ABC's Listing as a Ladder Rung for Reform

At a time of general weakness for capital markets, Agricultural Bank of China (ABC) successfully launched the largest IPO in history on the Shanghai and Hong Kong exchanges. Now, all four of China's major state-owned commercial banks have gone public and have joined the world's top 10 banks by market value. The world no longer talks about Wall Street alone but, as The Economist magazine recently put it, "Great Wall Street" as well.
But stepping onto the international capital market stage is just a starting point. Future, far greater challenges lie ahead on a long and difficult development road for China's banking industry. This is not the end of reform.
Having matured and left the government's clutches for new roles as public banks with global investors, these banks have evolved in ways that are immeasurably significant for China's banking industry and economy.

National bank reform has been a continuous process since starting in the 1980s, when the central bank and commercial banks were established. Then in 2005, the Big Four state banks (ABC, Industrial and Commercial Bank of China, Bank of China and China Construction Bank) began the just-ended process of going public.

These and other major advances came gradually, and now the state-owned banks are well-capitalized, their books are clean, and they‘re building a modern, commercial bank framework. None suffered seriously during the global financial crisis. Instead, they were strong enough to play the primary role in implementing China's loose monetary policy.

The success of the Big Four banks was, to a certain extent, all about riding a wave called the "China concept." Investors are now excited about the positive direction for China's macroeconomic trends. With the nation's economic potential and the massive scale of its banks, there is reason to be optimistic about the banking industry.

Yet many arduous tasks are waiting to be completed before real prosperity sets in. Going public was a goal during just one stage of banking reform. It would be unwise to conclude that, based on IPO success, all the work is done. We need to guard against the dangers of stagnating, or even backtracking, reform. And it remains to be seen whether the state-owned banks will continue to evolve toward becoming modern commercial banks in the truest sense.

Not Satisfied Yet

It should be remembered that China's full cost of reforming the Big Four has been very high. It took several rounds of stripping out bad debts, internal restructurings and capital injections from the government to reach today's results. It's estimated the nation's total cost for the reforms steps so far was nearly 4 trillion yuan, or the equivalent of the market value of all government holdings in the four banks. There is no reason to be complacent with the results at this point.

An analysis of the reform path shows that going public can be viewed as a type of management outsourcing by a company whose original owners are not qualified to run it. The banks outsourced oversight responsibilities through the market in order to supervise internal control.

But an IPO is just the first step in this process. To make state-owned banks truly marketized in function – not just in form – and establish a true corporate governance mechanism, external stakeholders must penetrate the company ranks and implement qualitative change.

Because China's state-owned commercial banks are transitioning from a state-owned past to a commercial future, there still exist widespread misunderstandings about their basic banking functions. Banks continue to be oriented toward deep-rooted responsibility; market value is not yet the basis of their operations. At a commercial bank, all staff members should share the same goals  and culture. And when making loan decisions, most bank staffers should be on the same page and able to make the right calls independently.

From this standpoint, China's state-owned banks still lag far behind others, even after going public. For example, they did not operate flawlessly while working with the government's recent economic stimulus project. Indeed, the loan-writing independence of these banks was called into question, and it remains to be seen whether their loan programs will affect long-term asset quality and performances at the banks.

In light of China's stage of economic development, the government will likely maintain a dominant role in the banking sector for the foreseeable future. So the next round of reform must help bolster governance at each bank. And the government, as a major shareholder in each institution, must play an active role and, with a sense of duty toward the banks and other shareholders, establish and manage a strong board of directors.

Corporate governance needs to be taken out of the hands of government officials. Transparency should be improved. And commercial banking principles should guide the development of each bank.

In this respect, state shareholders and regulators should trust the power of the market and avoid overstepping their bounds. Bad habits must be corrected. Government shareholders must respect corporate rules and exercise power only through shareholder meetings. Exclusive decision-making by a board of directors and a Communist Party committee, coupled with opaque management practices, must end as soon as possible. It's also unacceptable for regulators to attend board meetings. These kinds of changes are needed to guarantee that directors function normally with proper corporate governance.

ABC's situation is unique. A latecomer to reform, the bank went public in the face of weak international capital markets, making its challenges particularly difficult. But the tests have only begun. This is a bank with "agriculture" in its name doing business at a time of rapid urbanization for China. What business prospects lie ahead? How will the bank balance its political obligations to support the nation's agriculture sector, rural development and farmers?

ABC's reorganization did not rely on strategic investors from outside China. So in the future, how will the bank implement the necessary checks and balances both inside and outside the boardroom? These are questions that should be addressed at future stages of reform.

As China continues climbing the ladder of bank reform, the government must clarify the roles of government leaders, regulators, shareholders and managers to ensure that each follows the right path. Looking at the big picture, a long list of necessary tasks includes quenching bank thirst for capital, standardizing financial institutions, widening the door to international markets and encouraging private finance. A long road lies ahead.