By Zhu Qiwen

A bonanza year seems to be just around the corner for Chinese banks as their flotation draws ever closer.

But caution against regulatory weakness remains an urgent need.

With two of China's "Big Four" state-owned banks - the Bank of China and the Industrial and Commercial Bank of China - recently reporting healthy profits for the first half of the year, it looks as if all the State's bail-out efforts have worked.

It has become a consensus among China's banking sector that the introduction of foreign companies as strategic investors will help increase capital strength, optimize capital structure and diversify ownership of domestic commercial banks.

To facilitate the transformation of major state-owned banks into modern shareholding commercial banks, the State has tried a wide range of supportive measures including an unprecedented capital injection with US$45 billion from the country's foreign exchange reserves into the China Construction Bank and the Bank of China at the end of last year.

This year, the central government selected the two big State banks to issue subordinated debt to raise their capital adequacy in preparation for kicking off the initial public offering process.

With such support State banks are vowing to become competitive heavyweights in the global financial market.

However, in marked contrast to the domestic enthusiasm, foreign investors think differently.

Foreign investors would rather expect Chinese banks to demonstrate stronger investor values before they step in, said Sir Howard Davies, director of the London School of Economics and Political Science.

In a recent speech delivered at the China Center for Economic Research of Peking University, Davies, the former deputy governor of the Bank of England, indicated Chinese banks should, to a certain extent, improve their management before inviting foreign investors.

At a time when China's banking reform is approaching the make-or-break point, an open mind to various suggestions is surely needed.

China has one of the largest banking markets in Asia. Its banking sector held 29.2 trillion yuan (US$3.53 trillion) worth of financial assets at the end of May, accounting for more than 90 percent of the nation's total financial assets.

China's future economic growth thus, to a large extent, hinges on the reform of the banking sector.

The banking authorities deemed that finding strong international partners for the four big State-owned banks and exposing them to market discipline was the way to turn big State banks into genuinely commercial lenders.

The banking regulators established rigid criteria on the amounts and ratios of non-performing loans as well as the ratio of capital adequacy for those domestic banks who want to get listed.

Foreign banks will gain full access to the Chinese market in 2007 in accordance with China's commitment made upon its entry into the World Trade Organization (WTO). That means time is pressing.

It is true that all Chinese banks have devoted themselves to improving their assets quality by trying every means to reduce non-performing loans in recent years.

Nevertheless, the National Audit Office recently revealed that the local branch of Bank of Communications in Jinzhou, a northeast China city, willfully wrote off bad loans with counterfeit legal documents.

The case highlighted the danger of laying too much emphasis on reducing bad loans in absence of proper internal supervision.

Banks' efforts to lower their rate of non-performing loans and get rid of historical financial burdens should not come at the cost of necessary prudence in management.

A more serious problem is the quality of new loans domestic banks extended in recent years.

Without substantial improvement of their management, it is still too early to judge the lending decisions domestic banks made in the past few booming years.

As the Chinese economy slows to catch its breath, this problem surely calls for more attention from banking regulators.

"The global regulatory system is, in an important sense, only as strong as its weakest link," noted Davies.

The same is true for China's banking regulatory system.

To avoid a repeat of past problems, when rapid expansion left banks with many non-performing loans, particularly to State-owned enterprises, banking regulators must take significant steps to goad domestic banks to overhaul their system of checks and balances.

In addition, as domestic banks are set to embrace the global market, they should be ready to meet international standards.

As Davies correctly pointed out, many, perhaps most international regulatory standards have been developed without reference to the particular needs of developing countries.

But that does not guarantee nominal compliance with international standards.

If Chinese banks are to take their place in the global economy, they must meet both high capital requirements and strict regulatory standards.

"It is easy to say that one will upgrade one's regulatory system, but that is much harder to do in practice," Davies said.

Domestic banks should learn to say "no" to pressing demands for credit.

As well, China's regulating authorities should also learn to say "no" to domestic banks' continued malpractice.

(China Daily July 16, 2004)