Policy Risk of Current Bank Bailouts in China

Chinas banking risk is mainly driven by moral hazard, the inherent deficiency of stateownership. The ongoing reform strategy for state-owned banks, adopted by the government,mainly aims at this target, but fails to take a correct path. Since the government still holds thecontrolling right of the banks, there is no evidence to show that recapitalization and initialpublic offering (IPO) will lead to sound practices for banking governance. Furthermore, inorder to accelerate the recapitalization process, the reformers have injected a large amountof foreign exchange reserves into the state-owned banks, which consequently expands moneysupply and will lead to instability of future economic growth. Our conclusion is that there isa latent banking risk. Chinas banking reform should be in line with the external environmentand the overall economic reform process, and the reformers should always keep in mindthat sustainability of future economic growth is the ultimate means by which banking riskcan be cushioned and absorbed.