Vol 12 (2015) - Issue 1

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Potential Risks of Chinese Commercial Banks and Bankruptcy Legislation Development

Introduction
China launched its Reform and Opening-up Policy in 1978 and since then has been in the transition from a previous planned economy to a socialist market economy. The Chinese capital market and banking sector faced serious challenges and experienced significant changes. The reforms of Chinese enterprises promoted growth in the national economy on the one hand, and created the accumulation of non-performing loans (NPLs) on the other hand. This paper will try to analyse the reforms of the Chinese banking sector, the disposal of NPLs and its achievement, the potential risks within the Chinese commercial banks, and the development of bankruptcy legislation regarding Chinese commercial banks.

1 Generation, accumulation and disposal of NPLs from 1980s to 2000s
The generation and accumulation of NPLs of Chinese commercial banks can be traced back to the 1970s. In the early stage of the implementation of the Reform and Opening-up Policy, from 1979 to 1984, the 'big four' state-owned banks (Bank of China, Industrial and Commercial Bank of China, Agricultural Bank of China, and China Construction Bank) were spun off from China’s Central Bank, and they were expected to operate on a profit-and-loss basis. Prior to this, they were subject to the administrative order and often made loans to poorly operating state-owned enterprises (SOEs). Under the previous planned economy, these poorly operating SOEs had the responsibility for the social welfare of their employees. If they went bankrupt, the unemployed workers would lose their only source of income possibly leading to social unrest. Therefore, the government chose to sacrifice the interests of commercial banks in order to maintain a stable society. From 1990 to 1995, the non-performing loans rate (NPL ratio) of the 'big four' state-owned commercial banks increased from 12.2% to 21.4%, with the total amount of the NPL increased from RMB 220 billion to RMB 660 billion.
Several years after the 'big four' state-owned commercial banks were spun off from the Central Bank, in 1994, the central government launched the Capital Structure Optimalisation Programme (CSOP) in 16 pilot cities, later spread over the whole country, aimed at supporting financially ailing but still viable enterprises, and closing down those completely failed enterprises by administrative order instead of bankruptcy law and market rules. This was also called the 'planned bankruptcy'. It started from 1994 and lasted for 14 years to 2008, involving over 3500 economically distressed SOEs and about 6.2 million unemployed workers. During this period, the NPL rate of the 'big four' banks had increased sharply, in 1998 even reaching the rate of 40%. More than once were the 'big four' on the verge of insolvency.