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Preparing for financial turbulence in China

BEIJING () -- The dynamics of China's financial troubles are in fact similar to those in other economies, despite the vast differences in policy environment, financial tools and private-sector development.

Dealing with the existing bad debts isn't difficult because the accumulated provision for impairment of banks can cover them easily. The real challenge is to face up to the medium-to-long-term risks of such debts.

The government has room to maneuver in two main areas: macroeconomic controls and financial supervision. The first must be fact-based and forward-looking. This means a measure of independence for monetary policy making.

As long as political priorities continue to dictate monetary policies, the problem of bad loans can't be rooted out. Meanwhile, bank regulators must raise their game and improve their reach and efficiency.

After 10 years of banking reform, the industry is still tied to the state. Bad loans increase whenever the economy is shaky. Without clear rules governing property rights and a healthy credit culture, the reform of banks' branches lag far behind their headquarters.

The relationship between state-owned banks and private enterprise is also distorted and unnecessarily antagonistic, and bankers unfairly blame companies for their own lax risk management.

The problem is the unclear management of listed banks. The government disrupts the normal workings of a market by using banks as a stimulus tool, and whenever it interferes in their management. It is clear by now the state should not be a major shareholder of a bank. The government should make plans now to ease itself out of the industry.

Whether or not China's banking sector can weather the current storm will depend largely on the government's determination to respect and adhere to market principles. It has to stop its interfering and allow Chinese banks to become "real banks," as Deng Xiaoping pledged.

The ills of government interference are made clear in its handling of bad loans. Since the Wenzhou credit scandal last year, the government has repeatedly stepped forward to "rescue" companies in trouble, including by leaning on banks not to call in their loans.

The government temporarily averts a crisis by stepping in as a kind of ultimate guarantor. But the price of such "stability" is the creation of "zombie enterprises." The Chinese model of solving problems does not really solve the problems; it makes them worse.

The market is far better at hedging and balancing risks than the state can be, and it gives an economy in crisis a much better chance of recovery. Improving its workings is the only way to minimize risks in China's banking sector and pave the way for a sound regulatory culture.