The Commercial Banks' Liquidity Management in China
Tong Pin, Ding Zhisuo
Department of Administrative Information,
Industrial and Commercial Bank of China
In 1994, the People's Bank of China drew up and issued a set of indexes and regulations on assets and liabilities ratios management of commercial banks * This signified that commercial banks in China started officially to adopt the tactics of assets and liabilities ratios management. What are the similarities and differences between the tactics of the assets and liabilities ratios management adopted by the commercial banks in China and the tactics of combined asset and liability management adopted by commercial banks abroad? Can the existing index system and administrative rules solve the liquidity problem of the commercial banks in China? If the answer is "no", what external and internal conditions shall be created to strengthen and improve the liquidity management of the commercial banks? This article reviews the development of the liquidity supervision, control and management of the commercial banks in China and makes an analysis of the factors impeding the liquidity management of the commercial banks in China.
I. Status Quo and Characteristics of Liquidity Management of Commercial Banks in China
The circle of theoretical study holds commonly that the tactics of liquidity management adopted by commercial banks abroad has generally gone through three stages of development, namely asset management, liability management and combined management of assets and liabilities.
When mechanically using the theories about the development stages of liquidity management of commercial banks abroad to analyze and assess the historical development and current situation of liquidity management of the commercial banks in China, it is often felt that there are too many things to attend to, and that it is difficult to make a suitable beginning. Before adopting the policy of reform and opening to the outside world, China had no independent banking system, let alone an independent commercial banking system. The People's Bank of China performed both the function of the central bank and the function of the commercial bank. The banks were under the jurisdiction of fiscal departments. Their main duties were to extensively absorb social funds to help carry out the economic development plan and promote the national economic growth. Under the guidance of such a system and policy, the banks could not begin to talk about implementing liquidity management. Moreover, profitability and safety were not included in their operating targets. After the policy of reform and opening to the outside world was carried out, some solely state-owned commercial banks were separated from the central bank, resumed or newly set up. Many other kinds of new commercial banks were also established. Thus, a double-layer bank system consisting of the central bank and the commercial banks, which do their duties respectively, has gradually taken shape and been improved constantly. The establishment (at least the nominal establishment) of the independent commercial banking system has laid a system foundation for the emergence of the liquidity management of banking business. Under such a new system, the problems including liquidity, safety and profitability have drawn attention from academic circles as well as the banking system, both at home and abroad.
Looking back on the course of the reform and opening to the outside world of the banks in China in the past two decades or more from the angle of liquidity management, it can be divided into two stages.
1. The first stage is from the early period of the reform and opening to the outside world through to the mid-1990s. During this stage, the independence of commercial banksin China was only nominal and organizational. The business and management of the commercial banks bore a marked brand of the times of the planned economy. The main tasks of the banks were to carry out the designated credit plans to promote economic growth. After 1983 when the government started to support the state-owned enterprises by offering bank loans instead of fiscal allocations, in particular, the commercial banks had even heavier tasks to promote the economic growth than during the period of the planned economy. The balance of all the credit of the state-owned banks reached 3,2441 billion yuan in 1994, 175 times that in 1978. Such a high rate of credit growth should be supported by an even higher rate of liability growth. By chance, this was a period when China was experiencing the accelerated monetarization of the economy. Her economy was growing at an ultra-high speed and her residents' income was increasing quickly. Since the financial market was undeveloped and the banking was highly monopolized at the time, there was not sufficient competition between the banks and non-bank financial institutions. A big increase in the deposits of enterprises and residents resulted in the rapid growth of bank liabilities. The balance of all deposits in the state-owned banks reached 2,9331 billion yuan in 1994, 2585 times that in 1978 and 835 times more than the growth rate of the credit balance at the same period. In order to fulfil the credit plan, moreover, the commercial banks were allowed to apply for re-lendings from the central bank if they did not have sufficient sources of funds. During the three years from 1989 to 1991 alone, the re-lendings extended by the central bank to solely state-owned commercial banks went up by 254.9 billion yuan, equal to 38.5 percent of the increased amount of all deposits in the solely state-owned commercial banks during the same period.
The purpose and use of the re-lending from the central bank to the commercial banks in China different from those in the western developed countries. Re-lending in China not aimed at solving the problem of insufficiency of liquidity of commercial banks. It is in the form of direct or indirect special loans or is used to expand the scale of credit to help fulfil or over-fulfil the economic growth plan. Since the financial market was underdeveloped and the channel of investment was unitary, commercial banks were able to absorb most of the social fund even without any improvement of their services or the development of new products during the period. In addition, there was the support of the re-lendings from the central bank. Thus, it was easy for the commercial banks to increase their liabilities. The management of commercial banks concentrated on increasing credit supply, fulfilling credit plans and readjusting the credit structures. In other words, it concentrated on the business of assets. This could be called asset management. However, it was absolutely different from the asset management of the commercial banks in the western countries before 1960s in both the nature and the contents. It is not a kind of liquidity management, but a kind of aggregate and planned management under which the expansion of the assets and the readjustment of the assets structure should be carried out totally in accordance with the credit plans allocated by the central bank. It was not a kind of management and unanimous matching of the term structure of assets and liabilities and the degree of liquidity. At the time, the commercial banks had no responsibility of liquidity management. Besides, the central bank did not focus its work on financial supervision and control, but on formulating monetary policies and promoting economic growth.
It is appropriate here to review the issue from the angle of the reserve system. The People's Bank of China established the system of deposit reserves as early as in 1984, but such a system was different from that of the economically developed countries. The reserve requirements of the commercial banks in China deposited in the central bank could be used neither for payment and clearance nor as a tool of their own liquidity management. The reserve requirements collected by the central bank were mainly used as a source of re-lendings and as the fund for payment of the purchase of farm produce and by-products and for payment of some important industries and key projects.
2. The promulgation of "The Commercial Bank Law" in 1995 marked the beginning of a new stage of the management of commercial banks in China. The law clearly stipulates that commercial banks will adhere to the principle of profitability, safety and liquidity in management, be independent in management, take risks by themselves, assume sole responsibility for their profits and losses and exercise self-restraint; that the capital adequacy of the commercial banks will not be lower than 8 percent; that the ratio of the loan balance to the deposit balance will not be higher than 75 percent; and that the ratio of the balance of liquid assets to the balance of liquid liabilities will not be lower than 25 percent. By that time, the commercial banks' independence in management and their duties in liquidity management had been legally recognized. In 1996, the People's Bank of China issued a set of indexes and a set of rules about supervising, monitoring and checking the assets and liabilities ratios management of commercial banks. The indexes include 19 items such as the capital adequacy rate, the loan quality, the deposit-loan ratio, the inter-bank loan ratio, the asset liquidity ratio and the proportion of medium-and long-term loans. Most of the index items are about the liquidity management of commercial banks. In order to encourage the commercial banks to strengthen the management of asset liquidity, to guard against the payment risks and properly deal with the existing payment risks, the People's Bank of China promulgated "the Temporary Provisions on Guarding against and Dealing with Payment Risks of Financial Institutions" in 1997. The provisions set five items of warning indexes about payment risks (liquidity risks), namely, 15 percent or less for asset liquidity ratio, 13 percent or less for reserve ratio, 30 percent or more for bad loans and 5 percent or more for the ratio of net inter-bank loans to deposits. As of January 1, 1998, the People's Bank of China replaced the directive plan with the guiding plan in its administration of the increased loans of commercial banks. In March 1998, the People's Bank of China reformed the system of deposit reserves by integrating into one, the commercial banks' two accounts in the central bank, namely the account of required reserves and the account of excess reserves, so as to bring the payment and clearance functions of the deposit reserves into play. Meanwhile, the ratio of deposit reserves was lowered and the commercial banks could use the released reserves to pay back the re-lendings, thus gradually facilitating the financial relations between the central bank and the commercial banks, enhancing the self-consciousness of the commercial banks for liquidity management.
Outwardly, the commercial banks in China have entered the stage of assets and liabilities ratios management (analogous to the third stage of liquidity management of foreign commercial banks) since 1995 which is what most of the people in the banking circles in China believe. Is it real that the Chinese commercial banks have leapfrogged into the stage of asset-liability management from the stage of asset management? We hold that it is necessary to make a real and concrete analysis of the management tactics of the commercial banks. At first, it is imperative to reaffirm the fact that the concept of assets and liabilities ratios management is not the same as that of the combined management of asset and liability. In western countries, commercial banks take combined asset management and liability as a kind of liquidity management tactic for guarding against the interest risk and the liquidity risk under the circumstances of market economy. In China, however, the interest rates of the financial market has not been completely liberalized yet and the ratio management is obviously not mainly aimed at guarding against the interest risk, but the liquidity risk. The difference of the external financial circumstances (referring to the difference of the pricing system) essentially determines that the ratio management of China is totally different from the combined management of foreign banks in both nature and purpose.
In addition, combined asset and liability management is a kind of management initiative adopted by foreign commercial banks to cope with the marketization of interest rates. However, ratio management is not an initiative of commercial banks in China, but a goal that the country's bank supervising and controlling institution, the People's Bank of China, suggested and forced the commercial banks to gradually reach.
As China's reform and opening to the outside world deepened in the mid-1990s, great changes had taken place in the external environment of business of the commercial banks. The development of the capital market and the establishment of a group of commercial banks and foreign-funded banks made the competition among the commercial banks for liabilities (mainly the deposits) fiercer. Meanwhile, the competition in the field of assets is relatively moderate. The total amount, destinations and structure of the credit of the commercial banks were still under strict control of the central bank. Even after 1998, when the Central bank replaced the directive plans with guiding plans, the total amount and overall structure of the credit of the commercial banks are still experiencing intervention and restrictions by the central bank, though the commercial banks have more rights to independently choose the projects and the enterprises in extending loans. This stems from the fact that the commercial banks in China have always had the heavy task of promoting economic growth. As a result, they have to be under the guidance of the credit plan of the central bank. Moreover, the unique characteristics of China's banking regulatory system complicate the relations between the banks and the governments. The intentions of the local governments also influence to a certain degree the total amount and structure of the credit of the banks. After the mid-1990s, therefore, commercial banks in China could and still do little independently in the field of assets, both in the total amount and in the structure of credit. In the field of liabilities, however, they have room to independently expand the total amount and readjust the structure of the credit because the central bank imposes fewer restrictions on and control over them. Besides, the supervision and check up of the indexes of assets and liabilities ratios management by the central bank have made the commercial banks pay more attention to the business of liabilities. In order to meet the needs of both the guiding credit plans and the ratio management targets (which are gradually converging), the banks have to make the strongest efforts to promote their liability business and rapidly increase their liabilities. In other words, liability management is the foundation for carrying out the credit plan and the ratio management.
In the middle to late 1990s, the competition among the commercial banks in China in the field of liabilities was very fierce. Since the central bank of China adopted the administrative system that any new financial product of commercial banks (including new liability products) should be strictly examined and approved, it was very difficult for a commercial bank to beat the competition through developing a new product. So, the commercial banks preferred to take such relatively simpler liability management measures including setting up new subordinate institutions (which should also be approved by the People's Bank of China), increasing the staff members (including temporary agents) and soliciting deposits with high interest rates in disguised forms, some of which are legal and some illegal. As a result, big deposit clients became the focus of the competition. It is necessary to stress that the liability management tactics of commercial banks in China are different from that of the western banks in the 1960s through 1980s and strictly speaking, it is not the liquidity management tactics, either. At first, they were not aimed at solving the problem of insufficient liquidity, but expanding the scale, although the result of the competition in liabilities may have solved the problem of insufficient liquidity to a certain degree.
II. Factors Impeding Liquidity Management of Commercial Banks in China
In the past two decades of China's reform and opening to the outside world, commercial banks in China have adopted in succession the asset management tactics and the liability management tactics, but have never adopted the real combined asset-liability management tactics. So far, the commercial banks in China have never carried out the real or strict liquidity management. It should be admitted that such practice does not conform to the nature of a "commercial bank." Such a phenomenon stems from many factors. Besides the weak restricting role of the series of documents and policies on strengthening liquidity management of commercial banks promulgated by the central bank, there must be some other factors in the current financial policies and systems that impede the commercial banks to improve and enhance their liquidity management. It is self-evident that to make an analysis of the major factors will be significant for further reforming the banking system and further improving the supervision system.
First of all, internally the commercial banks in China lack an impetus mechanism that can effectively strengthen and improve the liquidity management. Judging by the evolution of the liquidity management strategies of foreign commercial banks, asset management, liability management and combined asset-liability management are all means of liquidity management adopted within the commercial banks to adapt themselves to the changes of the external circumstances. At present, however, Chinese commercial banks mainly rely on external forces and the mandatory order of the central bank to make them carry out the liquidity management.
The banks do not pay much attention to liquidity management and there is not an effective system of self-restraint mainly because the following two facts: First, they are state-owned. Behind the management of the banks is the powerful guarantee of the government. Generally speaking, the government will not stand idle if insufficient liquidity occurred. Second, the banking industry is highly monopolized. The solely state-owned commercial banks lack strong rivals of other kinds of banks and non-bank financial institutions. At the end of 1999, the proportion of the deposits in the four solely state-owned commercial banks to that in all the financial enterprises throughout the country was still as high as 6373 percent.
Secondly, the central bank's supervision of the liquidity management is severely limited by insufficient information. Sufficient information is the prerequisite and foundation to guarantee an effective liquidity management of the commercial banks and an effective financial supervision of the central bank. At present, the statistical system and statements of the commercial banks in China mainly pay attention to time point and stocks of balance. However, the central bank's supervision of liquidity management must be on the basis of period of time and amount of flows. Though the central bank requires all the commercial banks to report the statistics of non-spot supervised indexes while implementing the assets and liabilities ratios management, the accuracy of the core indexes of these statistics is not guaranteed because of the limitations of the accountants, statistical systems and technology. Some expired indexes are even collected through estimation by the grassroots subordinates in the commercial banks. Both the headquarters of the commercial banks and the central bank do not have scientific information system to pick out and put under control these false indexes. The insufficiency and inaccuracy of information directly cause great difficulties for the headquarters of the commercial banks and the central bank to accurately monitor the liquidity situation. As a result, they cannot carry out scientific and strict liquidity management. Even if the insufficiency of liquidity has become urgent in some places, they are not yet informed. Information insufficiency has greatly limited the banks' ability of guarding against the liquidity risk. The ideal situation is that when a problem of payment occurs, the central bank is able to accurately distinguish a temporary liquidity insufficiency of a commercial bank from its insufficiency of ability for payment.
Thirdly, the inconsistency of the monetary policy and supervision policy of the central bank also impedes implementation of the measures for liquidity management of the commercial banks. Of the two major functions of the central bank of China, formulation and implementation of the monetary policy to exercise macroeconomic control has always been prior to financial supervision and control. But the monetary policy and the supervision and control policy are not always identical. Sometimes, there are obvious contradictions. According to the requirements of the supervision and control, the commercial banks will gradually reach the level set by the regulations on assets and liabilities ratios management. However, the monetary policy which is aimed at macro economic control often demands the commercial banks to increase credit and gives "guiding suggestions" about the destinations of the credit, though this may lower the level of liquidity indexes of the commercial banks. Since the monetary policy is prior to financial supervision and control, the central bank has to soften the requirements for the supervision and control indexes of assets and liabilities ratios management of the commercial banks. In the course of time, the commercial banks would think that these indexes are for reference only.
Fourthly, the capital market in China is imperfect and underdeveloped. In terms of theory, the development level of the capital market has a kind of relation of contradicting and depending on each other with the liquidity level of the commercial banks. The more developed the capital market is, the fiercer the competition that the commercial banks face in the liability field will be and the more difficult the liability liquidity management will be. In terms of assets, however, a developed capital market will help increase the assets liquidity of the commercial banks and facilitate the liability liquidity management. The final result depends on the net effect of the influence of both assets and liabilities.
The situation of the development of the capital market in China is obviously interrelated with the liquidity of commercial banks. When the stock market and long-term state bonds market begins to thrive, the growth rate of general savings in the banks and the growth rate of inter-bank deposits and loans will correspondingly and markedly go down and up, respectively. Since the stock market in China is very speculative and often fluctuates heavily and irrationally, the liability structure of the commercial banks also fluctuates heavily. Meanwhile, the underdeveloped capital market makes the asset-liability liquidity management more difficult. In addition, China is adopting a strict system of the separation of banking and securities industry. The commercial banks are not allowed to engage in business of securities and insurance. Even if they engage in investment in the state bonds, they are strictly bounded within the total amount and a number of varieties. As a result, the asset structure of the commercial banks is monotonous and cannot be independently reshuffled and diversified. So, there is little room for liquidity management. These also impede the commercial banks in effectively executing the measures for liquidity management.
Fifthly, the interest rates are planned. At present, China is still adopting the strict planned interest rate system. Under such a system, the commercial banks cannot independently set the price of funds in line with the immediate situation of the funds supply and demand and with the contribution of the client. This is harmful to the adoption of scientific and effective liquidity management. The planned interest rates also restrict the commercial banks from developing new financial products such as interest-rate swaps. These new financial products are both a tool for optimizing the profitability and a tool for liquidity management. Outwardly, the same interest rate system helps the commercial banks to avoid interest rate risks in the business. But, it also restricts the commercial banks from bringing their ability of liquidity management into full play. Undoubtedly, the planned interest rate system helps reduce the variable that the commercial banks have to take into account in carrying out liquidity management, thus simplifying the work of liquidity management. Meanwhile, however, it weakens the commercial banks' consciousness and independence for strengthening liquidity management. When the liquidity situation deteriorates, it is difficult for the central bank to know whether it is because of the irrationality of the interest rate system or because of the commercial banks' incapability of liquidity management, thus it is difficult to define and fix the responsibilities of the commercial banks.
The weak consciousness of the commercial banks for liquidity management and the lack of coordination of the systems and policies of different aspects have directly resulted in the low efficiency of financial services in China. At present, the state-owned commercial banks in China have about one time of loan turnover a year, only half or one-fifth of that of commercial banks in the US and Europe. The slow turnover of fund is an important factor causing the resource-intensive financial and economic growth in China and is the basic problem impeding the central bank to fulfil "fine tuning" the monetary policy. Due to the slow turnover and weak liquidity of funds of the commercial banks, the central bank has to mainly rely on marginal and incremental readjustment whether it tries to ease or tighten monetary base. In order to hit the set targets of stimulating or tightening the economy by incremental readjustment, it requires not only a strict time limit, but also a big growth rate. In other words, under the current circumstances when the liquidity of the commercial banks in China is not strong, the monetary policy of the central bank has relatively small elasticity and low efficiency.
The weak liquidity management of the commercial banks has also directly (and most dangerously) resulted in the vulnerability of the banking industry. Any factor that is harmful to liability growth such as a drop of the interest rate, or a thriving stock market, or even a rumor about possible bankruptcy of a commercial bank may cause liquidity insufficiency of the commercial banks. In recent years, some small local banks in China have had the problem of payment insufficiency. Though, because of the monopoly and the government's credibility, the state-owned commercial banks have managed to keep their business steady, the effects of the changes taking place in the external policies and environment on the liquidity still obviously exist.
World Economy & China Number 1, 2001