For Chinese reform, it's private banks or bust
Rate liberalization cannot occur until there is more privatization in banking.

TonyV3112 / Shutterstock.com

The annual meetings of China's National People's Congress this month offered two main signals about reform under President Xi Jinping. First, the battle has been joined in finance between the market's decisive role and the state's dominant role. Second, there is no battle outside finance-the status quo of state dominance was otherwise left almost entirely unscathed.

Outside finance, reform was noticeable only for its absence. Premier Li Keqiang's work report, traditionally the heart of these annual meetings, could have been presented years ago by reform-averse former Premier Wen Jiabao. From labor rights to competition for state-owned enterprises, the policy accomplishments remained few, while Mr. Li's promises were numerous and vague.

It is possible that Messrs. Xi and Li are sincere where their predecessors were not, but this month's policy documents fail to advance the ambitious, broad plan offered at last fall's Party Congress, which included such bold pledges as the integration of urban and rural land markets and generally seemed too good to be true.

Messrs. Xi and Li appear focused on macroeconomic stability, as China's leadership has been for most of the past five years. The true macroeconomic situation and the correct policy response are open to (much) debate, but the implication for market-oriented change is chilling. If difficult reforms such as opening the capital account won't proceed until macroeconomic conditions are acceptable, Beijing has caught itself in a vicious cycle: The long absence of market reform has led to macroeconomic weakness, which in turn is now inhibiting reform.

The best bet to break the cycle is finance. The People's Bank of China is leading the charge as it has for a decade, and Messrs. Xi and Li appear more willing than their predecessors to let the central bank move forward, as with its decision to widen the yuan's trading band against the dollar. Therefore Governor Zhou Xiaochuan made the loudest reform announcement of the National Party Congress, offering his opinion that within two years the ceiling on bank-deposit rates would be lifted.

This appears to be a big deal. The ceiling on deposit yields is the last major, direct interest-rate control remaining, and two years is an aggressive time frame for its removal. At this point in 2016, there may be no formal regulatory limits on the price of money. Given the extreme size of China's money supply-65% larger than America's-a competitive market price for money would be transformative.

But don't take that bet. Even if the ceiling is lifted in two years, there will be no competitive market price because there will be no competitive market. Banks may technically be free to compete for depositors, but they won't do so.

The reason is that state banks are too important a tool for the government. They cannot be allowed to fail or even totter because that would jeopardize their capacity to act as fiscal agents in crisis (as they did with massive stimulus in 2009). Approximately 90% of banking assets are owned by the state, so the vast bulk of the banking sector won't act competitively in 2016 no matter the situation with interest-rate controls. Authentic rate liberalization cannot occur until there is far more extensive privatization in banking.

That's why the real reform news this month was Beijing's approval in principle of five new private banks, which received far less attention. Officials have been unclear about timing, but the participants are intriguing. They include the conglomerate Fosun and the auto-parts giant Wanxiang, whose deep pockets have been illustrated by multiple investments overseas. More important, the group includes Alibaba and Tencent, the Internet titans that already have online banking businesses of sorts.

The creation of a competitive banking industry requires the private share of assets to climb sharply. Only if this happens can genuine competition ensue and a market interest rate emerge. The existing customer bases of Tencent (with a market cap of over $100 billion) and Alibaba (which appears headed for one of history's largest initial public offerings) suggest that they may be able to scale up especially quickly, pushing the process along despite the gigantic asset lead that state banks possess.

The National People's Congress was a disappointment, but it is true that an eventual market price for money would be transformative. The main thing to watch in coming months is how quickly Beijing's Bank Regulatory Commission moves on letting private banks open.

- Mr. Scissors is a resident scholar at the American Enterprise Institute.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Derek M.
Scissors

What's new on AEI

Defeating ISIS: AEI experts weigh-in before the president’s address on Wednesday
image Degrading, defeating, and destroying the Islamic State
image Wealth Building Home Loan: Building wealth through homeownership and retirement savings
image The $3 iPhone
AEI on Facebook
Events Calendar
  • 15
    MON
  • 16
    TUE
  • 17
    WED
  • 18
    THU
  • 19
    FRI
Tuesday, September 16, 2014 | 5:00 p.m. – 6:00 p.m.
The Constitution as political theory

Please join us for the third-annual Walter Berns Constitution Day Lecture as James Ceasar, Harry F. Byrd Professor of Politics at the University of Virginia, explores some of the Constitution’s most significant contributions to political theory, focusing on themes that have been largely unexamined in current scholarship.

Wednesday, September 17, 2014 | 8:10 a.m. – Thursday, September 18, 2014 | 1:30 p.m.
Third international conference on housing risk: New risk measures and their applications

We invite you to join us for this year’s international conference on housing risk — cosponsored by the Collateral Risk Network and AEI International Center on Housing Risk — which will focus on new mortgage and collateral risk measures and their applications.

Event Registration is Closed
Thursday, September 18, 2014 | 2:15 p.m. – 3:00 p.m.
Speaker of the House John Boehner on resetting America’s economic foundation

Please join us as Speaker John Boehner (R-OH) delivers his five-point policy vision to reset America’s economy.

Event Registration is Closed
Friday, September 19, 2014 | 9:15 a.m. – 11:00 a.m.
Reforming Medicare: What does the public think?

Please join us as a panel of distinguished experts explore the implications of the report and the consumer role in shaping the future of Medicare.

Event Registration is Closed
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.