CHINA has suggested its decision to roll out deposit insurance for bank accounts beginning on May 1 will usher in a wave of creative destruction, chastening the cronyism that plagues the country.
And there is some logic to the official spin. There is a flip side, after all, to Beijing’s declaration that normal consumers will be kept safe in a period of market turmoil — namely, the banks themselves could be permitted to go bust.
If there were reason to believe that would really happen, it would be an important step toward straightening out China’s financial system, and to achieving the country’s longer-term goal of making the yuan a global reserve currency.
Unfortunately, China’s system of moral hazard will not be worth much until it passes far more ambitious financial reforms. Here are three reasons why.
First, China’s banking system is still very closely tied to the state. China has a long history of organising bailouts for state-owned companies, including one of Asia’s biggest-ever bank bailouts in 1998.
“As long as banks are state owned and senior officers are appointed by the organisation department of the Communist Party,” says Shanghai-based Andy Xie, former Asia-Pacific chief economist at Morgan Stanley, “reforms will always be superficial.”
When Beijing allowed the solar company Shanghai Chaori Solar to default on domestic bond payments in March 2014, it seemed to signal a shift. But that turns out to have been an aberration.
In the 12 months since, China hasn’t seen any further defaults. An important upcoming test will be how Beijing handles the Shenzhen-based real estate developer Kaisa, which could soon renege on its US currency notes. Whether Beijing lets Kaisa default will say far more about its commitment to capitalism than deposit insurance.
Second, China may not even know the extent of the problems in its financial system. Guan Jianzhong, chairman of China’s Dagong Global Credit Rating Group, recently told Bloomberg that the debt ratings issued by his “irresponsible” Chinese competitors are often “useless.” He went on to say that “the ratings are creating credit risks and blindfolding people, instead of revealing the risks.”
Questionable accounting practices also extend to China’s local governments, which have amassed at least US$4 trillion (RM14.68 trillion) of debt. Their use of off-balance-sheet financing vehicles means even Chinese President Xi Jinping doesn’t know the true magnitude of China’s debt profile.
Beijing won’t be able to accurately assess the risk of letting individual companies or banks to go bust until China’s regional finances are less opaque, its companies more shareholder-friendly, and its shadow-banking sector less massive.
Third, there is reason to doubt the commitment of Chinese policymakers to creative destruction. Consider China’s central bank governor Zhou Xiaochuan.
On Monday, he lowered mortgage requirement to save China’s markets from turmoil. He also assured Chinese investors that more such measures might be on the horizon, insisting “China can have room to act” to keep the economy afloat in tough times.
Zhou’s statement came at a time when China’s economy seems to be vastly overcapacity and on the downside of a credit glut — pushing the country toward deflation.
A government committed to capitalism would seize the opportunity to let creative destruction do its work: an economic slowdown could pop the country’s growing bubbles in credit and real estate.
Beijing, however, has so far shown little interest in cleaning up its decades of economic excess.
It is safe to say that China’s leading economic actors have taken note of this hesitance, and will continue to act accordingly — that is to say, irresponsibly.
And the creation of deposit insurance is unlikely to weigh very heavily in their decision-making. — Bloomberg View
William Pesek is a Bloomberg View columnist.
This article first appeared in The Edge Financial Daily, on April 3, 2015.