The modern financial organizational system should consist of different forms of ownership of banks, including State-owned banks, shareholding banks and private banks.

The development of non-State financial institutions, including private banks, is required for the development of the forces of production, the further opening of the economy to the outside world, and the co-existence of various kinds of ownership.

In the past few years, China witnessed the rapid development of its private economy.

The private economy has become an important driving force of overall economic development.

In coastal areas, the private economy accounted for more than half of the region's total gross domestic product.

The change in economic structure requires financial institutions to provide more efficient services for the private-sector economy.

However, State-owned commercial banks, which control the majority of the country's financial resources, are reluctant to offer loans and other services to private companies.

This situation remains despite the government's continuous efforts to urge financial institutions to increase support for these companies.

So private banks - which are more flexible and beneficial for the private economy - should be set up.

In recent years, the relevant government departments have repeatedly said that China would open up its energy, telecommunications and finance industries to private Chinese companies before they were opened up to foreign investors.

In January 2002, the central government said that private Chinese investors will be encouraged to invest in areas in which foreign companies can invest.

The doors allowing private capital to invest in banks are opening.

Now that China is a member of the World Trade Organization, the development of private banks will help inject vigour into domestic banks and increase the competitiveness of the entire banking industry.

The finance industry acts as an economic lifeline. But this does not mean the State will have to monopolize the industry. In fact, banks are a kind of company specially engaging in the money business.

So long as banks, with different ownership, abide by the relevant commercial banking laws and regulations and try to improve their business management, they can achieve good results and play an important role in economic development.

Since private banks usually have a clear ownership structure, flexible mechanism and excellent personnel, they are always welcomed by small- and medium-sized companies and other parts of the non-State economy. Private banks have a bright future.

As China's financial reform goes further, State-owned commercial banks - which have too many departments and outlets, as well as too many employees - have begun to streamline their structure and shift their business focuses to large and medium-sized cities.

This provides enormous development opportunities for small and medium-sized financial institutions, including private banks, to develop business in smaller cities and the country's vast rural areas.

Earlier in 2002, officials from the People's Bank of China announced that the central bank had agreed in principle to allow a city at prefectural level or above that does not have any city commercial banks to set up new commercial banks, if the banks are in line with the requirements of the commercial banking law and if each bank's capital funded by local companies and individuals reached 100 million yuan (US$12 million).

This suggests that there are no policy barriers for private investors to apply to establish a private bank.

In March 2001, six large private companies in Southwest China's Chongqing Municipality applied to launch the Huakang Bank. The application has basically been approved by the local government and the central bank.

The second way to establish a private banking system in China was to absorb private investment to form privatized rural shareholding commercial banks in rural areas.

In 2001, the relevant government departments began to prepare for the establishment of rural shareholding commercial banks in Changshu, Zhangjiagang and Jiangyin cities in Jiangsu Province.

The banks were based on the areas' rural credit co-operatives. They also absorbed rural residents, individual entrepreneurs and medium- and small-sized companies run by farmers as their shareholders.

The banks mainly serve local rural residents and companies.

Most urban credit co-operatives have a high rate of non-performing loans and face being kicked out of the market.

But a number of excellent urban credit co-operatives could be developed into private banks, so long as the relevant government departments help them improve their ownership structure and management level.

In April 2002, eight city commercial banks in East China's Zhejiang Province announced that they would welcome the participation of excellent private companies.

This indicates that some medium- and small-sized city commercial banks have plans to turn themselves into private banks.

It is estimated that China has more than 12 trillion yuan (US$1.446 trillion) in private capital.

If some of this capital entered the banking industry, the commercial banks would have sufficient capital.

But China will have to take a prudent attitude when developing private banks.

The country still needs to do a lot of preparatory work before fully opening the financial market to private capital.

The experiences of foreign countries suggest that the entry of private capital into the banking industry entails great risks.

New banks are always prone to have problems and to become bankrupt compared with large qualified banks.

As a result, regulators - including the central People's Bank of China - will have to map out detailed regulations regarding such areas as approval procedures, capital adequacy and the qualification of shareholders.

Most private companies are eying the banking industry because the industry could help raise their image and reputation. Investing in the banking industry could also earn them higher profits.

If China does not establish regulations on market access and quickly open the sector to private capital, private investment may flood in.

If unqualified members entered the banking industry, the result would be disastrous.

China will also have to set up an "exit" mechanism for private banks.

If a private bank has problems in its business operations or has difficulties in paying depositors or faces possible bankruptcy, who will be responsible for the bank? How will depositors' interests be protected? How will private banks be prevented from shifting their risks to the central bank?

The "exit" mechanism would help solve these problems and force private banks to choose high-quality managers to improve their business operations.

Although private banks are non-State financial institutions, they will have to be supervised and regulated by related government departments.

The author is a professor at Beijing-based University of International Business and Economics

(China Daily January 6, 2003)