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Monday, 16 February 2009
Don’t force banks to undertake high risk at low rates
However, it is unrealistic to require Chinese banks to take high risks or serve the public unconditionally, given that they are unable to fend off risks associated with financial innovation. pdf
Don’t force banks to undertake high risk at low rates
Sun Lijian 16 February 2009
In view of the global economic crisis, Chinese banks have been criticized for their reluctance to lend to businesses and to lower home loan interest rates.
Some experts blame the banks for being too profit-oriented and lacking social responsibility. They call for further opening China’s banking industry to break Chinese banks’ monopoly in the market and force them to better serve the public interest.
However, it is unrealistic to require Chinese banks to take high risks or serve the public unconditionally, given that they are unable to fend off risks associated with financial innovation.
It goes against their operational mode to issue high-risk loans during the economic downturn, regardless of their own deposit-loan balance or liquidity.
Banks’ reluctance to grant new loans is a kind of self-protection, especially in these conditions in which they cannot avoid risk.
The banks’ concern about the quality of new loans explains why they are unwilling to grant 30 percent discount on home loan interest rates.
Indeed, the banking industry needs competition.
But too much competition, rather than helping to raise efficiency, may destabilize the banking system by degrading the quality of bank assets.
Banks justify their existence with their ability to solve the problem of information asymmetry between creditors and debtors with professional skills. That incurs costs.
Too much competition may narrow the interest rate difference between deposits and loans to such a degree that banks could not even cover the costs of information collection.
The lack of effective evaluation of credit-worthiness would lead to the continuous deterioration of loan quality until there is a credit crisis in the entire banking system.
The US subprime mortgage crisis has taught a useful lesson.
In fact, the key to improving the service quality of Chinese banks is strengthening their ability to control risks.
Partly due to government overregulation, Chinese banks lack diversified lines of businesses and are weak in risk management.
Accordingly, Chinese banks often accumulate too much capital when the country adopts restrictive macro control policies and grant too many loans when the country loosens its control.
Now that China is taking measures to stimulate the economy, banks need to be cautioned against issuing too many loans.
Concerning the public’s lack of preferential interest rates, the government should undertake more of the risks of low-interest loans, rather than forcing banks to grant loans regardless of their liquidity or the advice of strategic investors.
Nor should the government introduce competition into the market that lacks a risk-aversion mechanism.
The government should encourage more insurance companies to join with banks in interest-rate cut projects or even allow banks to securitize a certain part of their low-interest rate loans to ensure liquidity.
In short, the banks’ social responsibility lies more in undertaking manageable business risks than in unconditionally serving the interests of the public.
(The author is professor of finance and executive vice dean of the School of Economics at Fudan University.)
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Don’t force banks to undertake high risk at low rates
Sun Lijian
16 February 2009
In view of the global economic crisis, Chinese banks have been criticized for their reluctance to lend to businesses and to lower home loan interest rates.
Some experts blame the banks for being too profit-oriented and lacking social responsibility. They call for further opening China’s banking industry to break Chinese banks’ monopoly in the market and force them to better serve the public interest.
However, it is unrealistic to require Chinese banks to take high risks or serve the public unconditionally, given that they are unable to fend off risks associated with financial innovation.
It goes against their operational mode to issue high-risk loans during the economic downturn, regardless of their own deposit-loan balance or liquidity.
Banks’ reluctance to grant new loans is a kind of self-protection, especially in these conditions in which they cannot avoid risk.
The banks’ concern about the quality of new loans explains why they are unwilling to grant 30 percent discount on home loan interest rates.
Indeed, the banking industry needs competition.
But too much competition, rather than helping to raise efficiency, may destabilize the banking system by degrading the quality of bank assets.
Banks justify their existence with their ability to solve the problem of information asymmetry between creditors and debtors with professional skills. That incurs costs.
Too much competition may narrow the interest rate difference between deposits and loans to such a degree that banks could not even cover the costs of information collection.
The lack of effective evaluation of credit-worthiness would lead to the continuous deterioration of loan quality until there is a credit crisis in the entire banking system.
The US subprime mortgage crisis has taught a useful lesson.
In fact, the key to improving the service quality of Chinese banks is strengthening their ability to control risks.
Partly due to government overregulation, Chinese banks lack diversified lines of businesses and are weak in risk management.
Accordingly, Chinese banks often accumulate too much capital when the country adopts restrictive macro control policies and grant too many loans when the country loosens its control.
Now that China is taking measures to stimulate the economy, banks need to be cautioned against issuing too many loans.
Concerning the public’s lack of preferential interest rates, the government should undertake more of the risks of low-interest loans, rather than forcing banks to grant loans regardless of their liquidity or the advice of strategic investors.
Nor should the government introduce competition into the market that lacks a risk-aversion mechanism.
The government should encourage more insurance companies to join with banks in interest-rate cut projects or even allow banks to securitize a certain part of their low-interest rate loans to ensure liquidity.
In short, the banks’ social responsibility lies more in undertaking manageable business risks than in unconditionally serving the interests of the public.
(The author is professor of finance and executive vice dean of the School of Economics at Fudan University.)
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