Banking in India and China

INB 311

India and China

Dr. Lairson

Finance

Banking in India and China

China:

The Chinese government has always controlled the financial system as a core feature of its economic policy. This was true under Mao and under Deng.

The Chinese banking system reflects the overall system of state capitalism:

Central Bank – Peoples’ Bank of China (PBOC)

Large State-Owned Banks (IPOs with partial private ownership)

Bank of China
China Construction Bank

Industrial and Commercial Bank

Agricultural Bank

Local and ministerial state-owned banks (partial private and foreign ownership)

Shanghai Pudong Bank

Other Mixed state-private banks

Private regulated banks

Wenzhou model

Private shadow banking system (mostly unregulated)

Foreign owned banks

tightly controlled except in Shanghai Free Trade Area
low market share – 2% of bank assets

Chinese government controls interest rates:
High savings

Low rates for borrowing

Encourage investment and savings and discourage consumption

Liberalization of Interest rates

Now banks can charge market rates

Soon banks can pay market interest rates for savers

Chinese SMEs have trouble obtaining credit

Chinese Bank Lending:

Source: McKinsey

Does Size Matter?

Shadow Banking In China

What is a shadow bank?
Why do shadow banks exist?

Expansion of private and SME sector in China
Poor access to credit

Demand for credit creates high price and supply of funds follows

Low interest rates to savers in China creates demand for higher returns

“Trusts” (Regulated by China Banking Regulatory Commission (CBRC)

Poor access to credit for consumers

Example of Yangzijiang Shipbuilding (Entrusted Loans)

IN THE town of Jingjiang, a few hours’ drive from Shanghai, Yangzijiang Shipbuilding is making 21 huge container ships for Seaspan, a Canadian shipping firm. An enormous sign declares, “We want to be the best shipyard in China.” It is certainly among the most profitable, earning 3 billion yuan ($481m) last year. But only two-thirds or so of that came from building ships. The rest came from lending money to other companies using a local financial instrument called an entrusted loan. This puts Yangzijiang at the forefront of another industry: shadow banking.

Over two-fifths of Yangzijiang’s loans go to property developers in smaller Chinese cities; land makes up nearly two-thirds of its collateral.

Trusts

Several trust products have defaulted, although investors in most of them have got their money back one way or another. Over $400 billion-worth of trust products are due to mature this year—and borrowers will want to roll over many of those loans. Many observers worry that investors will lose faith in trusts, prompting a run, which may, in turn, blight certain industries and other parts of the financial system. No country, pessimists point out, has seen credit in all its forms grow as quickly as China has of late without suffering a financial crisis.

Network (Guanxi) borrowing – Hangzhou

Potential Chinese Banking Crisis

Lending patterns

Local government borrowing and infrastructure development

Non-performing loans

Real Estate bubble from empty Chinese houses (condos)

IHS, a consultancy, recently predicted that such a property crash could reduce China’s GDP from a forecast 7.5% this year to 6.6%, and to 4.8% next year. That may not sound like the end of the world, but by China’s standards, it would be an alarming slowdown.

India:

Basic Features:

Central Bank – Reserve Bank of India(RBI)
RaghuramRajan – head of RBI

Strong liberalizer

Commercial Banks

State-Owned banks –Public Sector - 27 banks

State-Owned Rural Banks – Regional Banks – 196 banks

Public Banks dominate Indian banking system – 90% assets; 75% loans

Commercial Private Banks

RBI Plans to expand licenses for banks

Non-bank banks

Specialized Banks

Investment Banks

Development Banks
Mutual Funds

Microfinance

Foreign Banks – 5-6% of India bank assets; plans for liberalizing foreign banking in India

In 1969, India’s PM Indira Gandhi nationalized the banking system, an action that seemingly gave the Indian government comparable control over the Indian finance.

Reform has been partial and has left a strange mixture of public and private.

• Public banks still dominate and provide ¾ of all loans even as foreign banks provide about 5%.
• Private banks are important, even as a major role is to finance government debt. Banks must put 23% of capital in government bonds, 4% in Reserve Bank of India, and direct 40% of loans to priority sectors, mainly agriculture.
• There is a large – but uncertain sized – shadow banking system.
• There is a substantial non-performing loan (NPL) volume and many include politically connected firms.
• The most sophisticated part of Indian banking is carried out offshore and is linked to foreign banks.
• The system remains subject to rapid declines in the value of the rupee

The Indian financial system is burdened by the fiscal difficulties of the government:

Permanent fiscal deficit, persistent current account deficit and large external debt.

Much is a result of flat revenue despite growing economy and using budget to win votes

Financial system must supply funds for the deficit and finance the borrowing needs of the private sector

Capital controls and Hot Underground Money

In Guangdong, Pearl River Delta cities like Zhuhai, Shenzhen, Guangzhou and Dongguan are major underground conduits for Chinese hot money. The province, where imports and exports amounted to $984 billion last year — a quarter of Chinese foreign trade — has served as a portal for capital flows since China’s economic opening three decades ago. Collectively, the cities are a hotbed of underground banking that also extends to Macau and Hong Kong. Macau, a gambling center, and Hong Kong, a global financial hub, are special administrative territories of China, with financial systems separate from the mainland’s.

In Zhuhai alone, more than 1 billion renminbi is transferred daily through underground networks, according to six agents who spoke to Reuters — part of a tight-knit group of some 100 agents operating in the border area. “Our business has gone up some 30 percent in the past three years,” said one agent, who gave his name as Li.

Globalization of the RMB

Exchange Rates

Pacific Exchange Rate Service

US Dollar and Chinese RMB -2005-present

1RMB = XXX $

1 $ = XXXRMB

US Dollar and India Rupee

India Exchange Rate

The trigger for the rupee’s 30% slide against the dollar from May to August, as well as for declines in the currencies of Indonesia, Turkey and some other emerging markets, was fear over their growing balance of trade and current account deficits. For years, financial markets ignored this issue. Then, suddenly, after the U.S. Federal Reserve announced in May that it was likely to soon begin reducing the size of its $85 billion monthly bond purchases, the focus turned to current account deficits in emerging countries.

India and Energy

Highly regulated fuel prices for consumers, fuel subsidies that are shouldered by the government and state-owned upstream companies, and inconsistent energy sector reform currently hinder energy project investment. Some parts of the energy sector, chiefly coal production, remain relatively closed to private and foreign investment, while others such as electric power, petroleum and other liquids, and natural gas have regulated price structures that discourage private investment.

About 30% of India’s energy needs are met by petroleum. But some 80% of this oil is imported — the major factor behind the country’s ballooning trade and current account deficits. In the fiscal year ending March 2013, India’s net oil import was 2.6 million barrels per day (bpd), at Brent crude prices averaging $110 per barrel. Over the past decade, the more than five-fold rise in India’s net oil import bill to $109 billion last year enlarged its trade deficit to $196 billion, causing a current account deficit of $88 billion or 4.8% of its $1.8 trillion GDP. It is this data that hurt the rupee last summer and led some nervous foreign investors to pull their money out of the country.

A puzzling aspect of India’s oil imports is that domestic refining capacity is four million bpd, 400,000 barrels more than domestic consumption. Most of the recent capacity increase has come from Reliance Industries’ 1.2 million bpd complex in Jamnagar and Essar Oil’s 400,000 bpd plant in Vadinar. These privately owned plants are expected to help reduce imports as well as boost exports of higher-value refined products. But Indian refiners are likely unable to compete in global markets, unless subsidized by the Indian government, against lower-cost producers from the Middle East, especially Qatar, given their far cheaper input costs.

India’s proven crude oil reserves are estimated to be about 5.5 billion barrels, with 53% of it onshore and the rest offshore. That is barely enough to meet domestic consumption over the next four years. Exploration and production of major oil deposits, if any, take decades. The railways and coastal shipping, using India’s long coastline, are both highly energy-efficient transportation alternatives that will sharply reduce oil imports. But to do this, as well as develop other major sources of energy like solar and nuclear plants, the Indian government will have to spend hundreds of billions of dollars, a difficult prospect since India is also running a budget deficit which was officially put at 5.2% of GDP last year.

So, policies to curb the growth as well as sharply reduce consumption of petroleum products need to be aggressively implemented. But the Indian government spends an estimated US$25 billion a year to subsidize the purchase of diesel, kerosene and other petroleum products that benefit farmers, truck transport operators and car and other automobile owners. Last year, there were 2.7 million cars sold in India plus 800,000 commercial vehicles and 13.8 million two-wheelers, such as scooters and motorcycles

Source: Economist