Reforms to China’s banking industry needed

Asia World

Author: Yong Tan, University of Huddersfield

Despite sustained growth, data is highlighting potentially significant issues within the Chinese commercial banking industry. Implementing a series of reforms are needed and would raise efficiency and improve stability.

Staff members work at counters inside a branch of Industrial and Commercial Bank of China (ICBC) in Beijing, China. 1 April 2019. (Photo: Reuters/Florence Lo)

Staff members work at counters inside a branch of Industrial and Commercial Bank of China (ICBC) in Beijing, China. 1 April 2019. (Photo: Reuters/Florence Lo)

Examining the three main ownership types of Chinese commercial banks — state-owned commercial banks (SOCBs), joint-stock commercial banks (JSCBs) and city commercial banks (CCBs) — reveals startling discrepancies in executive pay. Although SOCBs have the highest after-tax profits, top SOCB executive pre-tax salaries are less than 1/7th that of comparable JSCBs. While non-performing loan ratios in the sector climbed to a 10-year high in 2018, risk levels among these three different types of banks are very similar.

According to the annual financial statements published by the different banks in 2017, among the five SOCBs, the chairman of the Bank of China has the highest before-tax salary of 0.7 million RMB (US$100,000). In comparison, the before-tax salary of the president of the China Merchants Bank (a JSCB) hit 5.22 million RMB (US$750,000) and the chairman and president of the Bank of Ningbo (a CCB) each received before-tax salaries of 2.7 million RMB (US$390,000).

This data reveals a very serious issue in the Chinese banking industry — why do the management staff of SOCBs have a significantly lower level of before-tax salary compared to the JSCBs and CCBs, considering that the SOCBs have the highest level of after-tax profits but a similar level of risk? And why should the Chinese Government take this seriously?

Critically, failing to balance performance and salaries can contribute to perceptions of unfairness. This can have a negative influence on their work.

But the mechanisms for rewarding chairmen or presidents of SOCBs are different than with JSCBs and CCBs. Unlike in JSCBs and CCBs, SOCB executives can be elected as alternative members of the Communist Party central committees. 20 people from more than 100 state-owned enterprises are elected. The chairman of the Bank of China, the chairman of the Industrial and Commercial Bank of China, the president of the Agricultural Bank of China and the chairman of the China Construction Bank are alternative members of the 19th Central Committee — a high honour and a glowing recognition of personal achievements. This is a strong stimulus for performance among SOCB management staff.

In addition, chairmen of the SOCBs also have the possibility to be further promoted as government officials at the city or provincial level. Notable examples include the previous chairman of the Agricultural Bank of China, Jiang Chaoliang — now a member of the 19th Central Committee and the Secretary of the Provincial Party Committee in Hubei — and the former chairman of the China Construction Bank Guo Shuqing, who served as governor of Shandong Province from 2013–2017.

Yet the chances for political promotion are nevertheless slim. This raises the question of whether salary increases would be a more effective way to encourage performance amongst SOCB chairmen and presidents. On the other hand, such high before-tax salaries for the chairmen and presidents of the JSCBs and CCBs are not an optimal allocation of resources and could lead to reduced bank efficiency and profitability.

Beyond executive pay, other issues are receiving insufficient attention in the Chinese banking sector.

China completed the process of interest rate liberalisation by the end of 2015 in the hope that a market-driven rate would increase competition within the industry. To gain competitive advantage and improve sustainable development, Chinese commercial banks are encouraged to increase funding for research and development. New business models derived from innovation will give a competitive edge to these Chinese commercial banks.

The Chinese government and banking regulatory authority should consider expanding the use of technology. A relevant mechanism could be established levying digitalisation rather than human labour in loan businesses. By digitising more information regarding an enterprise’s loan application, appropriate interest rates, loan periods and debt risk would all be determined faster. A system of automatic rejections and approvals would cut costs while even potentially reducing the incidence of non-performing loans.

This idea has not been put into practice yet and does carries downsides. It would likely result in large-scale layoffs. Additionally, digital systems and software do not always fully capture the information of borrowers, potentially leading to biased or misguided loan decisions. Every coin has two sides and the consideration and implementation of this recommendation should undergo a series of reviews.

This process hinges on developing suitable digital systems and software. The layoffs resulting from this is not necessarily a bad thing, because the labour can be used in other departments or other activities, leading to a more optimal allocation of labour.

Yong Tan is Senior Lecturer of international business at the University of Huddersfield. He is the author of the books ‘Investigating the Performance of Chinese Banks: Efficiency and Risk Features’ (2016, Palgrave Macmillan), ‘Efficiency and Competition in Chinese Banking’ (2016, Elsevier) and ‘Performance, risk, competition in the Chinese banking industry’ (2014, Chandos Publishing).