Stability achieved; now, efficiency

During the banking reform in the past decade, State-owned banks have achieved the short-term goal of "stability" through restructuring and the introduction of strategic investors. However, it is hard to say how much they have achieved in terms of the long-term goal of "efficiency".

Banking reform in China over the past decade has had three main features:

First, the primary goal of the reform is to maintain stability rather than to improve efficiency.

Second, the opening-up policy is so far viable only to State-owned banks and not to the entire banking sector.

Third, the institutional mechanism for progress is not consolidated and the reverse is likely to occur.

China's commitments to the World Trade Organization mean that it needs to open up the banking sector further, allowing foreign banks to compete domestically with State-owned banks. However, State-owned banks would feel the heat from increased competition, and would need to take steps to reduce leakage of market share to their foreign competitors.

Before China entered the WTO, I had remarked in an article that the opening-up of the banking sector and the reform of State-owned commercial banks should go hand in hand. If reforms lag the opening-up process, it would lead to higher systemic risks for the banking industry. The reform of State-owned commercial banks is not just about their own future, but is also linked to the overall economic and social stability.

At that time, speeding up banking reform had become a "consensus". If you look at the details of that consensus, you will find some differences with the need to balance the short-term and the long-term goals the main focus of discussions. Improving efficiency and better supporting economic growth in the long run and reducing financial risks in the short term were other objectives.

A perfect reform program should in theory be able to handle both these factors, but for the decision-makers at that time it was not that easy a task to achieve. All they could do was to take one decision and ditch the other. The result was short-term "stability" got the upper hand over long-term "efficiency".

The thought process at that time was that as long as there was no financial crisis in the short term, there was always a chance to solve the long-standing problems. On the contrary, if a financial crisis breaks out, the long-term scenario is even more uncertain, and the opportunity for reform may be lost altogether. And how short can the "short-term" be?

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