A Chinese view of governance and the financial crisis: An interview with ICBC’s chairman
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I came across this interesting article earlier when flipping through McKinsey Consulting’s website that may shed some light of some of the differences through a case study. Here is a copy in full:
Regulators struggling to fix the world’s troubled financial institutions may take heart from the experience of China’s large state-owned banks. In the late 1990s, Chinese state lenders were all but insolvent, with nonperforming loan ratios at many banks exceeding 50 percent. A decade later, China’s state banks have found their footing—and have managed to keep it amid a global financial crisis that has their European and US counterparts reeling. The bad-loan ratio has been reduced, and this year China’s state banks expect solid profits and continued rapid growth—despite the global downturn. What’s more, top bank executives express confidence in their capacity to heed government instructions to boost lending while effectively controlling credit risk.
Industrial and Commercial Bank of China (ICBC) is generally regarded as the strongest of China’s state-owned bank giants. It is also the largest bank by market capitalization and total profits—both in China and the world—with total assets of more than $1.4 trillion. ICBC chairman Jiang Jianqing met recently with McKinsey’s Dominic Barton, Yi Wang, and Mei Ye to share his thoughts on corporate governance, risk management, and the origins of the financial crisis.
The Quarterly: Why has ICBC put so much effort into thinking about corporate governance?
Jiang Jianqing: We share the vision of the Basel Committee that good governance is essential not only for the stability of the banking industry but also for the economy as a whole. Effective governance is the means of building and maintaining the qualities that are at the foundation of all commerce: confidence and public trust. It’s disheartening to see how many financial institutions lost sight of these basic truths. I find it ironic that some of the financial institutions that have struggled or even collapsed in wake of the financial crisis were touted as global role models before the crisis struck.
I remember the findings of a 2002 McKinsey survey concluding that institutional investors will pay a premium for stock offered by well-governed companies, especially in developing markets. The survey also found that, in deciding where to put their money in these countries, investors pay more attention to governance issues than to financial metrics. We recognize that corporate governance is an important tool for maximizing shareholder value, and that’s why we put so much effort into thinking about it.
The Quarterly: What lessons have you drawn about governance in the wake of the financial crisis?
Jiang Jianqing: My view is that there is no single model of effective governance. What works in some countries or cultures may not work elsewhere. In the United States and Europe, equity investment is highly fragmented, so management of the company must be delegated to a board or a small number of key executives, and various incentive mechanisms must be used to motivate people at the helm to run the company in a way that creates value.
Many Asian businesses are controlled by a single family. Family-run firms are thought to be highly efficient. But regulating the relationship between large and small shareholders is often a problem. In China, large banks and businesses favor a model in which the state owns a large proportion of company shares. In our case, for example, Central Huijin Investment and China’s Ministry of Finance each hold more than 30 percent of ICBC shares. Such arrangements aren’t unique to China: in Austria, Israel, Singapore, and many other nations, the proportion of state ownership for large companies can range from 40 percent to 70 percent. The challenge with this model is how to manage complex networks of trust agency relationships. In these types of organizations, reliance on incentive systems alone tends to do more harm than good.
Each model has its strengths and weaknesses. They all bear careful study. It seems to me there are no obvious best practices. But we’ve learned from the financial crisis that there are plenty of worst practices.
Running a bank is like running a marathon: getting a fast start doesn’t assure success. Indeed, runners in the lead after the first 1,000 meters may not even make it to the finish line. In a marathon, the key to victory is stamina and a balanced pace. Similarly, balance is the secret to effective governance. More specifically, what I mean by this is you have to balance short- and long-term profits, as well as short- and long-term risks. I’m certainly not suggesting the Chinese approach to corporate governance is perfectly developed. But I do think there are flaws in the Western system of relying so heavily on incentive systems.
The Quarterly: How do you control risk in a big institution like ICBC and how do you build that into the culture of the organization?
Jiang Jianqing: We’ve learned our lessons on risk. In June 1999, the nonperforming loan ratio at ICBC reached 47.5 percent. At the time, some Western media claimed Chinese banks were technically bankrupt. You can’t imagine the pressure we bankers faced then.
The first step in addressing the problem was to focus on risk management. After I was appointed president in 2000, one of the first things I decided was that we must hold the nonperforming ratio for new loans to less than 2 percent of assets. We created a credit-management system to control existing and new loans. By addressing irregularities and punishing violators, the quality of new loans quickly improved. Since then, ICBC has kept its nonperforming ratio for new loans to 1.7 percent.
Changes in the regulatory environment helped as well. In the wake of the Asian financial crisis, the Chinese government reorganized and developed the nation’s financial regulatory system, putting great emphasis on risk management, creating the China Banking Regulatory Commission, enacting a range of new rules and regulations, and introducing stricter external auditing and accounting standards. China’s large commercial banks developed sound governance structures and were subjected to close scrutiny from investors as they prepared to list shares publicly. This combination of internal and external factors substantially improved the governance of China’s financial institutions and left them in much better shape to manage risk today. Now ICBC’s bad loan ratio has been reduced to 2.2 percent.
In the end, though, the key to risk control is employing good people. That’s why we put so much emphasis on ethics and developing a corporate culture that values precision, professionalism, and teamwork. Good governance is impossible without a good corporate culture.
The Quarterly: In response to the global financial crisis, the Chinese government has recently announced a series of measures to spur domestic demand. How do you balance concerns about maintaining credit quality with the bank’s social responsibilities and government directives to support growth?
Jiang Jianqing: The government’s recent decision to boost domestic demand offers a great opportunity for the banking industry. However, ICBC is a commercial bank and we have to view these opportunities from the business perspective. I believe we have the ability to seize the opportunity and spur economic growth while also controlling risks. The fact that China’s finance industry has not been badly hit by the ongoing crisis should be attributed to great efforts and timely reform initiated by the Chinese government after the Asian financial crisis. The high-risk situation that China’s banking institutions experienced before is the last thing we want to see this time.
The Quarterly: Has the financial crisis altered your thinking about the merits of introducing more complicated forms of financial products, such as credit default swaps or other derivatives?
Jiang Jianqing: Derivatives weren’t the straw that broke the camel’s back. The current crisis is the result of a combination of problems. We shouldn’t reject the need for innovation in financial services merely because it carries some element of risk with it. In China, we say: you can’t stop eating just because you’re afraid of choking on your food.
China’s challenges differ from those faced by financial institutions in more developed economies. We haven’t suffered severe losses in the current crisis, because we didn’t invest in the complicated products that triggered it. But if you think carefully, this could be exactly where challenges emerge in the days to come. As interest rates are increasingly determined by the market and financial disintermediation that develops in China, the traditional loan-led banking model is bound to change. We’ll have to have more complicated financial products. Yes, we need to minimize risk, but we can’t dispense with innovation. The question is how to strike the proper balance. China’s banking industry will suffer setbacks. The best we can hope is to limit the pain of adjustment.
The Quarterly: Could you talk a bit about your board? What do you expect your board to do to help you?
Jiang Jianqing: It is currently composed of 15 directors—4 executive directors, 7 nonexecutive directors, and 4 independent directors. I see the board as the soul of a company. Sound corporate governance has a lot to do with a board’s structure, decision making style, and efficiency. The quality of a board’s members determines the board’s ability to perform its duties. A good board structure should be independent, professional, ethical, honest, and dedicated.
Our board has made great efforts to enhance ICBC’s development and risk management. Shortly after the company went public, the board developed a three-year plan with specific targets around restructuring, regional development, innovation, differentiated service, cross-border operations, comprehensive risk management, IT, and HR. In the past three years, those targets have all been met or exceeded. These efforts have earned us global recognition. Last year, The Banker magazine picked ICBC as its “Bank of the Year” for Asia. We also were honored for excellence in corporate governance by the Chamber of Hong Kong Listed Companies.
The Quarterly: What are your goals for the bank in the years ahead?
Jiang Jianqing: Recently we designed the strategy for 2009 to 2011. We resolved that we will become the world’s most profitable, preeminent, and respected bank.
Given our size, we feel we should be able to earn larger profits than any other bank. We seek rates of ROE, ROA, and income per customer on par with the highest levels in China and overseas. Since the introduction of international auditing, in 2003, we’ve enjoyed a CAGR of 37.5 percent in profits—making us one of the fastest-growing banks in the world. Our goal is to extend this cycle of profitability and rapid growth. We’ve set high standards of excellence for corporate governance, customer service, and financial innovation. We also aspire to be a global leader in the financial-services industry—with a strong brand name and a solid record for corporate citizenship and social responsibility.
The Quarterly: What are your plans for international expansion?
Jiang Jianqing: We’re very cautious when it comes to investing. Before the crisis, we had many opportunities for acquisition. Fortunately we resisted that temptation. We have a clearly defined strategy. Any potential acquisition target must expand our regional footprint and improve ICBC’s core competencies and long-term returns. So our overseas expansion will be a gradual process—another marathon.
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March 28th, 2009 at 7:19 am
Like Jiang said, in a less elegant way, China wasn’t the one that invented MBS, CDO, default swap, or allowed 30-to-1 ratio on these derivatives.
March 29th, 2009 at 12:09 am
Can you expand on your opinion that “China takes a more ‘holistic,’ perhaps results-oriented view to economic prosperity whereas America tend to take (historically at least) a more ‘individualistic,’ equal-opportunity point of view.” I didn’t notice anything the banker in this interview said that an American banker wouldn’t, except when he said that it might be a good idea for the state to own 40 to 70 percent of the banks.
March 30th, 2009 at 6:39 pm
China To the Rescue
By Christian Thwaites on Forbes
Beijing’s stimulus package is far better than Washington’s
The emergence of China as the model for economic level-headedness is the latest in a period of bewildering ironies. While U.S. economic debate vacillates between complex asset repurchases and quasi-nationalization, China’s response is both immediate and longer-lasting.
China, a one-party state with a centrally planned capitalist economy, is a living contradiction of liberal economics. But for the next three to five years, the prosperity of America rests closely on events in China. It is axiomatic that, because of China’s $2 trillion of foreign exchange reserves, we depend on its goodwill to fund deficits. But the dependence runs deeper. From trade, security, diplomacy and competitiveness, we are unlikely to grow unless China prospers. Fortunately the signs are good, for two short-term–and one very compelling long-term–reasons.
A Fast Economic Stimulus. At nearly $600 billion and 18% of GDP, the Chinese plan unveiled in November is proportionally the largest in the world. It is also focused and sprinkled with generous tax cuts. The results took less than three months to arrive. Spending on infrastructure, low-income housing and technology is already moving sharply ahead from late 2008 levels. Compare this to the extended projects in the U.S. $787 billion stimulus that will have little effect until 2011. The Chinese style of direct, targeted and lower taxes inspires greater confidence than the opacity, diffusion and higher taxes of the U.S. version.
Stabilize then Grow Consumer Demand. China is aware that, in a world recession, it cannot export its way to growth. The package contains little in the way of export promotion. Years of double-digit GDP growth have not met the demands of its population for goods, services, housing and health care. So the government implemented $80 billion of tax cuts, increased social security benefits and spending vouchers. The multiplier effect is immediate. Chinese consumers, with little or no non-mortgage debt, should start to spend at a rate 11% greater than 2008. The Chinese consumer’s share of GDP at 30% compares to the West’s of 80%. It will not take much to change behavior and release spending power into the economy.
The New Africa. As one commentator, Richard Dowden, has noted, “whereas the West sees Africa as the place to make poverty history, the Chinese see it as a place to make money.” China treats Africa differently, not as an impoverished threat but as a long-term business opportunity. In less than 10 years, China has locked up long-term supplies of oil, copper and other key raw materials and commodities. They trade not only with obvious resource-rich counties like Angola, Zambia and Equatorial Guinea, but also troubled states like Congo, Sudan and highly fertile Ethiopia, Uganda and Tanzania. They have diplomatic representation in 49 African capitals. Westerners complain. But the Chinese invest where angels fear to tread, and the result is higher levels of investment than all NGOs have mustered in 50 years. President Hu Jintao recently concluded his sixth visit to the continent, to countries unlikely ever to be on even a junior State Department associate’s itinerary. For the next five years, China and Africa will be inextricably linked and increasingly independent of Western economic malaise.
The stimulus package from Beijing is the most promising opportunity to reinvigorate world demand. The measures will help ensure growth of the Chinese economy by 8% in 2009, a current account in surplus of $180 billion a year and bank solvency. The markets like it. Since President Obama’s election, the Shanghai Composite index of leading stocks has risen 37%, while the S&P 500 has fallen 19%. U.S. dollar-denominated Chinese corporate bonds trade at less than 180 basis points over U.S. Treasuries, an indication that default risk is minimal. There is little fear of inflation, a strong currency and a budget deficit equivalent to less than the cost of a couple of U.S. bank bails-outs.
We should welcome China’s good health. To complete the irony, they are calling for a stronger dollar as they rightly fear a real-time experiment in Gresham’s law is taking place. Our administration remains insouciant. We depend on China’s prosperity and for the next few years look to help keep their economy on course, for all our sakes.
Christian Thwaites is president & CEO of Sentinel Investments.
March 30th, 2009 at 7:00 pm
@Otto Kerner #2,
You are right. I have not carefully distilled what I meant when I wrote:
What I mean is the philosophical approach – which depending on circumstances – may or may not lead to concrete policy differences.
Property is one example. In the West, property right is considered a basic right – whereas in China, property rights have been assigned as a form of economic regulation (in this case, to enable decentralization of certain economic activities).
If circumstances arise where the removal of such a right may be justified for the public, they will be removed without causing too much consternation.
There are many other differences – such as role of gov’t in regulations, the role of property (mentioned above), the role of gov’t ownership, the role of public policy in business, etc., etc.
In the above interview, it is quoted:
If you go back to the late 1990’s as well as early 2000’s, you’ll find (in the U.S. at least) so many articles and critiques on the role of Chinese gov’t in Chinese economy. The gov’t is almost always depicted as distorting market dynamics. These articles almost all unanimously touted that the way forward has to be a “freer,” more American system. They also touted that the Chinese banks cannot be reformed without first putting all the state owned companies out of business…
This is partly why Jiang said:
Another difference that can be inferred from the above quote is that the West seems to focus more on structure whereas China seem to focus more on people. Although in reality, good management require a mixture of both.
Anyways – I don’t think I am quite prepared to give a comprehensive overview of the difference between Chinese capitalism and American capitalism (or Western capitalism in general) in part because all these concepts – especially in today’s economic crisis – are in flux and still developing. (This is why I am only willing to refer to this as a case study…)
But I think there are definitely fundamental philosophical differences that over time, will definitely be worth our time to discuss in more depth!
March 31st, 2009 at 4:38 pm
@ Allen: I agree with most of what you say. The only thing I’d add is that the last decade or so in US history is, in my opinion, an aberration in American history that is being corrected as we speak. I wouldn’t characterize it as being THE American position, rather it is AN American position that has been tried and is currently being discarded as a failure. I’d expect the readjusted American system to move closer to some of what China is trying, and the Chinese system to loosen up over time with less control by the government, so both moving to a happy medium between where each of them are now.
I’d almost rephrase your initial question to be “What is the difference between government regulation of capitalism in the United States and China?” Within the rules allowed by each, the capitalism as practiced seems the same to me. China controls less in some areas (safety, IP protection) and more in others (investment, real estate and banking).
March 31st, 2009 at 7:42 pm
@Steve #5,
While I am tempted to agree with you – that China and U.S. are moving toward a similar type of capitalistic system, I still think that there are important fundamental differences.
I still think the U.S. fundamentally likes to focus on creation of “free” markets – where individuals are the ultimate beneficiaries of the economic system – where individuals are guaranteed with certain rights (i.e. property rights) – and where the destiny of the economy lie with the individuals – whereas China likes to focus on development of the society and economy as a whole – where the government is in control of setting overall policy – with individuals only as cohorts to help the government achieve that overall policy.
Maybe I am becoming ideological myself by saying the above.
Or maybe the differences in perspectives above will lead to interesting differences in the future.
Time will tell…I guess! 😉
March 31st, 2009 at 8:34 pm
The fundamental difference between Chinese capitalism and American capitalism is that in China, capitalists have to beg politicians; in America, politicians have to beg capitalists.
March 31st, 2009 at 9:25 pm
@ Allen #6: I agree with you. Though the two systems will become closer, they’ll always be separated by the differences you mention.
April 8th, 2009 at 3:26 am
I’ve said this before, but… if you keep this discussion in the frame of American vs. Chinese capitalism, I have nothing to complain about. However, if you begin to talk about Western capitalism as something including the US and Europe, you’re going to get into (intellectual) trouble. The idea that society as a whole should develop, not just free markets, is hardly some invention by China (and you don’t need Confucianism to explain it either).
Anyway, while we’re at it: Allen and Steve, what do you think about Wahaha’s description?
April 8th, 2009 at 4:06 am
@Wukailong #9,
I personally think Wahaha’s description is kind of cute. Of course – while that expresses a perspective (perhaps even a valid insight), what we are probably more interested in here is to capture some of the undercurrents of current developments … and a perspective of where things will go – for that, we need to share different ideas … experiences … etc.
While we are at it – I wonder when we talk about American vs. Chinese capitalism: we might as well talk about American vs. European capitalism?
April 8th, 2009 at 6:36 am
@Allen: Something like that, yes… Or perhaps we should talk about state capitalism as opposed to laissez-faire capitalism. I believe many of the eastern European countries that changed their systems back in the 80s and 90s went over to something more closely modeled on the US example, because they believed back then that only a complete negation of their previous system was the way forward.
April 8th, 2009 at 7:05 am
“Running a bank is like running a marathon: getting a fast start doesn’t assure success. Indeed, runners in the lead after the first 1,000 meters may not even make it to the finish line. In a marathon, the key to victory is stamina and a balanced pace. Similarly, balance is the secret to effective governance. More specifically, what I mean by this is you have to balance short- and long-term profits, as well as short- and long-term risks.”
What strikes me is that this slow but steady strategy, with focus on the future, is also the approach the CCP takes on most issues. Again, these guys (CCP) are amazingly patient and rational. I really think the west underestimates the ability and strategy of the top chinese leaders. And because of this, the world will wake up one day to find that china has progressed much further than was previously thought possible.
April 11th, 2009 at 3:20 pm
the crisis really killed lots business in China.
April 11th, 2009 at 6:56 pm
@ Wukailong #9: I think it’s pretty clever but I’d put it slightly differently; The fundamental difference between Chinese capitalism and American capitalism is that in China, capitalists have to bribe politicians; in America, politicians have to bribe capitalists with government spending in order to get campaign contributions. 😛
@ colin #12: I don’t think China is being underestimated at all, except by some uninformed media who have no conception of how things actually work. There are books galore out there written by American authors (Tom Friedman, etc.) touting China’s successes and strategies. In my opinion, overplaying or underplaying China’s successes and failures indicates a lack of understanding of the country. All approaches have strengths and weaknesses, regardless of the system. Some systems have more strengths than weaknesses and vice versa, but to act as if it’s an all or nothing scenario seems naive.
China does some things well and some things poorly. Overall, the good outweighs the bad economically and that is why China is progressing. Their leaders at the top aren’t geniuses but they are sharp. Many local leaders are corrupt and the top leaders know it. China will continue to grow, run into difficulties here and there, make adjustments and continue on its way. That’s the optimistic outlook and the one I subscribe to.
I think you might be underestimating the ability of countries to observe and analyze the behavior of others. Chinese officials are analyzing non-Chinese government practices as well as there being non-Chinese governments that analyze Chinese practices. This isn’t just the “west” but countries from all over the world. That’s one of the primary functions of any government.
April 12th, 2009 at 2:09 am
Allen, I forgot to say at the time that I found your explanation in #4 to be quite interesting and well-put. I certainly agree that this will be fruitful area for discussion in the future, even if it is subtle and hard to parse.
Chris, thanks for your even-handed and thoughtful comments.
April 13th, 2009 at 2:00 am
@Steve: Good one. 😉 And here’s another one – in Sweden you have to have the unions on your side to get the majority.
I’ve seen several criticisms of democracy on this forum, the most common one being that a country shouldn’t be ruled by the privileged, but by “the people”. It’s a great idea, but how do we create such a system when historical experience shows us there’s always some privileged group? It’s capitalists, politicians, bureaucrats or unions… but not a unitary people. Perhaps it’s that view of one people that ought to change.
April 16th, 2009 at 6:05 pm
Bamboo shoots of recovery — Signs that a giant fiscal stimulus is starting to work
By Economist.com
Finally, western economists get it right about China’s economy composition. China is less export-dependent than they thought. This report gives its due to China’s macro-economy policy executed in recent years. It now seems a fast recovery from this down-turn is possible.
“THE Chinese consider eight to be a lucky number because it sounds like the word meaning “prosperity”. And luck, combined with a massive fiscal stimulus, may yet help the government to achieve its growth target of 8% in 2009. Earlier this year, most economists thought such growth was impossible at a time of deep global recession, but some are now nudging up their forecasts”
“Exports, on the other hand, tumbled by 17% in the year to March and global demand is widely expected to remain weak this year. This is the main reason why some economists expect GDP growth of “only” 5% for 2009 as a whole. But the gloomier forecasts tend both to overstate the importance of exports and to understate the size of the government’s stimulus”
“Contrary to conventional wisdom, China’s sharp economic slowdown was not triggered by a collapse in exports to America. Its growth began to slow in 2007, well before exports stumbled, driven by a collapse in the property market and construction. This was the result of tight credit policies aimed at preventing the economy from overheating. The global slump dealt a second blow late last year, but China is less dependent on exports than is commonly believed. Exports account for nearly 40% of GDP but they use a lot of imported components, and only make up about 18% of domestic value-added. Less than 10% of jobs are in the export sector.”
http://www.economist.com/finance/PrinterFriendly.cfm?story_id=13497030