In an interview on the Chinese Economy

Since we’re discussing the problems facing China’s banks, shall we talk about Carl Walter and Fraser Howie’s Red Capitalism? You mentioned you think this is going to be a bestseller.

To the extent that a book on finance can be a bestseller, yes, I really hope so! People need to pay attention to it because it’s a very important book. Carl has been in Beijing since the financial sector opened to foreign activity in the early 90s. He’s seen the evolution of the entire process and has an insider’s view.

Most investment bankers like to talk things up, but that’s not something we can accuse Carl of doing.

By the late 90s, China’s banks were technically insolvent because the non-performing loans ratio was 40 to 50 per cent. Carl’s still a big fan of Zhu Rongji, the former prime minister. One of Zhu’s greatest achievements was to ‘solve’ the problems in the banking sector by setting up asset-management companies and recapitalising the banks. Today, of course, the banks are still lending very recklessly despite a lot of reform – the formation of credit and risk-management committees, for example. The banks continue to require bailouts and recapitalisation from the Chinese government, which props them up so that they can sell these bank shares to the public in Hong Kong or Shanghai. Carl sees this process as a kind of Ponzi scheme.

And you disagree?

Zhu was very inventive in trying to recapitalise the banks while still maintaining state ownership over them. That was the goal and continues to be the goal of policymakers in China: prop up the banks and make sure non-performing loans don’t appear on the books. We don’t actually know the amount of non-performing loans that exist on the ledgers of China’s banks. Whenever a loan becomes problematic, especially when the borrower is a major SOE, it’s restructured – i.e. rolled over or extended.

So despite all the high-profile stock market listings in Hong Kong, it’s the same old story – these banks are in very bad shape.

Yes. Carl and I were hopeful in 2005 and 2006, the period just after these banks were listed. We thought things might turn around. But 2009 was a watershed year: the central government essentially ordered the banks to lend to local governments to finance infrastructure projects and beat the world recession. The order from Zhongnanhai, the complex where China’s top leaders are based, was that cost was of no consequence and that we needed to maintain growth of at least eight per cent. The banks duly lent the highest amount in Chinese history. There was over 30 per cent growth in credit expansion in a year. All the cautionary procedures the banks put in place were useless. Now, of course, the government has to deal with these loans, many of which are becoming problematic.

Do you agree with Carl’s analysis that none of these big Chinese listings were privatisations in any sense – they were just state monopolies or duopolies selling off a few shares?

It’s a way to rope in money from investors. Share issuance didn’t really change anything. The party is still in every large, state-owned corporation. And most shares are still owned by government entities. Most of the large SOEs just obey Zhongnanhai’s orders. They don’t really care about profits and they can get cheap, low-interest loans from the banks.

Still, one good outcome of listing the minority shares of SOEs and state-owned financial institutions is that there’s much more transparency now. Even if some balance sheets are manipulated, the fact that these quoted companies need to issue annual reports and quarterly summaries leads to a lot more information on how the companies are run. A careful observer can look at the figures and see when something untoward is happening. And that’s what people like me are doing now. You can view the publicly available information and spot some disturbing trends. You can then bring evidence to the table when you’re arguing against people who are very bullish about China.