Chinese banking; or, Who says stenography doesn't pay?

Bad news if you're a corrupt Chinese banking executive: The International Herald Tribune (part of the NYT empire) reports that reforms aimed at improving management at China's state-run banks are on the way.

Corruption is certainly a serious problem. If you read any of the numerous articles out this morning about this reform proposal, you will quickly notice that every paper seems to have its own embezzlement story. (The most intriguing may be MarketWatch's fleeting reference to a typist who allegedly pocketed $6 million; the Cranky Economist is obviously in the wrong line of work.)

But this is only the tip of the iceberg when it comes to problems in China's banking sector. Even if all of the country's bankers were as honest as can be, there would still be trouble. They would still be carrying an unsustainable burden of non-performing loans.

The problem is that for decades now, the state-owned banks have been a vehicle for subsidizing state-owned enterprises. It's a convenient way for the Communist system to pretend that there is some degree of economic accountability for the enterprises. Would that it were so. Instead, the banks are expected to continue pouring ungodly amounts of money into inefficient enterprises, subsidies that go on the books as loans, loans that have virtually no chance of being repaid.

Which in itself would be bad but not dangerous, except for accounting. Loans go on banks' balance sheets as assets, in China as elsewhere. So if the banks write off these bad loans, suddenly their balance sheets would deteriorate significantly. (Western banks have to use cash from current revenues to restore the balance when they write off their bad loans, but the scale of the problem is an order of magnitude larger in China, and will require a lot of money from the government.) So China's banks are already perched precariously on the edge of the precipice. The entry of foreign competition in 2007 (as mandated by the WTO) could well push them over the edge, as they have to compete with efficient and well capitalized external banks.

There's a political element as well. Chinese families have abnormally high savings rates. And most of that savings goes into deposits at the local bank, a bank that is either state-owned itself or intimately linked to a bank that is. If these bad loans force any of the big state-owned banks into insolvency, expect runs (it has already happened several times in recent years, in rural provinces) by Chinese people desperate to reclaim their life savings and angry at the government that has jeopardized the money. Will this be the equivalent of Polish solidarity? It'll be an interesting couple years.