| In the last 20 years there have been at least 10 countries that have suffered from the simultaneous onset of a currency crisis and a banking crisis. The result has been fullblown economic crises causing, in many of the cases, GDP contractions of 5 to 12 percent in the first year of the crisis, and negative or only slightly positive growth for several years after. Even countries with a high degree of transparency and sophisticated institutional structures have faced financial crises in recent years.The paper has nine chapters. The first chapter is an introduction. China has to manage the transition from a less opened to a more opened country while at the same time managing the transition from a planned to a market socialist economy. China's ability to do both successfully suggests two lessons about the pace and sequencing of reforms. The first is that introducing competition does improve performance and productivity. The second, that it is crucial to maintain social organization during these transitions and to create the institutional infrastructure that a market economy requires. The introduction outlines the main points of the banking reform.The second and third chapters discuss the financial risk during transition. China faces the difficulties of restructuring banking and financial systems. For in socialist economies, so-called financial institutions did not perform any of the functions that they do in modern market economies. Indeed, the name "bank" itself is misleading -and may mislead both policymakers and those inside the banks themselves. Under socialism, banks were not engaged in selecting and monitoring projects; production and investment decisions were made elsewhere; and the bank provided the finance only "under instruction." It provided a set of bookkeeping entries, a form of record-keeping, but banks were not key decision-makers. In modern market economies, they are the key decision-makers. Transforming banks from socialist to market institutions is thus not just a matter of changing ownership or control, but a watershed change in function and organizational culture. Without recognition of the importance of this change, attempts to restructure China's financial institutions will not be successful.The fourth chapter deals with the restructuring of SOBs(state-owned banks).This task of restructuring the financial sector is all the more difficult because it is not simply a matter of raising the capacity of SOBs. Implementing commercial banking principles is likely to be made more difficult by the absence of appropriate accounting standards elsewhere in the economy and the problematic nature of contract enforcement. It will therefore be very important to build this institutional infrastructure at the same time that China undertakes financial reforms.There has been recognition of the weaknesses in China's financial institutions and the need for a capital injection. Capital is needed to ensure that the banks meet capital-adequacy standard (which is important not only to protect the financial viability of the institutions, but also to ensure that the institution has appropriate incentives).If it were possible to determine the net worth of the banks today, satisfying the capital adequacy standards through a capital injection would be relatively easy; the capital provided to the banks could be viewed as an investment, and with appropriate capital accounting, this investment would not even show up in current budgets. Moreover, if done correctly, such expenditures would not necessarily beinflationary, but would only prevent a deflationary spiral that might start from financial failure and the resulting contraction in credit.As the new commercially based regime takes hold, banks should be given a chance to start with a clean balance sheet, rather than the poor ones that they have inherited. The process of recapitalization will require prudent management, however. Before proceeding with substantial capital injections, policymakers will need both lo know with some certainty the size of the hole i... |
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