First, some U.S. banks interested in competing in China's domestic market think that Chinese banks are provided an unfair advantage under the current regulatory regime, and that China has not fulfilled its obligations under its World Trade Organization (WTO) accession agreement to open its financial market to foreign competition. China's Banking Sector

Prior to the beginning of China's economic reforms in 1978, the Chinese banking system was largely government-owned and isolated from the global economy. For four of the five equitized banks the majority of the shares are non-tradable shares held by the People's Bank of China (PBOC), the Ministry of Finance (MOF), or other government entities, raising questions about their degree of separation from government control (see Table 1 ). Local Banks

The category of local banks includes a variety of financial institutions. The PBOC and the China Banking Regulatory Commission (CBRC) effectively oversee the operations of all banking institutions in China. Although China has made apparent efforts to comply with its WTO obligations, several U.S. banks maintain that China's laws and regulations, and the manner in which they have been enforced, have created barriers to entry for U.S. banks. However, the central government was unwilling to fully relinquish control over the equitized banks. Although China's central and local governments continue to wield significant influence over the operations of China's banks, these commentators say, they are no longer simply extensions of the government. Unresolved NPLs of the past, newly emerging NPLs associated with a recent sharp rise in local government debt, and hidden exposure to underground banking have increased the likelihood that China's banks may experience a rise in NPLs and, in some cases, edge towards insolvency. Local Government Funding Platforms as a Possible Source of Non-Performing Loans

A second source of possible financial troubles for China's banks emerged out of the combined effects of China's post-global financial crisis stimulus program, flaws in local government financing, and the credit decisions of the banks. The Wenzhou financial crisis exposed a previously unseen and underappreciated vulnerability in China's banking system. In addition, the CBRC conducted a stress test study of China's banks to determine if they could withstand a sharp decline in property values. Allegations of Subsidized Loans

The media and reports about China's banking system are replete with allegations that Chinese banks provide subsidized loans to preferred companies—usually state-owned enterprises (SOEs)—as part of a central government strategy to make Chinese companies more domestically or globally competitive. The Historical Evidence

The claims that the Chinese government is directing Chinese banks to provide preferential loans to selected enterprises generally relies on two types of financial evidence: 1. that the selected enterprises are being provided a disproportional share of loans or credit; and 2. that the terms of the loans being provided to the selected enterprises are based on preferential treatment, usually in the form of lower interest rates. Congress could consider various options with respect to evaluating and responding to allegations of inappropriate bank subsidies in China. If implemented, Wen's proposed reforms may provide an opportunity for U.S. banks and other financial service providers to enter China's financial market. The extent to which the 112 th Congress may choose to play a role in this issue remains to be seen.
China's banking system has been gradually transformed from a centralized, government-owned and government-controlled provider of loans into an increasingly competitive market in which different types of banks, including several U.S. banks, strive to provide a variety of financial services. Only three banks in China remain fully government-owned; most banks have been transformed into mixed ownership entities in which the central or local government may or may not be a major equity holder in the bank.
The main goal of China's financial reforms has been to make its banks more commercially driven in their operations. However, China's central government continues to wield significant influence over the operations of many Chinese banks, primarily through the activities of the People's Bank of China (PBOC), the China Banking Regulatory Commission (CBRC), and the Ministry of Finance (MOF). In addition, local government officials often attempt to influence the operations of Chinese banks.
Despite the financial reforms, allegations of various forms of unfair or inappropriate competition have been leveled against China's current banking system. Some observers maintain that China's banks remain under government control, and that the government is using the banks to provide inappropriate subsidies and assistance to selected Chinese companies. Others claim that Chinese banks are being afforded preferential treatment by the Chinese government, giving them an unfair competitive advantage over foreign banks trying to enter China's financial markets.
While some question what they characterize as unfair competition in China's banking sector, others are concerned that many of China's banks may be insolvent and that China may experience a financial crisis. According to these commentators, efforts to resolve a serious accumulation of non-performing loans (NPLs) only disguised the problem. In addition, China's NPL situation may have been worsened by its November 2008 stimulus program and the emergence of "local government funding platforms" that generated an estimated $1.7 trillion in local government debt. A financial crisis in the city of Wenzhou revealed the previously underappreciated risk associated with China's "underground" banking activities. Some analysts fear that a sharp decline in China's property values could precipitate a financial crisis that could effect the U.S. economy.
China's banking system raises two key issues that may be of interest to Congress. First, Congress may choose to examine allegations of inappropriate bank subsidies to major Chinese companies, particularly state-owned enterprises (SOEs). Second, under its World Trade Organization (WTO) accession agreement, China was to open its domestic financial markets to foreign banks. Congress may consider reviewing China's compliance with the WTO agreement and press the Obama Administration to raise the issue with the Chinese government.
This report will be updated as circumstances warrant.