Two weeks before the Chinese New Year, the Chinese government provided two of the country’s biggest state-owned banks a much-needed gift: new capital of $45bn.

The capital injection, supported by the country’s abundant foreign-exchange reserves, will go a long way to bolster the financial health of Bank of China and the China Construction Bank. Each received $22.5bn. Two other leading banks, the Industrial Commercial Bank and the Agricultural Bank, are expected to get the same amount from the central bank soon.

With the extra capital, the estimated 5% capital-asset ratio of the so-called Big Four will move closer to the 8% required by the Bank of International Settlements. Their non-performing loan (NPL) ratio will also drop substantially, from the official estimate of 22% for all four. The Bank of China can halve at one stroke the volume of its bad loans, which amounted to $47bn at end-June 2003.

Analysts say the capital injection was in line with Beijing’s commitment to make its banks more competitive before it opens its financial market fully by 2005, as required by the WTO. “The timing comes as no surprise. The authorities have been discussing bank restructuring plans, and the market has been expecting a bailout announcement early this year,” said Jonathan Anderson, economist at UBS AG in Hong Kong.

The fact that Beijing dipped into the country’s record-high foreign exchange reserves of $403bn (at end-2003) to save the banks, rather than using government bonds to help them, was surprising.

In an earlier rescue exercise in 1998, it provided the Big Four with Rmb270bn ($32.6bn) of long-term treasury bonds. A year later, it further created four asset management firms to take over Rmb1,400bn of bad loans, accumulated mainly by the Big Four.

Since then, the state banks have been working hard to reduce their bad loans, but have made little progress. Their NPL ratio, according to official estimates, hovered around 22% to 30% in most years, thanks to the distressed financial situation of their main clients, state firms.

Independent agencies such as Standard & Poor’s said the real NPL ratio was close to 40% to 45%, the highest ratio in Asia and a destabilising factor undermining China’s otherwise strong economic growth.

The injection of foreign exchange is “a quick and efficient, though unorthodox, method of bank recapitalisation,” said Mr Anderson. “It does not increase the gross stock of government debt, it provides banks with highly liquid Tier 1 capital and it requires prior approval from the legislature,” he said.

The question remains whether the Chinese banks can finally get their act together and improve on risk management. If not, more government bailouts might be required in future.

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