Deputy Governor of the Central Bank of China


Serge Berthier.-The People's Bank of China has been more or less under reform since 1993. Why is it taking so long to reform the bank into a proper Central Bank (1)?

Liu Mingkang. - The restructuring of the Central Bank is a very important issue. It cannot be done in haste. We are now at a turning point as we reach the stage where the bank will focus only on its supervisory functions. By the end of this year, all the bank's branches will have divested their commercial operations. By December 1st, 1998, the Central Bank will have nine regional branches, at Shenyang, Tianjin, Jinan, Nanjing, Shanghai, Guangzhou, Wuhan, Chengdu and Xian instead of a big network of provincial branches.

S.B.- What is the purpose of creating a new layer between the provinces and the centre?

L.M.- To be truly independent, we need to keep away from a possible intervention of the localities. A Central Bank needs to be independent in setting up its monetary policy, in supervising all the financial organizations, and in cooperating with foreign partners worldwide (2).

S.B.- And so, the best way to sever the existing ties between the local branches of the People's Bank of China and the centre is to reorganize from scratch…

L.M.- Actually I just want to use the word "restructure". All the thirty two provincial branches will be kept, but they will no longer be branches but only supervisory offices. All ties with the local economic entities will be severed by the end of the year.

S.B.- Is everything decided or are there still some decisions to make?

L.M.- As regards the structure, we know exactly how we are going to group the existing branches under one of the nine regional branches. The network, the structure, the function regional branches would play, all these elements have been agreed upon. The only remaining issue is the human resources problem. We need to reallocate people, and we need to choose the best for the positions available (3).

S.B.- The reform of the financial sector is one of the five reforms that Prime Minister Zhu wants to carry out before the year 2000. What does it entail?

L.M.- China has always been a firm believer in a very firm and solid timetable. Within three years, we set out to make major changes. During the first year, that is the current year, we are completing the overhaul of the People's Bank. The next stage will see an expansion and the improvement of the risk monitoring system. We will bring it up to the quality of international standards. On a limited scale, it is already there, but next year it will be done on a larger scale as it will be implemented throughout the country.

S.B.- Obviously, one of the first consequences will be to unearth a substantial number of non-performing loans and the extent of the weakness of the banking system…

L.M.- A massive recapitalization of the four big banks is under way. 270 billion yuan of debentures have been issued and the exercise will be completed by the end of 1998. It can't be done as fast as one wishes because if you want to issue a bond, a lot of checks need to be done, such as the capital adequacy ratio you will reach. You also need to assess what will happen afterwards and watch the reaction of the bond market, because if we use such an instrument, we want it to be negotiable. Therefore it is important to think about the next step for the second issue. It is a systematic job. It takes time, but definitely, the recapitalization will be completed before the end of the year.

S.B.- Year one focus on the strengthening of the Central Bank, year two, on the cleaning-up of the books and the setup of new standards, what is happening in year three?

L.M.- The completion of the streamlining of the banking sector. All the commercial banks in China, starting this year, have been instructed to streamline their structure. They have to reduce their operating costs and sub-branches by twenty per cent within three years.

S.B.- Do you mean they have to close one fifth of their branches and cut their staff by 20% as well?

L.M.- Yes, they must reduce their staff cost but they should also reduce their sub-branches. Everywhere we are facing the problem of too many branches. We are showing the way. We have cut our number by about 28%. China is seriously listening to the message that we all got from this financial crisis around us. We've got to be more efficient, we need to cut the fat.

S.B.- How many people are currently working in the banking and finance sector?

L.M.- We have roughly two million people working in the banking sector.

S.B.- So, it is a shake-up that will affect basically two million people as everyone will be under pressure, isn't it?

L.M.- Yes, that is why you need to have a motivation system strong enough to keep the people. In such circumstances, training is a big issue. You need educated people, qualified people. Naturally, it does not mean that we have all these two million people to train. There is a strong hierarchical system, we need to have different levels of training for different levels of responsibility. Nevertheless, it means a lot of resources. We need to further the education and the training at home and abroad.

S.B.- From outside, the Chinese banking system looks rather obscure and very much influenced by tradition. Are you prepared to expose it a little bit more to outside influence?

L.M.- It is not so obscure. We received a lot of technical assistance coming from the World Bank, the IMF, the Bank of International Settlement (BIS), the Asian Development Bank (ADB). We also have many bilateral technical agreements on specific projects with other foreign banks. In view of what happened in the rest of the world, we can see that all the Foreign commercial banks are very keen to help the Chinese bankers. But training remains the biggest issue.

S.B.- Is the push to increase infrastructure in 1998 to meet the target of 8% gross domestic product growth consistent with the fact that the commercial banks have instruction to assess projects only on economically viable projects?

L.M.- The accurate picture of what is happening in China now is that every time our prime minister Zhu Rongji says that we need to encourage the domestic demand and to make sure that the 8% growth we demand is all there, every time he mentions that task, he also mentions another task: "don't dictate any bank to loan the money to specific projects". All the banks need to guard themselves against potential risks in their new-loan assets policy. Every time he repeats those two aspects it is very encouraging (4).

S.B.- This is the official line and it is indeed very encouraging. However, in the past, such official lines were ignored at the local level. Why should it be different this time?

L.M.- We should not confuse two issues. In China, for fiscal policies we have fixed targets, but on the banking side, we do not have fixed lending targets. In other words, how much money will be levied as equity financing to boost the infrastructure and pay for big projects is a fixed target of 100 billion yuan before the end of this year. They will be financed by long-term government bonds. That money will go as equity financing to specific projects, till we have used the whole amount. Banks are not required to finance the projects.

S.B.- But this is assuming that the project is entirely paid-off through equity financing, which is very unlikely. A portion of the expenditure will be met through banking facilities, one way or another. How does it work then if the project needs additional financing and the banks playing the game say: "no, thank you, we believe that the project is not viable?".

L.M.- This has already happened. One of the policy banks has already turned down projects on the ground that the financing arrangements were not viable. Let me say this: the 100 billion yuan will be collected, this is a fixed target. As far as the banking side is concerned, so far there has not been any fixed target. How much money banks have to loan is decided by their adequacy level and their own assessment on commercial terms of the potential of the borrower (4).

S.B.- You won't deny however that the Central Bank is monitoring a number of ratio as well as the growth of liquidity in the system?

L.M.- The Central Bank uses what we call its window to do the moral persuasion, the oral persuasion. It means we have meetings with the banks. We remind all the commercial banks to pay enough attention supporting good projects, but only good ones (5).

S.B.- What about the policy banks such as the State Development Bank or the Agricultural Bank?

L.M.- The policy banks are there to finance state-sponsored projects. They are development banks. We ask them to do more in the infrastructure area, specially on long-terms on toll-roads, railways, airports, transmission of power networks and so forth. But even policy banks can say no. They can say: "this is a project I don't want to finance". They have 100% freedom to assess the viability of such projects taking into account the equity financing allocated to the projects. And we are very pleased to see that they are taking it very seriously. As I said, one of the policy banks, the State Development Bank already gave a few "no" answers this year.

S.B.- If a policy bank says no to a state-sponsored project, what happens then?

L.M.- The project is looked at again, in particular its viability. If after a second assessment the government still wants a particular project to go ahead, like say, in public utilities, then the government will increase its equity financing so that the package will become financially viable (6). The additional funding, which reduces the amount of borrowing, will come directly through an injection of capital, through paid-up shares. This is how the mismatch will be tackled. That is what is happening now in China. There is no order from this government to loan money up to a certain amount. There is no credit target as such (7).

S.B.- Maybe, but if you set a target of 8% gross domestic product growth rate, it follows that monetary supplies must be expanded and a number of monetary targets reached.

L.M.- What happens in China is that we have a certain number of loans that we want to see extended this year, but this is only a guideline. It is not a quota that banks should set. So the word target is misleading. We are happy to see that what we considered appropriate will be realized, but if it is not achieved because the banks, for some reason, feel they cannot lend further on a sound basis, there is no penalty, no criticism, no pressure to force them into loans which make no commercial sense. They are left to make up their own minds (8).

S.B.- Left to themselves, the banks will have a tendency to compete in the same sectors, in the most profitable areas. Don't we then have the risk of seeing too much credit going in one place and not enough elsewhere?

L.M. - That is a fair comment. But is it a real concern? We have huge needs, especially in the inland provinces. What we have done is that we have listed nine lines of businesses that won't create any bubble in the future. Within that framework, banks can say yes or they can say no.

S.B.- Are the commercial banks, once they have been reorganized and are on a sound footing, going to be privatized?

L.M.- We are not talking about privatization at this stage, but what we are going to do is to turn many medium-size commercial banks into legal entities with equity holders. We will then simply choose one or two with the possibilities to be listed outside of China. This is something we are studying now. It does not mean that privatization in China isn't mentioned. You know, a few years ago many people were saying that the only way out was privatization. But look around. Banks have been privatized everywhere and you can see that all the countries badly hit by the crisis had privatization much earlier than us. It means that privatization is not the answer to everything. It has to be linked with a solid policy and right fundamentals. To privatize banks does not mean that weak companies have disappeared. They might be still hanging in there (9).

S.B.- Not to mention again the question of the yuan, there has been a lot of talk about currency restrictions on foreign-exchange transactions. It has also been highlighted that, although the trade surplus has been substantial so far, about 30 billion dollars, there has been no significant changes in the total reserves of China since last year. So people are talking about capital flows outside the country. What exactly is going on?

L.M.- The reserves have slightly increased since last year. They stand at US$141.1 billion at end of September but people are surprised that it does not tally with the surplus you mentioned. In fact, several factors have to be taken into account. Starting from January, we have a new regulation that is affecting the way foreign currencies are accounted for. Now, all companies trading with foreign countries can keep a hard currency account. In other words, they can keep the proceeds from sale without transferring the currencies to the Central Bank as it was the case before. They do not need to convert them. So effectively, those currencies are kept by the banks and the companies can use that from time to time. It is more convenient. That is why the surplus didn't directly go into the reserves. Part of the surplus is kept at the banking level as the float of the companies doing business overseas. Another factor which is not negligible, but went unnoticed, is that the government has increased the amounts of currencies that people going abroad can buy. For the past six months, we have seen a sharp increase in the deposits in foreign currencies of the common people. Currently, they hold about US$8 billion. That is a substantial amount. A third factor is the extension of credit facilities to buyers of Chinese goods. Due to the hardships happening to a lot of companies overseas because of the current financial turmoil, our exporting companies have loosened the terms of payment, extending credit for up to one year. So the money has just not been received yet. This was done in order to boost our exports.

S.B.- Did it work?

L.M.- Our best scenario as regards exports is a rate of about 5 to 6% growth year after year, and so far we have achieved it year after year.

S.B.- But this time, at a cost…

L.M.- What we have seen is that the time settlement has been increasing sharply in the first part of the year. Another problem on the increase is that, on some of our exports, we suffered a loss because of the bankruptcy of the foreign importers.

S.B.- People mention that the companies are trying to keep the money out of China for fear of a devaluation. Is it serious?

L.M.- Some organization, especially the export and import companies had a psychological problem because they feared that the currency would devalue or depreciate, that is why some hard currency is kept outside of China. We are indeed carefully monitoring such a situation. We are very watchful and we have asked those doing this to get the money back as soon as possible as it is illegal, but actually it happened (10).

S.B.- As in any crisis, it is a matter of confidence. What can be done to increase the confidence of the people?

L.M.- We are still thinking about what measures we should take to boost the confidence of the people and alleviate their concern as regards the currency. China is, in that respect, not different than elsewhere, it is all psychological and that is why we have to be careful if we decide to put some regulations into place. One thing is certain: the confidence of the people makes sense. That is why we don't want to devalue the currency.

S.B.- But can China stick forever to its policies just on its own?

L.M.- Global order needs to be kept. That's why it is necessary to communicate with our partners, including Japan and other countries, because confidence really is the key nowadays.

S.B.- Do you expect Japan to turn round its economy pretty soon, which will alleviate a lot of the pressure on China and Asia as a whole?

L.M.- Japan still has some strength, and if the Japanese are responsible, they have to make full use of their strength. We expect that they will do enough to sort out the situation. We are happy to see that they are moving forward, although slowly. It is important for them, it is important for Asia and it is important for the world.

S.B.- If two years ago, in a seminar, I would have mentioned the stability of the yuan as one of the key elements of a financial crisis, I would have been the laughing stock of the assembly. Don't you find it ironic and paradoxical that a global financial crisis is proving how sound was the prudence of China as regards the opening of its capital account?

L.M.- Two years ago many people were neglecting, as in the past, that China has always had a very complex and steady strategy of its own development and attitudes towards international affairs. I am sure that you remember what happened prior to the hand over of Hong Kong, which was in itself a major undertaking. A lot was said against China and its attitude. Nobody wanted to believe that our concept of "one country, two systems" was sound and that it would be a success. Of course, nobody imagined that there would be a real economic crisis to test it. What people at the time focused on, what they predicted, proved to be absolutely wrong. One country-two systems works so well in Hong Kong that the one thing that the people did not forecast was that Hong Kong would suffer a financial crisis with the realignment of its stock market, the adjustment of the real estate market, speculators coming in, etc… while China would enjoy stability. I am very sorry about the turn of events there but many people couldn't understand who China is and where she stands in the world. That is a pity to see that you need a crisis to see how healthy our strategy is. For years many people criticized China, saying it was stubborn when talking about capital accounts (11). Everybody was talking about free capital accounts, all their advantages, and the globalization and privatization, etc… Today we have, in a sense, a ridiculous situation. It makes us both sorry and very happy. Sorry for their past attitude and the consequences and happy to see that people are starting to come to their senses.

S.B.- China has always been very cautious in her dealings with foreigners. It is not new, but why it is so, remains puzzling. In what context do you look at new concepts that might improve the economy or the banking system, or the livelihood of the people for that matter?

L.M.- It is a fact that advisers never know the costs, nor do they bear them. The fact is that if you open the door first and decide to close the door once again, that causes panic at some stage. China is such a country that when we open the door, we would never, ever think that we would close it again. So we do it slowly, steadily and surely, but step by step. That is a healthy strategy. People are surprised by our cautiousness. It is because only when we feel fully confident do we move and when we move, we don't want to come back. This is the strategy of China.

S.B.- You say people are starting to come to their senses. Is it a satisfactory situation when you know it is due to the unforeseen crisis?

L.M.- It is a fact that the crisis was in a way "good" for China, but the price to pay has been too high and was not necessary.

S.B.- Would you agree with people saying that the crisis has accelerated the entry of China onto the world stage?

L.M.- Yes.

S.B.- What ideas did the crisis bring to the forefront?

L.M.- That it is good for every country to think twice before listening to some experts coming from other countries. Even today we still have to weather the waves and we have to take a stand against the devaluation, which has a cost, but we believe it is a good policy in the long term for China but also for the world, for those who have been hit in the front waves of the financial crisis. We are responsible to everybody and we are responsible to ourselves.

S.B.- You mentioned earlier that nobody wanted to believe in the "one country, two systems" concept. It seems to work so well that the correlation existing between the hinterland of Hong Kong and Hong Kong itself has broken down. So far the economy of the Guangdong province has registered a 10% growth rate while Hong Kong has sunk into recession. Then the Hong Kong Monetary Authority came under heavy criticism for its massive intervention on the stock market against speculators. Are all these unforeseen developments good in the long term?

L.M.- It is not my place to make comments on what happened in Hong Kong. We have two currencies and two supervisory bodies. Decisions made in Hong Kong are made by the Hong Kong government, but I think that the Central Bank in China was supporting the Hong Kong government in its efforts to stabilize the currency, because in doing so it can stabilize the confidence of the Hong Kong people. We realize that speculators cannot create fundamentals but they do create exaggeration. That is the only thing they can do but sometimes, at critical time, exaggeration works. So I understand the measures adopted by Hong Kong to safeguard its interests. We also are happy to hear that the Hong Kong government wants to maintain its attitude of "market neutral" and what it is doing is to fine-tune some market rules instead of some intervention, so that is a healthy and necessary action. Even the intervention was based on the Basic Law. It has the right, legally speaking, to do so because according to the Basic Law, it has the right to use that tool (ie. intervention) to maintain the stability of the currency.

As regards your remark on the correlation of the economic growth between Hong Kong and Guangdong, first of all we have to remember that such a relationship is mainly based on import-export flows, what we call current trade. What happened in Guangdong this year is that the 11% GDP growth was not driven this time by the external trade, but purely depended upon the domestic-led infrastructure and investments and so on and so forth. Therefore the correlation in GDP growth rate between Hong Kong and Guangdong has decreased. However we do hope that in the future we can realign such correlation. Hong Kong has many experts in fields that Guangdong is lacking. Take law firms, finance, banking, transport, etc… That is the homework we are willing to do.

S.B.- As a central banker, what is your opinion on the euro?

L.M.- We do think for many reasons that The euro could be a strong currency. If that is the case, it will change the source and the behavior of many Central Banks. As a settlement currency, the euro definitely will be one of the major ones. As a reserve currency, sooner or later it will be part of the reserves of every Central Bank. For long-term debt, especially from OECD export-credit backing up what is coming from Europe, such as trade in French Francs, Deutsch Marks, Swiss Francs - Swiss Franc is outside but nevertheless will be somehow linked - the euro constitutes a big change. It will affect in our portfolio, our hedging system and strategy. We are looking forward to seeing the changes, overcoming the difficulties and making it work (12).

S.B.- Do you have any advice from one Central Banker to another one?

L.M.- One thing is critical if you want countries to take Euro as a reserve currency, the European governments should quicken the pace to increase the liquidity of that new currency in debt markets and capital markets, because that is a big difference between the US$ and the European currencies. If the liquidity could be dramatically improved, it would definitely provide a new hedging instrument among countries. This will of course take time, but even at the initial stage, it needs to be done.

Autumn 1998


1.- The most important reform was made in 1994, which marks the start of the reform of the banking sector as a whole. A law was adopted barring the Government from borrowing from the Central Bank. At the same time, the People's Bank of China started to divest the commercial operations of its many branches, but the process has been arduous. Commercial operations run by the Central Bank at the local level include urban credit, co-operatives, brokerages, accounting and auditing offices and even pawnshops. Provincial Central Bank heads have been given up to the end of the year to liquidate the branches' stakes in the operations and sever ties with any economic entity.

2- The restructuring of the Central Bank includes: 1) assuming responsibility for overseeing foreign-exchange business of financial institutions from the State Administration for Foreign Exchange Control (SAFE), 2) returning supervision of securities to the China Securities Regulatory Commission, 3) handling the administrative closing of financial organizations and setting up rules for such closures.

However the Central Bank remains very much under the control of the State Council and its Currency Policy Committee only has the power to recommend interest-rate cuts, with the final decision the State Council's.

3.- The Central Bank announced in September 1998 that it reduced the number of departments and offices to 112 from 138 and have only reappointed 189 senior staff in the process - a 28% decline. Some departments have been merged, others have been eliminated entirely. The bank also shed its insurance office, as a new government oversight committee is being formed to oversee the Chinese insurance sector.

4.- China's outstanding loans rose 16% to 8,089 trillion yuan between January and August 1998.

In 1997, Chinese banks with more than USD 20 billions in assets

Assets USD bil.

deposits USD bil.

loans USD bil.

net profits USD mil.

Industrial & Com Bank of China





change from previous year





ranking in Asia /(year before)

2/ (2)




Bank of China





change from previous year





ranking in Asia /(year before)





China Construction Bank





change from previous year





ranking in Asia /(year before)





Agricultural Bank of China





change from previous year





ranking in Asia /(year before)





Bank of Communications





change from previous year





ranking in Asia /(year before)





During the same period total deposits grew 16% to 8,923 trillion yuan. Individual deposits rose faster than corporate deposits, 17% against 13%. Total individual deposits amount to 5,090 trillion yuan while corporate ones amount to 2,962 trillion yuan.


5.- The Central Bank does not entirely rely on moral persuasion as mentioned. In June, it cut the commercial bank deposit rate - the rate commercial banks receive on their deposits at the central bank - to 3.2% from 5.2%.

6.- In early February 1998, Chinese Vice-Premier Li Lanqing announced a multi billion infrastructure plan for the next three years. Fixed-assets investments growth, which had dropped to 9% in 1997 from 12.5% in 1996, and 18% In the early 90s, remained however subdued in the first part of 1998. Then, end of August 1998, the Finance Minister Xiang Huaicheng told a meeting of the National People's Congress that the government would raise 100 billion yuan in long-term bonds to be used for infrastructure projects that are urgently needed for economic and social development. Projects include environmental protection, water conservancy, infrastructure, flood control, roads, railways, telecommunications, airports and grain reserves. Most of the projects target rural areas. The bond issue will be spread over the state budgets for this year (ending in March 1999) and next year. A further 18 billion yuan from this year budget has been redirected to pension insurance, disaster relief and social security for people laid off by state enterprises, a move that outline the severity of the social upheaval taking place. The money comes from cuts made in the original allocation for scientific, technological and educational development. Although the budget of the government will register another deficit, China's domestic debt consumes so far only 7% of the GDP - considerably lower than the 60% of the industrialized world.

7.- The State Development Bank of China increased loans 24% in the first half of 1998 from a year earlier and, according to the official China Daily, the bank has adopted some "flexible measures to ensure timely funding" for key projects. During the same period, personal deposits in the banking system rose 16.8%. They account for 57% of total deposits.

8.- The country M1 money supply (cash in circulation plus demand deposits in banks) increased 13.2% to 3.650 trillion in the first nine months of this year. M2 (M1 plus savings, time and other type of deposits) money supply rose 16% from a year earlier to 9.979 trillion yuan over the same period.

9.- As early as 1995, the State Administration of State-owned properties was saying that 27.6% of state-owned enterprises have incurred more debt than they have assets. However what makes the Chinese economy unique is that in all state-sector bankruptcy cases they are few creditors, and they all actually represent a single entity: the state.

In 1995, for the first time the central government announced that, in a bid to speed up the process of state-sector bankruptcy, it would set up a 14 billion yuan fund to reimburse the losses of banks - major creditors of all state-owned enterprises. At the time, it was estimated that Chinese banks had accumulated more than 600 billion yuan in bad loans, including 170 billion yuan extended as a virtual subsidy to loss-making industries and 100 billion yuan resulting from chain debt (dubbed "triangular debt") among enterprises.

10.- To counter speculative activities against the yuan, the People's Bank of China and the State Administration of Foreign Exchange have issued in September 1998 a circular banning the early redemption of hard currency loans. It means that banks are no longer allowed to help clients to secure yuan borrowings from mainland banks for conversion into hard currency if the purpose is only to redeem a loan before its due date. The instructions came when it became obvious that the sharp increase in demand for stand-by letters of credit that was registered was not backed-up by a sharp increase in the trade figures. It meant that they were mainly used to secure yuan loans that were converted in foreign currencies.

11.- China' currency, the yuan, is convertible under the trade and service account only, or what is called the current account. Transactions under the capital, or investment, account aren't allowed. Therefore the currency is technically out-of-reach of speculative attacks. Nevertheless, loopholes in the regulations governing the current account made the set-up of phony joint venture companies to transact a financing deal possible. During the summer, the market saw heavy dollar buying on the official exchange in Shanghai, much of it without true trade-origin behind. Since then, the Central Bank has launched a sweeping clampdown on foreign-exchange irregularities. To strengthen its control on the current account dealings, the Central Bank has made it mandatory since August 1998 for the state commercial banks to channel buy and sell orders for clients to their headquarters in Beijing, where they are pooled and offset internally at the government's official rate. Unfilled orders are then shifted back to Shanghai and transacted on the official exchange. The move has considerably reduced the amount of yuan transacted on the exchange.

12- In August, the Central Bank announced that it was considering investing in the euro, to be launched in January 1,1999, to insulate itself from a possible recession in the U.S. The China Daily, the country's official English-language newspaper wrote that the Central Bank should hold dollars and euros in equal amounts of 40% and put the remaining 20% of reserves into yen. China doesn't say how much it keeps in particular currencies but it is assumed that the Central Bank has about 57% of its reserves in U.S. dollar and 25% (down from 33%) in yen.

Autumn 1998