Moreover, these banks are repackaging their loans as investment products to take them off the balance sheet which surely is an alarming signal.
The analysis of the situation makes it evident that most commonly observed transaction that is increasing the propensity of risk in the banking system, is with trust companies which raise millions of dollars primarily because they provide depositors with double the saving rate and complete guarantee of principal. Hence, being in times of low interest rate and inflation, a large percentage of people deliberately want to get involved in such transactions. This entire deal is a complex one; however, it can be simply explained by considering a situation in which a bank lends money to a trust company, which in return would give equivalent amounts of cash to the bank. Then the company develops wealth management products like mutual funds, retirement funds and estate planning, insurance products etc, and sells them back to the bank. The bank then sells-off these products to the investors; generates sales and the trust company is given the money back. Hence, the entire process is nothing but hiding the loans; an act which has increased pressure on Chinese banks to strengthen their financial grounds. Although the entire transaction seems advantageous for the economy as a whole, because trust companies provide double return to investors, which might encourage people to invest more, in turn money supply in the economy increases. Moreover, banks are making investments which are beneficial for their clients, trust companies and banks themselves. However, the apparent situation is the disguised version of the darker side of the picture. In actuality, banks lend money to trust companies which surely is a loan; however it is stated as an investment on the balance sheets. This in turn poses extremely high risk of having piled up bad loans in the economy in future.
Relevance to Financial Management
It is significant to mention here that keeping the current operational activities of Chinese banking system in focus, it is required for the companies operating in China, to very prudently plan for their financing mode. Because banks are understating their credit growth as a result of which they are exposed to a lot higher risk than what is apparent. Hence companies’ financing from the banking system, can be choked because of non availability of fund in future, primarily because of piled up non-performing loans; the probability of which is becoming high in Chinese economy. Moreover for banks, raising capital will become all the more dire in near future because of the high risk they are exposed to. Hence they would have to make sure that their assets exceed liabilities so that they can show strong financial base for to remain in business.
I believe that regulators have to make sure that such activities in banks are curbed to the limit till which it does not hurt the economy, for e.g. they can set the percentage of investment made in trust companies out of the total investment budget. If it would exceed, banks will be fined. The limit of investment obviously would depend upon the size of the bank. In this way, not only investors will be satisfied of having double the return but banks will also not be able to disguise their loans as investment to an alarming level. Moreover, they also can lower the lending rates which can discourage lending, but at the same time lower borrowing rates will help many struggling and newer businesses to expand with expected expansion in the economy
It is predicted that Chinese banking system will not crash but if these bad loans will keep surging, it will certainly worsen China’s domestic balance. In the end, I believe that if the regulators will not control the level of these non performing hidden loans in the banking system, the economy might face another banking crisis.
Nytimes.com (2010). Report warns of Risks to China’s Bank system. Retrieved July 20, 2010, from http://dealbook.blogs.nytimes.com/2010/07/15/report-warns-of-risks-to-chinasbank- system/?scp=5&sq=balance%20sheet%20&st=cse