China’s Hazy Hunt for Policy Loan Boundaries

October 27th, 2010 | Caixin

Financiers are debating policy institutions Eximbank and Sinosure over what constitutes commercial business

A blurry boundary between commercial operations and policy-related banking has divided opinions in Beijing over a planned, 50 billion yuan injection designed to boost the government’s China Export & Credit Insurance Corp. (Sinosure) and the Export-Import Bank of China (China Eximbank).

The high-level discussion has delayed the capital injections promised by Central Huijin Investment Co., an arm of China’s sovereign wealth fund, which recently raised the necessary funds through bond sales.

Huijin was supposed to pump 20 billion yuan into Sinosure and hand 30 billion yuan to Eximbank in support of reforms at each institution. But the money has been held up while policymakers debate the institutions’ business focus, and question whether they are indeed concentrating on policy-related or commercial lending.

The central bank, Ministry of Finance, and China Banking Regulatory Commission (CBRC) drafted an original reform proposal for the institutions that was approved by the State Council in January, setting the stage for the bond issue.

Their proposal charged Sinosure and China Eximbank with taking on enormous risk by rapidly expanding balance sheets during the global financial crisis. The report also claimed some of their businesses fit the commercial, not policy, category.

The report implied the government might consider tougher cost controls to reign in the institutions.

But Sinosure and Eximbank officials rejected the report’s conclusions, and instead called for a deeper review of their activities.

“All of these businesses should be considered policy-related,” Li Ruogu, chairman and president of Eximbank, wrote in a letter to the State Council.

And even while the proposed injections currently remain in limbo, Li’s side of the story appears to be getting at least a listening ear.

Support for Li could be read into the fact that “the reform proposal hasn’t gotten regulatory approval yet,” a source close to the financial institutions told Caixin.

Subsidy Concerns

Central bankers and other regulators worry about potential conflicts between policy-related business and commercial operations. They also fret about possible future costs to the state.

Commercial dabbling by policy institutions could “mean that state subsidies would be poured into a bottomless pit in the event of future losses,” said a source at the finance ministry.

Policy businesses typically involve commercial financial institutions, yet Eximbank, Sinosure as well as the policy-oriented Agricultural Development Bank of China have additionally engaged in their own lending operations in recent years. Whether these loans count as commercial is subject to interpretation.

“Consensus on commercial financial reform has been reached,” said a source close to the central bank. “But policy-related financial reform is still an open question.”

Led by the central bank, a reform drive launched in March 2009 took aim at Eximbank and Sinosure after China’s total import and export values fell sharply four months in a row.

The consensus at the time backed a plan to increase capital, strengthen policy orientation, and improve the corporate governance structure at the institutions, which at the time were seen as tools for not only policy-related functions but commercial businesses as well.

Each institution was directed to separate accounting systems into a national account for government-assigned projects, and a bank account for market-oriented and proprietary businesses. This led to an explosive growth in policy operations at Eximbank and Sinosure, while proprietary business also grew but more gradually.

Since then, the finance ministry, CBRC and other government agencies have looked more closely at what happened during that period, and found it difficult to categorize existing businesses at the institutions. They agree, however, that what’s completely policy-related should be separated from commercial operations for which the institutions should assume responsibilities for profits or losses.

Yet lately, it’s become more difficult to clearly identify risks, said sources at the finance ministry and CBRC. And big trouble with risky loans could emerge in two to three years, forcing the government to pay hefty bailout subsidies.

Now that the crisis is over, the institutions “should exit from temporary support measures,” the source said. “After implementing dual accounting systems for the two categories of businesses, subsidies will only be granted to projects assigned by the central government in line with actual losses and on a yearly basis.”

Two criteria will be used to determine whether a project is policy-related: the existence of risk compensation and financial fallback arrangements, and whether commercial banks are willing to get involved.

Commercial banks expressed solid interest and some even participated in a series of overseas investment projects launched by Eximbank last year, a CBRC official said. That points to a commercial – not policy-related – foundation for these projects, the official said.

Yet Eximbank and Sinosure officials insist all their current operations are policy-related, including their businesses tied to issuing loans without specific government direction to borrowers who agree to pay commercial interest rates. Eximbank launched this business in 2006, and Sinosure followed a year later.

Even though the institutions provide these loans at standard, non-subsidized interest rates the nature of each operation “is still policy-related,” said Zhu Hongjie, vice president of Eximbank. He said profits from this proprietary lending can be helpful in covering losses on subsidized loans, since “policy banks should not completely rely on the central government.”

Some industry analysts say policy-related institutions may be carrying out commercial business at least partly to improve personnel incentives.

Effective incentives and employee compensation levels at policy institutions have traditionally been far below those in the commercial banking sector. Non-policy lending “is equivalent to a practice of generating revenue independently” that can be used internally, said some industry analyst.

Yet the regulators who studied Eximbank and Sinosure see no reason to support their commercial operations, especially when that includes government subsidies.

“In the long term, policy-related financial businesses will account for an increasingly smaller proportion of the national economy,” explained a finance ministry source. “There is no need for policy-related financial institutions to be involved in every aspect” of the banking business.

By staff reporter Zhang Yuzhe

Category: Featured Articles, Finance