Up until the 1970s state financial functions were overseen by the People's Bank of China. Then the financial sector underwent huge structural transformation. The PBOC made way for the creation of other major banking institutions and other depository institutions. Currently the banking system in China is made up of a network of state policy banks, state-owned commercial banks, joint stock commercial banks, private commercial banks and a range of provincial level financial institutions and leasing companies.

The many layers of the system
Today, there are several layers to the Chinese banking system.

The PBOC serves as the regulatory authority, directly below which are four state-owned commercial banks. The central bank for China is the People's Bank of China (PBOC). Within the PBOC are two special divisions responsible for foreign banking operations in China. On the whole, the powers and functions of the PBOC are similar to those of the central banks in Western countries. This is particularly true with regard to the adoption of financial policies, supervision of the specialised banks and financial institutions, as well as the approval for the establishment and dissolution of banks and financial institutions. There is a commitment by the PBOC to rationalise and consolidate the domestic banking industry in preparation for the competition that will arise from accession to the WTO. This will include the merger of banks and the listing of many banks on the domestic and international exchanges.

China's banking hierarchy starts at the top with the four state-owned banks: the Bank of China, the Industrial and Commercial Bank of China, China Construction Bank and the Agricultural Bank of China.

Beneath these are three policy banks, the China Development Bank, the Export-Import Bank of China and the Agricultural Development Bank of China. These finance infrastructure projects and other, long-term state-supported or non-profit making projects.

Under this are the second tier state-owned banks (shareholding banks).

Next on the ladder are more than 10 joint stock commercial banks, most of which were set up in the 1990s. Four are listed on the domestic stock market: the Shanghai Pudong Development Bank, the Shenzhen Development Bank, the China Merchants Bank and the China Minsheng Bank.

In terms of overseas banking institutions, around 168 foreign banks from 38 countries have opened representative offices in 25 Chinese cities. Out of nearly 200 foreign banks operating in China, 88 have won the approval to do renminbi business

State-owned Commercial Banks
There are four state commercial banks in China which dominate commercial banking business. Their functions are as follows:

• The Bank of China. China's main international banking organisation, BOC, has an extensive network of branches in China and overseas. Its speciality is foreign exchange and it shares domestic foreign exchange activities with other specialised banks. The bank's major activities are commercial banking, interbank deposits and loans, purchase and sale of gold and foreign currencies, participation in international loan syndications, issuance of bonds in the international market, export credit financing, overseas banking services, overseas remittance, and banking transactions for foreign-owned enterprises. In late 2001, Bank of China International Holdings Ltd. and the Bank of China Group Insurance Co., Ltd, both registered in Hong Kong, began to establish outlets and launched operations in mainland China. Through this development, BOC can now provide all major financial services under the same brand name in mainland China.

• The Industrial and Commercial Bank of China, set up in 1984. ICBC took over the branch network of the PBOC that then took on the role of the central bank. The ICBC assumed the duties of local currency lending and deposit-taking for Chinese industrial and commercial enterprises, as well as trade-related services such as the issuance of letters of credit. The ICBC now has a network of over 28,000 branches across China and an investment banking subsidiary in Hong Kong.

• The China Construction Bank. Founded in 1954, the CCB specialises in handling China's capital construction investments, including large-scale technical transformation projects. The bank is charged with the allocation of funds for these projects and supervises the use of the funds. It gives priority to projects in the energy, communications, transportation, housing, and land sectors. It also has a domestic investment banking subsidiary, China International Capital Co., Ltd. (CICC), in which Morgan Stanley has a significant interest.

• The Agricultural Bank of China. The ABC was established in 1979 to take over the rural branch network from the PBOC and to provide banking services to rural businesses and individuals. It is responsible for the development of the agricultural and rural economy, and manages funds allocated for agriculture by the central government.

Originally these were specialised banks concentrating on the sectors of the economy their names would suggest. However, in 1994 the government established three policy banks for this role and the commercial banks turned their attention to becoming truly commercial. This strategy was enhanced by the Commercial Banking Law in 1995. In 1998 many of the local branch networks of these banks were replaced by a system of regional commercial banks and a new tier of private joint stock banks in 300 cities.

At the local level are more than 110 regional commercial banks, around 1,000 urban credit co-operatives, and some 35,000 rural credit co-operatives that provide basic banking services.

Policy Banks
There are three policy banks. The China Development Bank was the first policy bank and the Export and Import Credit Bank and the Agricultural Development Bank of China were formed later to manage policy loans and other subsidised financing in designated areas.

Regional Banks
There is a whole range of regional commercial banks which are now beginning to spread their business on commercial rather than regional grounds. Some of the biggest are the Pudong Development bank which became only the second bank to list in China on the Shanghai Exchange in 1999 following the Shenzhen Development Bank.

Co-operative Banks
There were originally some 3,000 urban and 50,000 rural credit co-operatives which have gradually merged into banks. For example the Shenzhen co-operative bank was created from 16 urban co-operatives and the Shanghai City United Bank was created from 99 urban co-operatives. They principally provide funding for small and medium sized businesses.

Second Tier State Banks (Shareholding Banks)
Second tier state banks are essentially joint stock banks, which have private shares owned by government or private entities. There are around 10 including: Bank of Communication, China Everbright Bank, CITIC Industrial Bank, Shenzhen Development Bank, Pudong Development Bank, China Merchant Bank, Fujian Industrial Bank and Guangdong Development Bank.

Most of these banks have the option of raising capital through share issuance. Originally set up to provide specialised products and services, they have since evolved to provide a full range of banking and other financial services. These banks are free of policy-loan constraints and virtually all of them are now seeking to list on the domestic stock exchange and some of them on the international exchanges.

Private Banks
The Chinese government recently gave its permission for a private bank, Minsheng to be set up. China Minsheng Bank is unique in largely having private owners. It focuses on lending to the private sector, including Sino-foreign joint ventures, and is listed on the domestic stock market. The government has indicated that it wishes to develop a new tier of private banks and also that it will allow foreign stakes in the Bank of China in due course.

Investment Banks
China's only real international investment bank is the China International Capital Corporation (CICC). Established in 1995 as a joint venture between China Construction Bank, Morgan Stanley Dean Witter and three smaller shareholders, it is allowed to underwrite domestic equities, take equity stakes in foreign investments in China, undertake mergers and acquisitions, organise project finance and handle foreign exchange.

Other than CICC only the Bank of China has a track record of providing investment banking services domestically although all the state commercial banks are expanding into this field. The China Development Bank (one of the three policy banks) has also set up an investment banking services with a view to handling project finance business.

Foreign investment banks are restricted in what business they can do, mainly international equity business. For now, they are unable to underwrite shares. There is however, continuing commitment to reform and open up the financial services market, in line with China's WTO obligations (see below).

A large number of foreign investment banks have representative offices in Shanghai and Beijing already, including Bear Stearns, Goldman Sachs and Merrill Lynch. British banks include: Nat West Markets, HSBC, Barclays Capital, Jardine Fleming, Rothschild and Warburg Dillon Read.

The WTO timetable and foreign banking institutions
Immediately after China's accession to the WTO the PBOC announced a specific plan for the opening of China's banking business to foreign banks to conduct renminbi-related business in certain cities.

Upon accession in 2001 to the WTO, foreign financial institutions were permitted to provide services in China without client restrictions for foreign currency business.

So far as local currency business is concerned, dating from 2003 foreign financial institutions have been permitted to provide renminbi services to Chinese enterprises, although this is still within strict geographic limits.

From 2006, foreign financial institutions will be permitted to provide services to all Chinese clients on the same level as local banks, without restrictions of any kind.

Your business
Foreign-invested enterprises (FIEs) (which is the Chinese term for companies that have some element of foreign funding or investment) may borrow from local or foreign banks, as they wish. Funds may be made available directly to the FIE or, alternatively, to the foreign investor for lending to the FIE. Borrowings may be in renminbi or foreign currency.

Borrowing may be for a specific project or for general working capital needs. However, the aggregate amount that FIEs may borrow is restricted because of regulations that determine the minimum equity requirements in relation to different total amounts of investment. The FIE's total investment is, broadly speaking, its registered capital plus its borrowings.

Loans granted are generally classified into two types: fixed asset and working capital loans.
• A fixed asset loan may be medium-to short-term, or medium- to long-term, and is used for construction costs and the purchase of equipment.
• A working capital loan is used to provide funds for the manufacture and turnover of products and other normal business activities.

HSBC and Standard Chartered Banks are the two of the biggest British banks in China. They both have licences to conduct renminbi business and have a network of branches in a number of Chinese cities. Typical corporate services provided by foreign banks in China include mortgage and loan services, cash management and online management. In some cases it is possible to trade in B shares with a foreign bank. Nat West and Barclays have representative offices in Beijing and Shanghai but restrict themselves to corporate banking business.

Changes afoot to solve problems
The problem with the current Chinese banking system is that it is slow and poorly equipped to provide businesses with the money they need for their various requirements. There are various measures being taken to reform the banking system including:
• Expanding money and capital markets, breaking down regional barriers and establishing a unified market.
• Establishing a national unified and orderly inter-bank lending market.
• Converting credit co-operatives into city commercial banks.
• Applying an internationally accepted accounting policy in the banking industry and in the state-owned enterprise sector.
• Fulfilling China's WTO commitment.

Non-Performing Loans
One of the most pressing problems affecting the banking system in China is that of non-performing loans. This has come about because the state-owned banks continue to lend to state-owned enterprises, irrespective of whether or not they expect to get repaid. This attitude is changing, as China continues to try to establish free market practices, but only very slowly.

New rules have been issued to stem the excessive flows of credit. Loans to management, shareholders and other related buyers have been capped at 10 per cent of a bank's capital. Homebuyers must now put down 30 per cent of the price (up from 20 per cent).

These steps, however small, are already beginning to have an effect. The growth of money has slowed marginally even without action on the currency. Auto loans have dropped by more than half and bank managements have made concerted efforts to redirect loans to profitable enterprises with a greater likelihood of repaying the loan in full and on time.

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