Red Capitalism

1. China's Financial System: Banks as the Core

In China, the banks are the financial system; nearly all financial risk is concentrated on their balance sheets.

Banks dominate. China's financial system is overwhelmingly dominated by its four largest state-controlled banks (ICBC, CCB, ABC, BOC), which hold a majority of the nation's financial assets. This concentration of power means that the health and stability of these banks are critical to the overall economy.

Limited foreign influence. Despite WTO agreements, foreign banks have a minimal presence in China, holding only a small percentage of total financial assets. This deliberate exclusion underscores the government's determination to maintain control over the financial sector.

Banks as instruments. The banks are used as both a weapon and a shield by the Party. They are the primary source of capital for state-owned enterprises (SOEs) and are shielded from competition and failure to maintain stability.

2. Crises as Catalysts for Banking Reform

At the end of each of the last three decades, these banks have faced virtual, if not actual, bankruptcy, surviving only because they have had the full, unstinting and costly support of the Party.

Recurring instability. China's banking system has faced near-bankruptcy at the end of each of the last three decades, highlighting its inherent fragility. These crises have served as catalysts for reform efforts, though the underlying issues often remain unresolved.

Party intervention. The Communist Party has consistently intervened to rescue the banks, providing financial support and implementing restructuring measures. This intervention underscores the Party's commitment to maintaining control and preventing systemic collapse.

Examples of crises:

• The late 1980s: Uncontrolled lending led to inflation and near civil war.
• The Asian Financial Crisis (1997): The collapse of GITIC triggered a major bank restructuring.
• The Global Financial Crisis (2008): The government ordered banks to lend aggressively, leading to new risks.

3. The Fragile Fortress: Banks' Recurring Capital Needs

Growing big is the best way for Chinese banks to make more money . . . This model of growth, however, neither assures the long-term sustainable development of the banking sector nor satisfies the need of a balanced economic and social structure.

Endless thirst for capital. China's banks have a recurring need for capital injections, driven by rapid asset growth, high dividend payouts, and the accumulation of non-performing loans (NPLs). This cycle of recapitalization highlights the unsustainable nature of the current banking model.

Dividend drain. A significant portion of the capital raised through IPOs is paid out as dividends, primarily to the Ministry of Finance (MOF) and Central SAFE Investment. This practice effectively transfers capital from the banks to the state, necessitating further capital-raising efforts.

The 2009 lending binge. The massive lending spree of 2009, aimed at stimulating the economy, has exacerbated the problem of NPLs and further strained the banks' capital adequacy ratios. This has led to a scramble for new capital in 2010 and beyond.

4. PBOC vs. MOF: A Struggle for Control

This time, we did not just play a game with accounting [a direct jab at the MOF’s methods in 1998]. Real money went into the banks.

Bureaucratic rivalry. The People's Bank of China (PBOC) and the Ministry of Finance (MOF) have engaged in a long-standing power struggle over control of the financial system. This rivalry has influenced the direction of banking reform and the allocation of resources.

Conflicting approaches. The PBOC has favored market-oriented reforms and international standards, while the MOF has prioritized state control and administrative measures. These conflicting approaches have led to policy inconsistencies and inefficiencies.

Key events in the power struggle:

• The PBOC's recapitalization of CCB and BOC in 2003, using foreign-exchange reserves.
• The MOF's assumption of control over ICBC and ABC in 2005.
• The establishment of China Investment Corporation (CIC) in 2007, giving the MOF greater control over state assets.

5. Captive Bond Market: A Tool for State Financing

Compared with other financial instruments and against the backdrop of a high savings rate and high ratio of M2 to GDP, China’s corporate bond market has been developing very slowly and its role in economic growth has been rather limited.

Limited market function. China's bond market is largely captive to the state, with banks holding the majority of bonds and prices set administratively. This limits the market's ability to efficiently allocate capital and price risk.

Government financing. The primary purpose of the bond market is to finance the government's budget, rather than to provide corporations with access to capital. This is reflected in the dominance of government bonds and policy-bank bonds.

Lack of liquidity. The bond market suffers from a lack of liquidity, with low trading volumes and wide price discrepancies. This makes it difficult for investors to accurately value bonds and discourages active participation.

6. National Champions: Privileged Oligopolies

The oligopolies dominating the domestic landscape are called “National Champions” and the “pillars” of China’s “socialist market” economy, but they are controlled by these same families.

State-backed dominance. China's "National Champions" are state-owned enterprises (SOEs) that enjoy privileged access to capital, resources, and political support. These companies dominate key sectors of the economy and operate as oligopolies.

Political connections. The National Champions are closely linked to the Communist Party, with senior executives often holding high-ranking positions in the government. This close relationship gives them significant influence over policy decisions.

Examples of National Champions:

• Sinopec
• PetroChina
• China Mobile
• Industrial and Commercial Bank of China (ICBC)

7. The Forbidden City: Power Dynamics in Beijing

The source of crony capitalism in China is the unrestrained power held by certain factions that lets them intervene in economic activity and allocate resources.

Bureaucratic silos. Beijing's government operates as a complex labyrinth of separate power centers, each with its own agenda and limited coordination. This fragmented structure can hinder effective policy implementation and create opportunities for corruption.

Influence of special interests. Special-interest groups, often linked to the National Champions, exert significant influence over policy decisions. This can lead to policies that benefit these groups at the expense of the broader economy.

The need for strong leadership. Only a strong leader can effectively coordinate the various bureaucracies and special interests, ensuring that policies are aligned with the overall goals of the Communist Party.

8. The Illusion of Modernity: A System Rigged for Control

The huge state corporations have adopted the financial techniques of their international competitors and raised billions of dollars in capital, growing to an economic scale never seen before in all of Chinese history. But these companies are not autonomous corporations; they can hardly be said to be corporations at all.

Superficial reforms. China's financial system has adopted many of the trappings of modern capitalism, including stock markets, bond markets, and international accounting standards. However, these reforms are often superficial, masking the underlying control of the Communist Party.

Control over ownership. The Party maintains ultimate control over the ownership and management of key enterprises, limiting the influence of market forces and private investors. This control ensures that the financial system serves the interests of the state, rather than the broader economy.

A fragile system. The combination of state control, recurring capital needs, and a captive bond market creates a fragile financial system that is vulnerable to shocks and crises. This fragility underscores the need for further reforms to promote stability and efficiency.

Last updated: April 12, 2025