Chinese banks get results, but their methods don't stand up to scrutiny

Outlook

As if Beijing doesn’t have enough to worry about as it tries to calm the nerves of increasingly panicky investors in China’s slumping stock market, the World Bank has lambasted its financial system as “unbalanced, repressed, costly to maintain and potentially unstable”.

In a report calling for “urgent reform”, it highlights what it sees as the risks inherent in a “distorted” financial system. Given China’s importance to the global economy it makes for sobering reading, painting a picture of politically driven, state controlled banks funnelling cheap money to all the wrong places, while impotent regulators look on.

These include state-owned enterprises, which waste cheap money on bad projects while small and medium enterprises are starved of funds; and local authorities, which rely on bank borrowing in lieu of an effective system of taxation.

The corollary of cheap loans, of course, is that depositors are paid a pittance and as a result Chinese people are said to have turned to riskier alternatives such as the shadow banking system.

The report’s suggested solutions won’t come as much of a surprise to anyone, given its publisher: stop interfering, beef up the regulators, divest large parts of the state’s holdings and manage what remains at arms length. For which read: become more like the West.

It would be very easy at this point for Beijing to point to the 2008 financial crisis and suggest that much of what the World Bank is recommending for China was theoretically in place in Britain and the US then. It didn’t work out too well.

It could also point to The Banker magazine’s annual rankings of the top banks by profits and capital strength, where Chinese banks dominate.

This is hardly the first report to raise issues with the way China’s increasingly powerful banks are run, but, while China has confounded its critics on repeated occasions, banking systems are prone to crises. One in China may be overdue. Regulators in Britain and Europe might therefore do well to include such an event in their stress tests.

It wouldn’t do any harm to test the ability of the banks they are responsible for to withstand such an occurrence.