Nout Wellink
Introduction
After leaving DNB, I was involved in Bank of China (BoC) and Industrial and Commercial Bank of China (ICBC) for ten years (from 2012 to 2022) as an independent non-executive board member. ICBC is, by total assets, by far the largest bank in the world. BoC ranks fourth in the world rankings.
Both banks are so-called state-owned banks and of great importance to the economic policies of the Chinese authorities. Close involvement in the governance of these banks has given me a good insight into the government’s economic policy intentions and how these policies are implemented.
My experience extends only to the big Chinese banks. These are well capitalized and professionally run, but are very large. ICBC’s balance sheet total, for example, is over $6 trillion. Number 2 in the world rankings is J.P. Morgan with “only” a balance sheet total of $3.8 trillion.
The financial and anti-competitive risks associated with extremely large banks (systemic banks) are significant, necessitating costly bailouts if they get into trouble. They are “too big to fail. Hence, after the 2008 financial crisis, all kinds of risk-limiting requirements were imposed on these banks and orderly liquidation became a possibility. This regime also applies to Chinese banks, although they operate in a completely different universe and the question is rather whether they are ‘too big to manage’.
Causes and consequences of scale
Scaled to the size of the Chinese economy, the balance sheet total of a bank like ICBC (about 30% of GDP, the gross domestic product) is not too bad in a way. That of, say, ING is more than 100% of the national GDP, but by contrast that of J.P. Morgan is only about 15%.
That some Chinese banks have become so large should not be explained so much by the colossal size of the country, but mainly by its previous use as a financial ‘conduit’ for government policies and by the underdevelopment of financial markets. Because of the latter, alternatives for bank financing were insufficiently available The major banks have gone from being a ‘conduit’ to becoming a bankable channel for financing the economy for government, business and consumers. In doing so, ‘Serving Society’ is paramount. At ICBC, a special committee has been created under the Board to give substance to this social responsibility; the Corporate Social Responsibility and Consumer Protection Committee.
At the time of the Corona crisis, when the signal came from the government that the banking system should come to the aid of small and medium-sized enterprises, the first reaction of one of my Chinese colleagues was, “Of course, but it has to be done in a bankable way. Only if we as a bank are financially sound can we continue to serve society.”
Advantages and disadvantages of scale and central control
The size of the banks where I have worked has made me more aware than ever of the advantages and disadvantages of scale, especially when combined with strong central control by authorities. Central control can optimize the cost advantages associated with scale and allows for rapid progress and long planning horizons. This allowed China, for example, to install more wind and solar power in 2023 than the rest of the world combined.
However, the combination of central control and scale is not without risks. If mistakes are made, the negative consequences are immediately very large. For example, misjudging the demand for solar panels initially created large overcapacity, leading to dumping practices and thus international trade conflicts. Overcapacity occurs with some regularity in China and is again feared internationally with regard to electric cars, for example. Care must be taken here not to throw out the baby with the bathwater and too easily assume unfair competition.
The bill for unjustified de-globalization may well be a lot higher than often assumed
The “mind-boggling” size of China’s major banks (ICBC has 750 million account holders, ING 10 million) requires the deployment of high technology. Scale therefore provides a huge incentive to push technological boundaries for operations. So it is not surprising that a lot is invested in technology and associated highly skilled staff. I have had the opportunity to witness this very closely.
Scale also enables the use of huge databases. As a result, artificial intelligence is playing an important role in risk management. When a bank like ICBC adds 20 million account holders in a year, these kinds of techniques have to be used.
The far-reaching use of technology also creates problems and risks, including in the areas of privacy and legal protection of citizens. These problems obviously play out outside the financial sector as well.The Chinese operating model
The Chinese economic governance model is characterized by central political direction from the Communist Party and economic decentralization. The balance between these two sides of the model, where the broad outlines of policy are set by the Party and implementation takes place at a lower level – provinces, cities, private enterprises – is a delicate, dynamic balance and not always in equilibrium.
In recent years, the Communist Party has been pulling its strings tighter. Illustrative is the increased role of so-called Party Committees, not only in state-owned enterprises but much more broadly in society. A bank like ICBC has a corporate governance structure similar to Western banks, but with the important difference being the existence of such a Party Committee. This reviews the bank’s policies against the policies of the Communist Party.
For my part, it has often been pointed out during meetings that this is potentially a fundamental departure from international corporate governance, as the Board is in danger of losing its position as the ultimate decision-making body. The retort was then always that the Party Committee only has an advisory role. Formally that may be true, but that advisory role has clearly become more pronounced and compelling in recent years
In my years at the two Chinese banks, by the way, there have been only positive signals from the Party Committee for the bank, for example, with regard to the necessary equity capital, the level of provisions, the fight against corruption, the customer complaint system, etc.
Unwanted side effects
Overly rigid regulations imposed from above can lead to unforeseen and unwanted side effects. This is a well-known problem, even in the Western world. In China, however, these problems are potentially greater because corrective institutions and legislation are not yet sufficiently developed and only new regulations can provide a solution.
For example, the interest rate of account holders at banks, kept artificially low for a long time (in order to finance state-owned enterprises cheaply), led to a huge flight towards non-supervised institutions. After all, a much higher interest rate could be obtained there. Furthermore, cheap bank financing deprived SOEs of any incentive to operate more efficiently. And, of course, low interest rates also contributed to high housing prices.
Another example of undesirable side effects: Provinces and cities compete with each other in sometimes out-of-control ways, because the success of local administrators led to an upward movement on their political career ladder. With great creativity, rules were therefore circumvented.
Provinces were therefore banned from borrowing at one point, but since the underlying impetus for administrators had not disappeared, they sought alternatives. The financing of projects that could make a good impression in Beijing, for example in the real estate sector; houses, roads, bridges, was arranged off-budget through so-called Local Government Financing Vehicles (LGFVs). These LGFVs, in turn, I saw the banks as areas of concern and problems to be solved.
Addressing unwanted side effects
Without going into details, my observation is that reforms occur in waves, mostly as corrective responses to unwanted or unintended developments of overly tight regulation. In the process, progress is made step-by-step, sometimes with another “Echternach step” backwards or sideways.
Clear progress has been made in the areas of interest rate liberalization and dealing with SOEs. The significant degree of interest rate liberalization reduced the impetus to invest savings outside the banking system. Furthermore, SOEs were pressured to reform through tightening financing conditions and bringing loans to the market for these companies. Instrumental in this were the banks, which had clear guidelines for increasing the efficiency of SOEs. Inefficient SOEs are obviously unattractive institutions for the government as well, and by now their profitability has improved markedly.
A step-by-step approach is characteristic of Chinese policy. With great regularity in my files I came across the remark: “stability during progress.” To avoid big mistakes, new policies are often tried out with pilots or small steps, for example through free trade zones.
Economic prospects
In the six decades since 1960 until the onset of the Corona crisis in 2020, the volatility of the Chinese economy has decreased significantly. Several rounds of reforms have contributed to this. A somewhat primitive measure of decreased volatility is the difference between the highest and lowest annual growth rates. This was, rounded off, 46% (!) in the 1960s, 13% in the 1970s, 11% in the 1980s, over 6% in the 1990s, and 6% and 3%, respectively, in the first two decades of this millennium. Particularly since 1978, when Deng Xiaoping came up with his major reform measures, China’s GDP development has become much less jerky.
For the coming years, a trend growth rate of around 5% or slightly below is obvious. This growth rate is in line with Chinese policy, which has shifted from high quantitative growth to a (much lower) quality growth. Quality comes before quantity and maintaining financial stability is an imperative prerequisite for the Chinese leadership.
Climate requirements, technological progress and “common prosperity” are major focal points of Chinese economic policy. Actually, these are the same spearheads as in the Western world, except that economic policy will continue to be characterized by so-called “Chinese characteristics” and technology a hot topic and source of potential conflict.
It cannot be denied that, contrary to the above, sometimes confusing and surprisingly harsh measures are taken when negative side effects have been allowed to fester for too long. Sufficient explanation and transparency are then often lacking. All this makes assessing what is really happening in the economic sphere and more broadly in China and why it is happening not easy.
The plank is often missed
Therefore, when assessing economic developments, the Western press often goes wrong. During my ten years at BoC and ICBC, I had the opportunity to read many times that the Chinese economy was more or less on the verge of collapse. And then they would come up with Western recipes for solving the supposed problems, without having sufficient insight into the causes of the problems, the mechanisms at work in China and the typical Chinese possibilities for addressing these problems.
To understand China and engage in meaningful dialogue with it, there must be a willingness to look at society and the economy through Chinese eyes and with sufficient knowledge. Of course, this does not mean that one must then agree with everything one sees, but it does mean that the basis for a meaningful dialogue is laid.
