Banking sector reforms in India and China: Does India’s experience offer lessons for China’s future reform agenda?

Abstract

India and China both carried out banking sector reforms in the 1990s. Despite taking a gradual approach, India's reforms have been the more comprehensive and have been implemented at a faster pace than in China. India's experience suggests that the following four issues would be relevant in China's future reform agenda: (1) privatizing the wholly state-owned commercial banks (WSCBs) and introducing measures to improve corporate governance; (2) removing Government intervention to make WSCBs more commercially oriented; (3) reducing the dominance of WSCBs by rationalizing weak banks and downsizing large WSCBs; and (4) if adopted, relaxing the stringent statutory liquidity requirement, which seems to discourage banks from lending. There are also lessons to be learned from India's reforms. First, the entry of new banks should be promoted provided they are sufficiently capitalized and are technology-oriented. Second, diversification of banks' business should accompany interest rate liberalization in order to compensate for the expected decline in net interest income and prevent banks from taking excessive risks. Third, strict regulations should be introduced to prevent connected lending.One of the features of the East Asian financial crisis was that short-term, massive foreign capital inflows, which were largely intermediated by domestic banks, greatly exposed them to both currency and maturity mismatches (so-called "double mismatch"). Sudden shifts in market sentiment driven by the burst of bubbles revealed the vulnerability of these banking systems and triggered a reversal of capital flows, easily leading to a currency crisis and a banking crisis. The occurrence of these "twin crises" in East Asia deepened the economic downturn by generating a free fall of the exchange rate and expanding the local currency value of foreign debt.Since the crisis, a consensus has been emerging among policy makers, academicians and media that avoiding a serious double mismatch is one of the most important policy objectives to prevent another crisis in the near future and thus, strengthening the soundness of the banking system in the borrower country is essential * Associate Professor of Keio University and Visiting Scholar to the Asian Development Bank Institute, Tokyo.

Financial factors and company investment decisions in transitional China

“…In addition, although the Chinese government has placed increasing emphasis on supporting the development of tertiary industry and the SME sector in recent years, the allocation of credits by state-owned financial institutions continues to be biased in favor of SOEs. According to the Commercial Banking Law, state banks have to provide credits for the projects approved by the State Council (Shirai, 2002). The insufficiencies of financial support and restricted facilities to obtain credits are believed to have blocked the development of the firms in these underprivileged sectors.…”

Economic reforms, efficiency and productivity in Chinese banking

“…A number of researchers (e.g., Bonin and Huang 2001;Bhattasali 2002;DaCosta and Foo 2002;Gordon 2003;Lardy 1999;Mo 1999) have focused on case studies, mainly describing the history and problems of reforms in China's banking sector. Only a few studies (Park and Sehrt 2001;Leung et al 2003a,b;Li et al 2001;Shirai 2002) have provided empirical assessments on the effects of reform measures on bank performance. Although a variety of methods and perspectives of reforms were discussed in these studies, two major findings stand out.…”

Law, Finance, and Politics: The Case of India

“…Moreover, the use of outside equity by riskier firms (as proxied by age and size) is reported to have increased significantly since 1990, implying that developments in the stock markets have assisted such firms in raising finance (Pal 2001;Shirai 2002;F. Allen et al 2006b;compare Sarkar 2006).…”

“…A similar pattern of development has not, however, been present in credit markets. Whilst banks have become more willing to extend credit, this appears to have been across the spectrum of borrower types (Shirai 2002), Source: World Bank (2006). with the result that access to credit by the more risky firms has not proportionately increased (Love & Peria 2005).…”