Commercial vs Policy Loans: A Policy Dilemma After Global Financial Crisis

China put forward fundamental reform in the banking sector in the mid-1990s to commercialize the state-owned specialized banks. This reflected the central government’s determination to enhance the efficiency of the state-owned commercial banks (SOCBs) by separating commercial lending from policy lending. Though the banking reform in the mid-1990s could not completely change the credit culture and fully commercialize the SOCBs, the operations of SOCBs and their nonstate counterparts have been more responsive to market signals and discipline. Nonetheless, in order to maintain a stable growth after the 2008 Global Financial Crisis (GFC), the central government initiated a 4-trillion yuan stimulus package which fostered the proliferation of local government financial platforms (LGFPs) and rapid credit expansion through shadow banking. Substantial amount of credits were channeled to projects of low returns and even created sizable excess capacity. Deteriorating credit quality heightens the risks in China’s banking sector. Though central leaders are certainly aware of the risks embedded in the banking sector, the GFC in 2008 and the trade war in 2018 prompted the Chinese government to focus more on macroeconomic stability and thus policy loans at both central and local levels will remain as important levers to stabilize the economy.