illegal, so information on this important sector is ture. There are at least five broad reasons for this much less readily available lending bias, some of which also apply in Western markets SUMMARY Strong business positions. Some of the majo Banks dominate the Chinese financial system, borrowers are simply very good credit risks be providing about three fifths of total credit to the cause of their strong business positions, resulting private sector. This is not too different from Eu- from monopolistic or oligopolistic power, supe- ropean levels, but contrasts with the US system, rior business models, or other factors. (In rece where financial markets and non-bank lenders years, firms with majority state ownership re provide significantly more credit than banks. The portedly represented 35% of business activity in Chinese banking system is fairly concentrated, China, but earned 43% of the profits )Firms may with five banks splitting almost half the total loan also have grown large because of their strengths market, which is somewhat less concentrated Further, size can bring a degree of diversification than many national markets in Europe but more that in its own right reduces credit risk and make concentrated than in the us hem more attractive borrowers. In all of these cases, there is no particular mystery as to why A major difference with more developed financial these SOE's would be favored customers systems, however, is the high level of state owner ship and control. The five largest Chinese banks Implicit government guarantees. There is a wide are majority-owned by the central government ly held perception that the government would not nd there are significant government stakes let a large state-owned enterprise formally default many of the other banks. Further, the government on their loans. This implicit guarantee is poten intervenes far more actively in banking decisions tially of great value, although it does not preclude than in the West. Most important, the central bank the lender suffering economic losses by being explicitly sets maximum interest rates for deposits forced to accept modifications to the loan terms nd minimum interest rates for loans, and often that fall short of default. There are also degree sets target levels for loan volumes in the strength of these implicit guarantees. For example, SOE's that are owned, or controlled in Government and party leaders can exert consid- practice, by powerful central ministries have a erable influence behind the scenes, often pushing greater certainty of support than entities owned loans to particular firms, sectors, or regions to by less powerful government bodies further their political agendas. The close linkag between the government and banking, as well Career safety. The large state-owned banks are as the pervasive power of the Communist Party, now sufficiently commercial in their outlooks that make this possible. Unlike in the West, the careers loan officers do risk their jobs if their borrowers of the most important bankers are determined by default. However, there is a clear perception that the Party and many of them move in and out of lending to a large Soe will never be a career-end the banking along the course of their ca- ing decision, whereas lending to private borrow- reers ers co The big banks lend principally to large, state- Personal relationships. Senior officials at large owned enterprises(SOE's), although the propor- SOEs are in a position to favor bank officers,in tion has declined substantially in recent year cluding through their Party influence, and there The Chinese Financial System: An Introduction and Overview JOHN L. THORNTON CHINA CENTER AT BROOKINGSThe Chinese Financial System: An Introduction and Overview John L. Thornton China Center at BROOKINGS 3 expensive informal lending channels. The in￾formal sector is less regulated, and sometimes illegal, so information on this important sector is much less readily available. Summary Banks dominate the Chinese financial system, providing about three fifths of total credit to the private sector.1 This is not too different from Eu￾ropean levels, but contrasts with the US system, where financial markets and non-bank lenders provide significantly more credit than banks. The Chinese banking system is fairly concentrated, with five banks splitting almost half the total loan market,2 which is somewhat less concentrated than many national markets in Europe but more concentrated than in the US. A major difference with more developed financial systems, however, is the high level of state owner￾ship and control. The five largest Chinese banks are majority-owned by the central government and there are significant government stakes in many of the other banks. Further, the government intervenes far more actively in banking decisions than in the West. Most important, the central bank explicitly sets maximum interest rates for deposits and minimum interest rates for loans, and often sets target levels for loan volumes. Government and party leaders can exert consid￾erable influence behind the scenes, often pushing loans to particular firms, sectors, or regions to further their political agendas. The close linkag￾es between the government and banking, as well as the pervasive power of the Communist Party, make this possible. Unlike in the West, the careers of the most important bankers are determined by the Party and many of them move in and out of the banking sector along the course of their ca￾reers. The big banks lend principally to large, state￾owned enterprises (SOE’s), although the propor￾tion has declined substantially in recent years. One of the great outstanding questions is why this occurs and how it might change in the fu￾ture. There are at least five broad reasons for this lending bias, some of which also apply in Western markets. Strong business positions. Some of the major borrowers are simply very good credit risks be￾cause of their strong business positions, resulting from monopolistic or oligopolistic power, supe￾rior business models, or other factors. (In recent years, firms with majority state ownership re￾portedly represented 35% of business activity in China, but earned 43% of the profits.3 ) Firms may also have grown large because of their strengths. Further, size can bring a degree of diversification that in its own right reduces credit risk and makes them more attractive borrowers. In all of these cases, there is no particular mystery as to why these SOE’s would be favored customers. Implicit government guarantees. There is a wide￾ly held perception that the government would not let a large state-owned enterprise formally default on their loans. This implicit guarantee is poten￾tially of great value, although it does not preclude the lender suffering economic losses by being forced to accept modifications to the loan terms that fall short of default. There are also degrees in the strength of these implicit guarantees. For example, SOE’s that are owned, or controlled in practice, by powerful central ministries have a greater certainty of support than entities owned by less powerful government bodies. Career safety. The large state-owned banks are now sufficiently commercial in their outlooks that loan officers do risk their jobs if their borrowers default. However, there is a clear perception that lending to a large SOE will never be a career-end￾ing decision, whereas lending to private borrow￾ers could be. Personal relationships. Senior officials at large SOE’s are in a position to favor bank officers, in￾cluding through their Party influence, and there