Magazine article USA TODAY

Banking on China

Magazine article USA TODAY

Banking on China

Article excerpt

"What have Chinese banks done differently from Western banks that brought upon such vast differences--one side churning out profits while the other stands on the brink of bankruptcy?"

UNTIL THE RECENT financial crisis that shocked the Western world, few people believed that the Chinese banks were comparable in strength to their American counterparts. However, during the global financial crisis in 2008-09, while U.S.-based global banking franchises scrambled to raise capital in order to stay afloat, often through diluting their shareholders, China's major banks not only were solvent, but prosperous and able to demonstrate high earnings growth. During this difficult period, the Chinese economy stood out as one of the few stabilizing factors in the economic world. With strong, massive balance sheets, Chinese banks played a critical role in providing the necessary "capital fuel" to support its billions of dollars in infrastructure projects and other incentive plans, allowing it to continue to move ahead with its economic development.

What have Chinese banks done differently from Western banks that brought upon such vast differences--one side churning out profits while the other stands on the brink of bankruptcy? The answer is simple in that Chinese banks follow the traditional banking model--a financial institution that takes in deposits and provides loans. Chinese bankers are "old fashioned," while many Westerners pursue faster and higher-risk profits generated from derivatives trading--refusing to focus simply on loaning money to qualified borrowers.

In this day and age, it is not difficult to imagine that a college graduate from a prestigious university would refuse a career as a loan officer. The fanfare of fast-paced Wall Street deal-making continues to attract some of the brightest minds to the industry. In other words, Chinese banks serve the economic need of borrowing and lending money while Western banks serve Wall Street's forever insatiable appetite and relentless pursuit of mega-profits despite higher-risk profiles that have doomed many.

When a Chinese bank approves a loan, the bank carries the note on its books against its own capital, thereby reducing its ability to extend more loans since the outstanding loan already counts against its capital reserve. That is the traditional approach in commercial banking. A Western bank, however, decides that once a loan is made and fees are collected, it wants to move the loan off its balance sheet so that the bank can provide more loans and collect more fees from new borrowers. This is where "securitization" comes in--a process in which a loan is divided into pieces and sold to investors just like stocks. These smaller pieces of the same loan then are each graded separately by credit rating agencies and each piece is assigned an investment score. Investors such as pension funds and other institutions that buy these securitized loan products often require minimum investment-grade ratings since it is broadly believed that the due diligence work performed on these products by accredited rating agencies can be misted. Holders of these securitized products often retain them over time while hoping to receive regular loan interest payments from the underlying loans.

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Once a loan is securitized and sold, it no longer stays on a bank's books as a liability, which then allows the bank to make new loans and therefore generate additional fees. When a bank carries a securitized loan product on its books, it is classified as an asset item, which increases a bank's appearance of size and strength, rather than a pure loan (regarded as a liability). The value of such securitized assets fluctuates according to market prices and mark to market accounting is applied. Each quarter, banks count these securitized products on their books and mark these instruments against market prices at that time. If the market prices are higher than the original value, a bank books a gain, showing an increase in earnings and a bank's stock could move up. …

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