Some Problems on Commercial Banking in China

In this paper, I discussed two problems faced by commercial banks in China in the early to mid 90's when inflation rate was high. The first problem is the use of interest rates indexed to inflation to stop disintermediation of bank deposits during the high inflation period. I observed that commercial banks cannot easily recover the additional cost of funds due to inflation from their borrower. Nor can the banks hedge the inflation risk in a public market. Banks accepting inflation-indexed deposits will then be exposing themselves to high bankruptcy risk. A proposal of offering deposit products that are denominated in RMB but indexed to gold or US$ prices is recommended as replacements for inflation-indexed deposits because for both deposit products, banks can hedge the fluctuations in interest rates through international public markets. The second problem is how banks can serve as effective monitors of economic performances of the State-Owned-Enterprises (SOEs) by allocating more credit to more efficient SOEs and by refusing credit to very weak ones. I review the problems currently faced by managers in the SOEs and in the commercial banks. I then recommend managers in commercial banks to be trained as effective loan managers capable of helping SOE managers build good businesses. Further, they have to conduct their own businesses in a very professional manner.