2008 was the thirtieth anniversary of China's reform and opening up in 1978. The past three decades saw some of the country’s most dynamic days. Today, the Main Talk starts a two-month series focusing on China's economic transformation. We begin our special report with financial reform-- regarded as the core of economics in China.

China's financial reform began in the end of the 1970s. The goal was to build a contemporary financial system. By 1983, the People's Bank had given up its universal functions and was acting solely as a central bank. The Agriculture Bank of China, the Industrial and Commercial Bank of China, the Bank of China, and the China Construction Bank then became the Big Four--- state-owned commercial banks focusing on rural areas, urban areas, overseas business, and domestic investment respectively.

Since 1994 the financial sector has made massive strides integrating into the world economy. Three of the big four, CCB, BOC and ICBC, have been listed in Hong Kong or mainland China since 2006. That year, ICBC became the world's largest IPO, raising 19 billion US dollars.

The ambitious efforts of the past three decades have shaped a strong financial system today. But will the policies that served China best in the past still serve it best today? And what lies ahead in the future? How will China deal with this current global economic downturn?

To discuss these issues, we caught up with Li Ruogu, chairman and president of the Export-Import Bank of China..

Li Ruogu is the Chairman and president of China Eximbank. He has served as Deputy Governor of the People's Bank of China. From 2003 to 2005, he also served as Economist of IMF for Asia, Executive Director of the Asian Development Bank for China, President of the Budget Review Committee of the ADB. Li Ruogu got his Master in law in Peking University in 1981 and MBA in Princeton University in 1983.

Banking Reform

Q: Welcome to the main talk. 

L: Thank you.

Q: Well, we know that China’s bank industry was pretty much dominate by the central’s bank, by the people’s bank. Before 1978, it was pretty much the only bank that control China that time. And later on, the role and function of the central bank was identified and actually we also established for the state banks, so-called the big four. And at that time they were signed distinct functions, for each one of them. So what was the context I mean why was distinct and unique functions assigned to these four banks at the time?

L: Before the reform that is before the 1978, that China had only one bank, is people’s bank, it both functioned as a central bank and also as a commercial bank, and why it split up into the four major banks? I think, after the reform, we actually gradually realized you can not to be the judge, at the same time, as the player, and this is not a good system, and we also learned form international experience, they have all had these two tiered banking systems. That’s one of the reasons why the people’s bank actually split up into the four banks.

Q: So overall how do you evaluate the performance of the four state-owned banks of the past two or three decades?

L: These four banks have a lot of satisfactory performances as well as some dis-satisfactory performances. Then we use these banks, use the money creation function of this banking sector to finance the development.

Q: What about the dissatisfactory elements, they are also saying the dominance of state-owned banks is really not compatible with the concept of the market economy that we are seeing today.

L: First of all, I think the people’s dissatisfaction against this banking sector is reasonable. the economic development growed very fast that this kind of demand for financial service also increase substantially. And our banking sector is actually left behind. That is the Negative part. But you cannot guarantee every decision of investment must be correct, must be profitable which is impossible.

Q: Now it’s the banks that are suffering from this.

L: That’s right. Some of the bad things, bad decisions should be assumed by the government. Roughly 85 percent of NPLs were played by the government at different levels.

Q: What do you think the state owned banks can do to improve their effectiveness and efficiency in the future?

L: The market competition can help improve the efficiency. We should also have the regulations, market rules, and all the things that need to be established if we can maintain a healthy market environment, a healthy competition, and healthy development.

Q: You talked about regulation, what is lacking in the current regulation of banking system that could be improved.

L: I think most of the important so-called regulators is internal- internal control, internal regulations.

Q: So are you suggesting… are you implying that in the current situation state-owned banks have problems in internal control?

L: You can partially interpret my explanation of the problem of Chinese banking sector as the internal control.

Q: What do you think should be controlled?

L: For example, in the banking sector, if one person has too much power, or, you have one person on a very crucial position and work too long, let’s say five years even ten years then you give him or her a lot of opportunities to create some loopholes or use the loopholes of the system to make their own interests. In many this kind of loopholes, we have no very riched experience in before, in the past, to make up those holes, we only gradually know that is the loopholes, the other is loopholes, then we try to make them up. So this is a gradual process anyway.

Exchange Rate Regime Reform

On July 21, 2005, China announced its currency would no longer be pegged to the US dollar. China began to reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. It marked a more flexible mechanism for the exchange rate's formation.

Q: China began its exchange rate reform, regime reform on July the 21st, 2005. Why was this long-awaited decision made at that time?

L: I think this so-called exchange rate regime reform actually has been discussing for a long time. And certainly the Chinese government, or the Chinese financial authority or namely the central bank always want to have a more flexible exchange rate regime. But it is a difficult job, and once you fix it, for example, actually we fix it at 1998, when the Asian financial crisis erupted. Actually we fix it at the request of the whole world, including the countries like the United States, but once you fix it, it’s a little bit difficult to move away from this regime. So the discussions actually, the urge for China’s to move, to appreciate the currency at a restarted 2002. Some of the Japanese economists of political figures called on China to appreciate the currency. And Japanese also persuade the United States to make pressures on China. And this is the so-called international pressure on us and also internally or domestically we also accumulate huge amount of surplus of trade, and both investment surplus as well. It is US dollars and international monetary system cause all these problems

Q: So there was no single, really no single triggering factor or incident.

L: I think so, I think it is a domestic demand and domestic development and international development allow us to make that decision at that time.

Q: Do you think the reform has been successful so far?

L: The flexibility we expected has not achieved and because the reform has not been completed. So therefore we cannot expect it happened at this time.

Q: Some people put 2010 on the timetable for RMB free exchange. What is your take on that? I mean what are the preconditions for this to happen?

L: There is two preconditions from my point of view, for a full convertibility of the currency; one is the management and the supervisory capacity of the financial authority or the financial market.

Q: Do we have it now?

L: I don’t think so. The second precondition is internationalization of the currency. Many currencies, including the German Mark and some other currencies, before they become the full convertible currency, they already partially, you know, internationalized. The Chinese currency is in the same situation. If you go to the neighboring countries, you will see they all accept RMB, Vietnam, Laos, Cambodia. Chinese economy is healthy and strong, the currency will be anyway appreciated, so holding RMB means holding wealth. So there will be more and more people and country economies accept RMB, gradually your currency will become internationalized.

Q: How long will that take you think?

L: A few years. After that the currency will be able to be a full convertible currency.

Financial Crisis

The US credit crunch is causing the world's worst financial crisis in almost 80 years. Banks are collapsing, markets lack confidence and governments find themselves struggling to cope with the economic turmoil. With these combined fators the world's financial sector is pressing the panic button. When people are worried about their financial future, Li Ruogu, a constant defender of a strong central bank, emphasizes the importance of a state-owned financial sector. In two of his books, "China's Financial Development in face of Globalization" and "China's Financial Development in the Age of Globalization", published in 2007 and the other early this year, Li Ruogu has documented his understanding and concerns of financial security issues.

Q: Now this year as we celebrated the 30 years’ anniversary of China’s opening up and reform. There is also a big issue that the world is facing, especially the financial sector, which is the US sub-prime crisis. What can we learn form that experience?

L: There are comments about the sub-prime crisis. But I probably have some different views on the issue. And I think the sub-prime crisis is not supervisory crisis, is not a supervisory problem. Again it is the internal control problem of the banks. I think they rely too much on the external rating agency to give their ratings of those sub-prime; they should have their own internal rating agencies or internal rating system which can more correctly, accurately evaluate the risk \. Let us do something to change the internal control and also the CEO selection process. And to select the right person to run a right system, then you have a much better choice to avoid huge or serious financial risks. This is one thing. The second, because of the nature of this instrument, they should know at the beginning. There are a lot of risks against this instrument. So they should have an allocation, or previsions to mitigate if something happens of their problem. So they have overall know this kind of things. So I think this is the lesson the banks, or financial institutions can learn from this sub-prime crisis. After the crisis, the US suggests we should have more unified supervisory framework giving central bank and more supervisory powers, which I think is correct.

Q: Well there is actually a lot talk around this, especially this year, you know during the two sessions, big ministry systems was a hot topic, and some people are saying they are bringing this issue up again, whether or not the central banks functionality should be divided among these three or four entities.

L: Actually, I myself, at the beginning of this reform in China, supervision reform, as my own views I said, we should not split up the central banks supervisory functions into full you know agencies. But anyway in those years, it was a separate function of the banks, and the security and insurance. So you have the reason to have separate supervisory agencies. But I think the direction of financial sector development is you have more integrated functions of the three. And then you need integrated supervisory system, so I think at this time we probably have to rethink about the reform in 2003, when we separate this supervisory function form the central bank. I continuously think we should have a more strong and powerful central bank to supervise the financial sector as a whole.

Q: Can a crisis like the US sub-prime credit crunch happen in China?

L: Currently, no, because the innovation in the financial sector in China is much much backward compared to the United States. So I think the Chinese banks will not be able to create this kind of sub-prime problems at this moment.

Q: You touched upon innovation and said that Chinese banks are not quite as innovative as the US counterparts. In fact, two years ago you wrote a book and you promoted the idea of creative finance, what do you mean by creative finance?

L: There is two aspects in general, one is supervision, and the other is the financial sector. The function is to actually promote innovation of the financial sector and to guarantee the innovative instruments or idea will serve the purpose of economic development to improving the life of the people.

Q: Over the past 20, 30 years, what do you see as the shortfall of the financial reform in China? How do we take the financial reform of the banking reform to the next level?

L: When we opened up, we opened up mainly to the foreign investors.

Q: Let’s switch this a little bit. In recent and especially last two years we saw a lot of Chinese banks, especially state owned banks getting listed overseas. This is a good sign. It shows that Chinese banks are having a bigger share or sale in the international market. How do we take the financial reform, the banking reform to the next lever, so that Chinese banks, especially the state owned banks can be more competitive on a global stage?

L: Next step I would say we should also gradually open the financial sector or banking sector, in particular, to the not only to the foreigners, but to the domestic investors as well, or domestic public, general public or if a private person or private firm, which wants to set up a bank, we should allow them to do that. We simply have a good regulation.  In general I think it’s increased the competition in the financial market.  It is to allow more people more agencies to participate in the financial development including foreigners and I think the financial sector should be firmly controlled by the state of government.

The financial crisis shockwaves emanating from Wall Street are devastating the global market. As laisse-faire capitalism shows its fatal flaws, the US financial system is arguably entering a period of socialist practices. For those around the world following the American Wall Street Model, is it time to rethink the future of our financial practices?

                                                                                        Nov.2008   ICS