China: Trouble in store

Postal savings accounts are increasingly popular, but the prospect of post offices being able to offer loans to rural enterprises threatens to undermine one of the few solvent branches of China's financial system.

By now, China watchers are well aware of the bad debt problems plaguing the country's large state-owned banks, but other areas of the financial system are facing troubles of their own.

One especially vulnerable but poorly understood sector is China's network of rural credit co-operatives (RCCs), which have traditionally supplied credit to farmers and township enterprises. Chinese financial officials, who are normally very cautious about disclosing information on the level of bad loans, admitted several years ago that the RCC sector as a whole had negative net worth, and the small size of individual RCCs has left them vulnerable to depositor panics.

Falling market share

In recent years, the market share of RCCs has been eroded by an even more obscure competitor, the state-run postal savings system. China's post office maintains a network of more than 31,000 deposit-collection points, with roughly two-thirds in rural areas. Until now, the postal savings system has been largely passive: post offices in rural China accept deposits and place them with the People's Bank of China, rather than relending them to local enterprises.

The role of postal savings in the Chinese economy is beginning to expand, however. According to the 2001 edition of the Almanac of China's Finance and Banking, a People's Bank statistical publication, the market share of the postal savings system at end-2000 had risen to 7.12 per cent of total deposits from 6.51 per cent a year earlier. The almanac's compilers note that rural Chinese are increasingly shifting funds into postal accounts, and give two explanations for the trend.

One factor, according to the central bank, is 'the gradual withdrawal of the state-owned commercial banks from rural areas'. China's four largest banks are under strong regulatory pressure to improve their profitability and curtail the growth of bad loans. In an effort to cut overheads, the 'big four' have begun closing thousands of rural branches, where there are fewer opportunities to make large loans and deposits per employee are lower than in the cities.

The second incentive for opening postal accounts is what the central bank euphemistically calls 'the process of systemic reform of rural credit co-operatives'. In fact, deposit growth at the RCCs has continued in recent years, although postal deposits are growing even more rapidly (see chart). The main factor deterring even faster growth in RCC deposits seems to be increasing concern about the solvency of the RCCs, which do not enjoy the nationwide scope of either the big four banks or the postal savings network.

Severe credit squeeze

According to a recent report on China-Online.com, rural China is now facing a severe credit squeeze as the RCCs seek to clean up their books at the same time as the big four banks close branches in the countryside and the postal savings system (which traditionally does not make loans) takes a larger share of total deposits. Postal savings offices in some areas now drum up business using slogans such as 'low risk at postal savings banks, which only take in and don't give out'. However, one unexplained comment in the 2001 almanac suggests that this situation may be changing as well:

'The People's Bank of China will also recycle postal savings funds at county level and below through re-lending for use in the villages, drastically improving relations between postal savings bureaux and local governments and powerfully encouraging the high-speed development of the village postal savings business.'

Change in central bank policy

Although this passage is not easy to interpret, it seems to indicate a change in central bank policy during calendar 2000, authorising local postal savings stations to make loans to community enterprises. In a Chinese context, the reference to 'improving relations' with local officials points to very strong bureaucratic hostility to the postal savings system, which is seen as draining capital from rural areas.

There is no sign in the almanac's statistics that postal savings stations had begun making loans by the end of 2000. If implemented, however, the stated policy shift would dramatically soften the budget constraints of China's township enterprises. Granting rural postal workers the freedom to lend money to powerful local employers is likely to undermine one of the few solvent branches of China's financial system – and unlike the RCCs, the post office faces no competitive pressure from nervous depositors, who assume that their accounts will enjoy an implicit sovereign guarantee.

The resulting Catch-22 resembles one aspect of the situation in Japan, where fears about the solvency of shaky commercial banks – which will soon lose their official deposit insurance – have pushed trillions of yen into the even more troubled postal savings system. Postal deposits in Japan now represent some 36 per cent of total personal savings, far more than the 7 per cent seen in China at end-2000. Moreover, the system's use as a slush fund for loans to government agencies has saddled the state with enormous off-budget liabilities. With China's major banks already much weaker than Japan's, this is an element of Japanese financial policy that Beijing would do well to avoid.