Nation's problems demand home-grown solutions

Most would agree that the key to solid, sustainable growth in an emerging economy like China's is to have a banking system that is well-capitalized, well-led and well-organized. Twenty years ago Chinese banks acted simply as cash machines for the central government without much regard for the creditworthiness of their borrowers, or for their own solvency. Since then, the country's banking system has made huge progress in changing to meet the demands of the world's second-largest economy. Yet the emergence since 2008 of a large unofficial, unregulated banking system in China shows that there are many Chinese savers and borrowers who are not being provided for by the official system. How can it cater better for today's Chinese households and small companies?

Before 2008 it was much easier for emerging economies like China to find models overseas for their banking system. Asians looked to the United States and Europe for leadership in how their financial institutions should operate. The credit crisis changed that. The US model of free-for-all competition and light banking regulation was shown to be dangerously unstable.

Today the debate about bank regulation continues. Academics from Stanford University lead the demands for much higher rates of equity funding for banks. On the other side, the banks resist these demands, as they imagine their bonuses melting away, as annual rates of return on equity fall.

Another hot question is whether tighter government regulation of banks interferes with their efficient functioning. If the Republicans succeed in returning to power when the next US presidential election is held in 2016, much of the unwieldy legislation that attempted to control US banks in the wake of the crash will be repealed.

While the Western economies slowly heal, and as the debate about banking structure and regulation continues, the Bank of International Settlements in Basel, Switzerland, provides some international consensus on bank regulation and capitalization, which China follows closely. But against a backdrop of debate, and as an emerging country with the world's second-largest economy, China's own circumstances are sufficiently unique to require Chinese solutions.

It is correct to place the focus of China's banking system on supporting the real economy, as Premier Li Keqiang did in a speech in Tianjin last month. But the rise of shadow banking demonstrates that China's official banks, led by the Big Four (Industrial and Commercial Bank of China Ltd, China Construction Bank Corp, Bank of China Ltd and Agricultural Bank of China Ltd), are not meeting the needs of the real Chinese economy. Official bank deposit rates are too low, and official bank lending often fails to support China's burgeoning private sector.

The rise of Chinese shadow banking is a market response to economic need. It should be regarded as a sign of a healthy economy, not as a dangerous weed that should be rooted out and thrown away. Insolvent and badly managed shadow banks will have to be closed down, no doubt. But many shadow banks are well managed and profitable.

The government is right to think of bringing shadow banks within the official banking sector and regulating them, not excluding them and closing them down. The same goes for Internet finance, led by Alibaba, Tencent and other large private Internet companies. Let a hundred flowers bloom in the banking sector, but let them bloom within a framework of capital adequacy and risk monitoring regulation that is the government's responsibility to provide.

The government's approach to banking reform - interest rate liberalization, introducing more competition by issuing new banking licenses to qualified domestic companies, and bringing shadow banks inside the official banking sector - is correct, because it is market-based and focuses on using competitive forces in the economy to provide more and better banking solutions.

But is reform moving quickly enough to meet the demands of a fast-developing Chinese economy? Perhaps not. It ignores the contribution that the foreign banking sector could make. Reform would be accelerated and strengthened by issuing full banking licenses to well-qualified foreign banks from the US, Europe and Japan.

Chinese consumers are very brand-loyal and cautious when it comes to choosing banking services. I suspect that most would prefer a Chinese bank to a foreign one, even though the foreign bank may appear more efficient, with better products.

Even if the foreign banks were free to compete fully on Chinese soil with their Chinese counterparts, the loyalty of Chinese consumers and the spread of Chinese bank networks would make foreign penetration into China's banking system a gradual process. But the arrival of HSBC and Citigroup on Chinese high streets alongside the Big Four would bring much benefit to China and speed up change. It would also help to open up foreign banking markets to Chinese banks.

The author is a visiting professor at Guanghua School of Management, Peking University. The views do not necessarily reflect those of China Daily.