In China, Cash Carries the Weight

Despite Banking Strides, Credit Largely Shunned

BEIJING -- When Wang Xiaoyu set out to buy some sleek Lincoln automobiles for the small company he owns, the problem was how to pay. No dealer in China takes personal checks. Credit card limits are too low. Car loans barely exist.

So he brought cash, more than $200,000 worth of it, in three rolling suitcases.

"Everything else is a lot of trouble -- just easier to use cash," said Wang, 29, who runs a consulting company that helps Chinese businesses find foreign partners.

China's state-owned banks rank among the highest-valued in the world, with stock market capitalizations in the billions of dollars, but they are widely considered the weakest part of the country's booming economy.

Although China has made strides in reforming its banking system over the past five years -- cracking down on corruption, buying out many troubled loans and allowing foreign banks into the market -- retail banking remains stuck in an earlier era. The problem isn't new, but the number of people in China who have enough money to need modern banking services is soaring. The system hasn't kept up.

Many employees' salaries are still distributed in fat envelopes of cash rather than by check or direct deposit. It's not unusual for life's major purchases, such as cars or even houses, to be paid for in cash.

It isn't just the banks stuck in the past; there's consumer resistance in China to financial tools that are routine in other countries. Credit cards are gradually spreading, for instance, but many people embrace them chiefly as a fashion statement. There are floral-scented ones, cards bearing Hello Kitty logos, pink cards aimed at women. But because they are only accepted at some stores, such as designer boutiques and larger chains, their utility is limited.

"The reason I got that in the first place was because it was cute and cool, and has value as a collectible," Zhu Jing, a 24-year-old bank clerk said as she flashed one of her cards. She has seven, including one with an MSN Messenger logo and another with an Olympics theme.

Chen Jing, a 28-year-old teacher from the eastern coastal city of Ningbo, however, came to the conclusion that the novelty wasn't worth the $25 annual fee. "I had a credit card but just canceled it recently because I don't need it and I never used it," Chen said.

The underdeveloped financial system has frustrated many Chinese consumers and foreigners trying to do business in the country. But China's banking regulators say the slow pace of change is in the national interest.

China's financial leaders say they are cautious about moving too quickly because they see the problems that has caused in other countries. They cite the United States as an example of what can happen to a country that hands out credit too loosely, pointing to high levels of indebtedness among young Americans and the recent problems in the mortgage industry that have caused families to lose their homes.

Wang Huaqing, assistant chairman of the China Banking Regulatory Commission, said in an interview that in recent months, the country has been alarmed to see novel financial schemes crop up. People have been caught taking out cash from credit cards and loans to gamble the money away in the stock markets or on speculative real estate. Gangs have been investigated for stealing people's identities to open accounts. And criminals have been put away for laundering money.

"We have been paying great attention to credit card risk and loan risk," Wang said.

As a result, Wang said, the country is trying to avoid allowing citizens to get their hands on credit too easily. He said restrictions on retail banking -- such as a $50,000 a year cap on how much a Chinese citizen can convert from yuan to foreign currencies and low credit limits on cards -- are meant to prevent these problems from spiraling out of control.

The slow development of consumer banking in China is rooted in the role banks historically played in the Communist state.

Until a few years ago, China's banks essentially were agents of government social policy, keeping state-owned enterprises afloat. Retail banking existed on a limited basis. Chinese citizens who wanted to invest had no choice but to put their money in state-owned banks because foreign banks were not allowed to operate in the country and because stock markets didn't exist.

Furthermore, the banks had little financial incentive to introduce fee-based retail banking. They were already markedly profitable from a large spread between lending and deposit rates, both controlled by the central government.

Now, retail banking is still a secondary reason for banks' existence. China's banks mostly supply credit to enterprises, said Arthur Kroeber, managing editor of the China Economic Quarterly in Beijing. He said the banks are not like those in the United States, which, he said, "provide credit to the creditworthy." They are "more like the idea of banks in Japan in the '70s or South Korea in the '80s and '90s."

"In a broad sense, the main purpose of the state-owned banks in China today is not profit maximization for shareholders," he said. "It's financing industrial development."

For instance, at the Industrial and Commercial Bank of China, one of the largest state-owned banks, bad loans represented 21 percent of its portfolio in 2005.

It wasn't uncommon for clerks at its remotest branches to use abacuses to make calculations. If a local branch was in trouble because of bad loans, the central government would send trucks with cash to bail it out and prevent a run on the bank.

But after a series of overhauls, the ICBC in October 2006 pulled off the biggest-ever initial public offering, raising $21.9 billion to make it the world's No. 5 bank by market value of its shares, just behind J.P. Morgan Chase. Its value climbed late in the year and it has since been the No. 2 or No. 3 bank in the world, depending on the closing price of various banks' shares. Only Citigroup of New York consistently outranks it now.

China's banks are so large that near-monthly announcements of embezzlement and bribery valued in the millions of dollars are mostly shrugged off by investors. For example, in 2005, shares in China Construction Bank, whose chairman resigned after allegations that he was taking bribes, soared during its initial public offering, which occurred after the scandal was announced.

"In any other country, this kind of scale of scandal would be a big event. But in China, the scandal cases did not really have a material impact on the operations of the banks," said May Yan, a bank analyst at Moody's Investors Service in Hong Kong.

Taking ICBC public was supposed to be part of China's transition to a free-market economy. But analysts say investors are throwing money at Chinese banks for an opposite reason: support of the Communist government, with investors calculating that the government won't let the country's flagship banks fail. "It's a bet on China," May said.

Kroeber backed that up. "There is an implicit message: If things get really bad, the government would come in," he said.

Moody's estimates that China has poured $432 billion into bailing out state-owned banks. Recapitalizing the Agricultural Bank and the China Everbright Bank may cost $150 billion more.

Wang acknowledges that excessive dependence on the government is not a sustainable strategy, because it means the banks won't innovate. "They don't have any motive to create new financial products," Wang said. "This is a big difference between China's banks and multinationals."

As the Chinese government opens its banking sector to more foreign competition, there's a recognition that China's citizens will turn elsewhere for banking. This year, China's government for the first time allowed foreign banks to take local currency deposits and offer yuan-denominated credit cards.

Wang said that in the future, China would inevitably have to cut the banks loose to fend for themselves.