According to the Financial Times the Chinese Industrial Commercial Bank of China (ICBC) has a problem. In its recent IPO in October, it raised $21 billion dollars. Of that $16.1 billion was raised in Hong Kong and remains offshore.
ICBC feels that the funds would be more useful if they were converted to renminbi. The problem though with exchanging that amount of dollars would put pressure on the Chinese currency to appreciate more than it already has. China has more than a trillion dollars in currency reserves. An additional $16 billion is not going to help.
It is not that the money would not be useful to ICBC. The money could put a substantial dent in ICBC’s bad loan pile. The Chinese government did something like that last year when it used a large chunk of their foreign reserves to help clean up state banks’ balance sheets prior to their very successful IPOs.
Yang Kaisheng, ICBC vice-chairman, has said that converted funds would be helpful, but he is not in a hurry, because he feels that the offshore funds could be used for lending in foreign currencies or foreign exchange trading.
This is definitely not a good idea. Chinese participation in commodities markets has resulted in some major debacles. In Singapore CAO lost $886 million because they could not get approval to terminate some trades from their masters in Beijing. A similar melt down occurred on the London on copper markets when a missing trader cost China an estimated $823 million.
There are also huge potential problems with foreign currency trading at the State Administration of Foreign Exchange also known as SAFE. This agency, which is supposed to be an agency under the central bank, manages China’s one trillion dollar reserves. It has two glaring problems. First, there is a dispute as to which arm of the government controls the funds. Both the Finance Ministry and the People’s Bank of China claim to be in charge. In a panic situation, confusion in the lines of authority could result in delay. In foreign currency trading, delay equals disaster.
The second problem is personnel. SAFE is trying to expand its operations. It is going to expand from two departments to four. Still it may be understaffed. According to literature dating back to 2001, each trader managed an average of $2.8 billion dollars each. This amount is greater than any commercial institution.
Even in the best institutions, controls meant to prevent a rogue trader from losing or stealing money have failed. Commercial traders are often the highest paid and most experienced. They make mistakes. Inexperienced traders will make more. The stakes in China are exponentially higher. Any catastrophe would reflect that exponent.
The problem with the management in all Chinese ministries like SAFE and state owned companies including banks like ICBC is that they are appointed not on merit, but by the communist party committee within the ministry or bank. So their loyalty to the party is often more important than their skills.
In the past few years, Chinese state owned banks have lost over a billion and a half dollars in embezzlement alone. This enormous sum does not even compare with the billions in bad loans. Allowing SAFE or ICBC to play with possibly hundreds of billions in foreign currency markets is like smoking in a powder room. The problem for the Chinese is that, unlike financial disasters at home, a catastrophe on international capital markets will be impossible to cover up.
It is not only foreign currency trading that poses a threat. Any institution is subject to the will of its masters. Publicly owned institutions eventually have to answer to the market place. State owned institutions have to answer to their political masters. As part of a push to gain control of more resources, China has recently been courting resource rich African countries.
The west has in the past lent billions of dollars to these countries in attempts to develop their resources and alleviate poverty. Much of the money has been squandered by corrupt politicians and the countries are often worse off. Eventually the loans have been forgiven and written off, since the countries in question had no potential to pay any of the money back.
China has stepped in to take up the “white man’s burden” with a series of development loans. With large sums of money outside the country, China’s leaders may feel that ICBC can help the national cause. The difference between ICBC loans and loans by western governments is that western governments were acting through development agencies using taxpayer money. ICBC would be loaning the money of its depositors and shareholders. Even without political pressure, ICBC risk management has been dreadful. It is doubtful that despite recent ‘reforms’ that its track record in international lending will be appreciably better, especially since it is a relation based system lending to other relation based systems. In such situations, the possibility for repayment is very small.
The problem of the off shore proceeds of ICBC’s IPO is illustrative of the problems of China’s financial system. To cure one problem, the capital of state banks, they increase the risk of another. The only way to really solve the problem is to allow foreign banking into China and to completely privatize the state banks. Turning its financial system over to the market, would also mean that the Chinese communist party would be turning over much of its power to the market. Something that is not going to happen.
