China to allow private banks

China says it will allow five privately financed banks to be created in 2014 as it aims to boost economic growth by scaling down state run businesses in favor of privately run enterprises.

In order to make its economy more productive, the World Bank has told China it needs to overhaul its banking system which lends a massively disproportionate amount of money to state run companies and extremely little toprivate entrepreneurs.

The China Banking Regulatory Commission announced an expansion in the role of private capital in banking. The Commission said it would include a pilot project to allow the creation of five private banks.

The private banks will either restructure existing ones or set up new ones “bearing their own risk.”

The Commission added that it would seek out ways to allow overseas banks greater access to China.

Chinese private banks will be closely monitored

According to China’s state run news agency Xinhua

“Strict procedures and standards will be set for the pilots, with demanding set-up criteria, limited licenses, enhanced supervision and a risk handling system, according to the CBRC.”

“The CBRC will try to relax the threshold for foreign capital to enter China’s banking sector and ease Renminbi operation requirements, while more policies will be issued to support banking reform in the Shanghai free trade zone and financial reform pilot zone.”

No details were published regarding who would be able to set up these privately financed institutions and how they could operate or compete.

The Chinese Communist Party currently has two aims:

  • Boost the economy which has lost much of the impetus built up during the 1990s and the first ten years of this century.
  • Retain control of key industries, but at the same time allow more competition into the system.

During the second quarter of 2013, China’s economy grew by 7.5%, a more than 20-year low. During the third quarter growth climbed up to 7.8%. The government forecasts 7.6% growth for 2014, the lowest rate for 15 years.

After a major meeting in November, the Communist Party said the market will play a progressively greater role in the economy, including foreign companies. However, it emphasized that state ownership will remain the major player.

China uses state-run banks to control the economy

Allowing private banks to compete hits at the heart of much of China’s business and political practices. The government uses state-controlled finances and credit to control the economy and to reward politically favored companies with low interest loans.

President Xi Jinping started taking measures to make the banking industry more market oriented last July by ending controls on interest rates that banks can charge on credit. This should allow borrowers to shop around for best loan deals.

Local government debts jumped 70% to 17.7 trillion yuan ($2.9 trillion), a December audit announced. Chinese authorities told local leaders that debt continued to rise relatively fast and should be reduced.

The only private bank in China among the nation’s ten largest lenders is China Minsheng Banking Group. However, small- and medium-sized enterprises make up 60% of the country’s GDP (gross domestic product) and about 75% of all new jobs. A combination of weaker global demand and tight credit is having a negative effect on private businesses.