In the Beijing headquarters of CDB Capital, the private equity arm of China Development Bank, there are three busts in the lobby. One commemorates Mao Zedong, founder of the People’s Republic. Another is of Deng Xiaoping, the architect of China’s reform era. But readers of WiC will be less familiar with the third bronze, that of Chen Yun.
Who was he? Chen was another prominent Party member in the founding of modern China in 1949. Historian Ezra Vogel calls him the “father of Chinese economic planning” and notes that Mao once asked why only Chen seemed to be able to make the economy run successfully.
Like many of Mao’s lieutenants Chen faced a period as an outcast during the chaos of the sixties and seventies but he made a comeback in the eighties, enjoying a position of near primacy with Deng. Today he is best remembered for opposing the rapid pace of Deng’s market reforms (Chen preferred tighter central control and refused to visit the experimental city of Shenzhen, such was its symbolism as the accelerator pedal of the opening up era). He summed up his own view in a famous bird cage analogy. The economy, he said, “is like a bird. You can’t hold it in your hand, but you have to let it fly. But it might fly away, and that is why you need a cage to control it.”
Vogel writes that Chen’s policy clashes with Deng, meant they were akin to “two tigers on the mountaintop”. But the rivalry did nothing to lessen Chen’s prestige. “Although some considered him too conservative and cautious, he was generally respected for his political judgement, his independent analytical abilities and his principled dedication to the Party,” Vogel surmises.
All great achievements, of course, but the main reason that Chen’s bust enjoys pride of place in the CDB Capital lobby is perhaps more filial, according to the authors Henry Sanderson and Michael Forsyth. That’s because China Development Bank (CDB) is run by the deceased politician’s son, Chen Yuan.
Or rather, CDB was run by him at the time Sanderson and Forsyth published China’s Superbank, their must-read book on the bank. That changed this week when Xinhua reported that Chen Yuan is stepping down, a personnel move that marks a seismic shift in China’s bureaucratic landscape. Chen has run CDB since 1998, shaping it according to his vision and having a profound impact on the nation’s economy, as well as those overseas.
Sanderson and Forsyth call Chen “the world’s most powerful banker” and CDB “the world’s most powerful bank”.
“China’s rise as a global economic superpower and the success of its top companies is intricately tied to CDB,” they write. “Understand CDB and you understand the core of China’s state capitalism.”
Much of that is down to Chenhimself, the authors add: “You cannot understand the rise of JPMorgan in the nineteenth century without understanding the life of its eponymous namesake. Likewise, the history of CDB’s emergence as the world’s most influential bank is closely linked with its longtime leader, Chen Yuan.”
The rise of Chen…
Chen Yuan was born in the revolutionary capital of Yan’an in 1945 (the Chinese Communist Party equivalent to being born in Buckingham Palace). The family’s elite position was secured as early as 1933 when Chen senior joined the Politburo Standing Committee. His father’s status was further consolidated when he conquered the scourge of inflation in 1952, a feat that had eluded Chinese rulers for decades.
Chen junior entered Tsinghua University in 1965, where he studied engineering, specialising in automation in particular. Like many of his generation, his career path was thrown off track by the Cultural Revolution.
On graduation he worked at a factory in Hunan, before returning to Beijing in 1973 and getting a job as a researcher at the Aerospace Ministry. It was at this point that he began to emulate his father’s interest in economics, studying foreign news sources to get a better sense of how the Federal Reserve worked. After Mao died and a relative sense of normality returned, Chen enrolled in graduate school, and further honed his English skills.
With his princeling credentials, a political career followed, first as a Party secretary in Beijing’s Xicheng District. However, in 1987 Chen failed to get elected to the city’s Party committee. This was a fairly major setback, but in an effort to cushion the blow he was made a vice-governor of the central bank. Over the next decade his new role would give him a new opportunity to understand the workings of the Chinese economy, as well as to gain an unrivalled international perspective by travelling abroad and hobnobbing with officials from multilateral agencies and other central banks.
Many foreign observers thought that Chen would be promoted to head the central bank, but in 1997 the then premier Zhu Rongji asked him to take over CDB instead.
What did he inherit?
CDB was created in 1994 from an assortment of Soviet era institutions. As that might suggest, it was a financial basketcase. In 1997 the bank had a non-performing loan ratio of 42.7%, and such lax compliance procedures that staff carried suitcases of cash around the country with them to pay their expenses.
When Chen arrived at the bank its loan book was a couple of hundred billion yuan and it had just one branch and a couple of offices. As he later told the Economic Observer: “The first objective I set for myself, as well as for CDB, was to become a real bank and not just an ATM of government.”
Over the next decade his unique combination of connections, willpower and vision would transform CDB from a weak policy lender into a banking powerhouse. By 2012 the bank reported assets of Rmb7.37 trillion ($1.19 trillion), says 21CN Business Herald. (To put that in perspective, that’s more than double those of the World Bank.)
Unlike his predecessor, Chen sought to make CDB better resemble a well-functioning international bank. He brought on board a new international advisory committee including the likes of Henry Kissinger, and instigated new credit controls and personnel policies (to weed out the incompetent).
As one former staffer recalls: “He had influence. People respected him and feared him, so people started to work hard to evaluate the process rather than just issue loans to everyone.”
Amazingly, by 2002 the NPL ratio was down to 1.78% and by 2006 Chen told a foreign visitor that CDB had no bad loans at all. This was achieved in two ways. Much of the heavy lifting came from the central government, which shifted Rmb100 billion of toxic lending into a new asset management company.
For the remainder Chen devised new ways to bring the NPL rate down. Uniquely in the Chinese banking landscape, he was allowed to convert Rmb21.7 billion of debt into equity. He was also very sharp in working out how to work with local governments to remedy debt positions. For example, in return for a new development loan, he persuaded the city of Tianjin to clean up a CDB bad debt owed by local car firm Xiali.
Using similar quid-pro-quo approaches, Chen had resolved Rmb90 billion of bad debt by 2003, according to an interview he gave Xinhua.
A new banking philosophy?
When Chen took over at CDB he seems to have admired the US financial system. He also wanted CDB to be profitable, an unusually commercial goal for a policy lender. But Chen was no more the product of the Washington Consensus than his father had been. Years earlier he’d put his name to a manifesto in the China Youth Daily that said: “The Party should not only hold the barrel of the gun, but also take control of financial assets and the economy.” Correspondingly, he dismissed believers in the invisible hand of the market as “utopians”.
Once at the helm of CDB, Chen coined the term “development finance”. It sounds innocuous enough but what it really meant was state capitalism. Chen and a fast-growing CDB would become a key cheerleader for the trend, helping state-owned firms to become national champions.
In fact, in the past five years a new term was coined – guojinmintui (the state advances as the private sector recedes) – to denote the inexorable rise of state capitalism (see WiC30). Much credit for this is owed to CDB which helped the larger SOEs get bigger and stronger. Huge loans were a part of this, such as the $30 billion lent last year to oil giant CNPC for foreign acquisitions.
Chen’s big idea: urbanisation
But while such marquee lending is the most visible aspect of CDB’s industrial policy, Sanderson and Forsyth say the biggest impact was felt at local level. Here a menagerie of SOEs big and small would all benefit, from CDB’s backing for urbanisation.
“From the beginning CDB got more deeply involved with local governments than any other Chinese bank,” write the authors, both of whom are journalists with Bloomberg.
Chen was one of the earliest powerbrokers to figure out how key the urbanisation trend would become.
But what marked out Chen’s financial genius was that he spotted something nobody else had figured out. He knew that Zhu Rongji’s 1990s tax reforms had left local governments with less of the fiscal take, meaning they could spend less on infrastructure. But he also saw that local government land sales were counted as extra-budgetary revenue.
“Local governments were sitting on one of the world’s most valuable resources with virtually no requirement to be accountable about how it was used,” Sanderson and Forsyth point out.
Chen saw that if CDB helped finance infrastructural investment like roads and railways, the value of nearby land would go up, thus giving cities a new source of income (primarily from selling parcels of land to developers). A virtuous circle would then be created which could not only finance the repayment of CDB loans, but also pay for further rounds of new infrastructure, thus expanding urban areas (another key beneficiary: SOEs which built most of the projects).
Chen’s petri dish for these ideas was Wuhu. In 1998 he provided Rmb1.08 billion of development loans and watched as the city transformed into a thriving metropolis. But the secret sauce for the transition was perhaps Chen’s most incredible invention of all: the local government finance vehicle (for our first mention of LGFVs, see WiC48).
The first one – Wuhu Construction Investment – was created with CDB’s help. Backed by the local government and CDB loans it was then able to borrow from other state banks, using land sales as collateral. This created huge leverage, enabling the rapid construction of further infrastructure projects. The Wuhu debt vehicle would see its assets grow from Rmb319 million in 1998 to about Rmb21 billion today.
According to CDB’s official history: “From then on, the Wuhu model was extensively applied across the country… leaving a precious legacy in the field of financing for urban infrastructure construction.”
The next major cities to get a dose of CDB’s financial wizardry were Tianjin and Chongqing. By the time of the 2008 stimulus package, many cities were using LGFVs, but the number would escalate dramatically thanks to the government’s order that Rmb4 trillion be spent to fend off the global financial crisis.
Sanderson and Forsyth observe: “The bank’s creation of LGFVs was the key that unlocked the motor of local government development, becoming the force that has created China’s economic growth.”
The authors say the numbers are staggering. There were around 6,000 LGFVs by 2010, with debts of at least Rmb10.7 trillion. Of the 341 that had accessed the bond market, some 147 said they had received bank loans from CDB, or had CDB as their bond underwriter, or had their bonds guaranteed by a CDB-funded guarantor. In all, these 147 LGFVs reported loans and lines of credit from CDB amounting to Rmb929 billion.
In short, Chen has left an indelible mark on the development of China’s cities (as well as on their finances – more on which later). But he doesn’t feel the job is anywhere near complete: at the bank’s annual work meeting in January he declared that over half CDB’s new loans this year would be earmarked for “urbanisation and related developments”.
A hybrid bank?
As Chen’s empire grew, it became harder to describe CDB’s purpose. At the clear cut end of the scale, it gave out loans for projects considered a priority by the government. For example, it provided 60% of the lending to the Three Gorges Dam and underwrote Rmb43.4 billion of finance for the building binge around the Beijing Olympics.
Equally, when the government called on China’s companies to go out and become global players, CDB was happy to oblige with financial support. A case in point: Huawei, which got a $30 billion credit line. CDB’s financing meant that it could then offer better terms than its competitors. One former European executive told his chairman: “We won’t die at the hands of Huawei; if we die, it will be at the hands of China Development Bank.”
There were other policy goals that CDB assisted with too. It helped African governments (and major Chinese companies) pay for massive new infrastructure projects (its African loans total $13.7 billion). It made mega-loans to Venezuela ($40 billion, in this case) in return for the oil supplies China craved. And when Beijing prioritised new energy as a strategic sector, CDB offered $47.3 billion in credit lines to support Chinese solar and wind companies, according to Bloomberg New Energy Finance.
All of the above can be understood as the typical territory of a policy lender. But what makes CDB look more of a financial octopus are its other activities. It owns a securities venture and is a top bond underwriter. It has a leasing arm and a credit guarantee company. And it has a private equity arm, CDB Capital.
In fact, it seems that Chen’s ambition was to create a financial colossus. The extent of that ambition became clearer in 2007 when CDB paid £1.5 billion for a 3.1% stake in Barclays to help the UK bank finance its bid for ABN AMRO. Had that bid succeeded, CDB would have been required to invest a further $10.5 billion. As it turns out, the acquisition failed, but CDB still had to put more cash in when Barclays raised capital in 2008. The investment has been a poor one (CDB bought Barclays when its stock traded at £7.20, versus £2.94 today).
Aside from planting flags on maps, it’s hard to see why a Chinese development organisation would feel the need to buy into a Western bank. Nor was this Chen’s only attempt. He also sought to purchase stakes in Citigroup and Dresdner Bank. But on both occasions the State Council vetoed the move, perhaps mindful of how badly the Barclays deal had gone.
The erosion of Chen’s powerbase…
In the space of a decade Chen had built an organisation that was far-flung and powerful. Yet because of his parentage and personal connections, he’d been able to run CDB without much in the way of interference.
“Chen’s status as a princeling had allowed him to build something almost as big as the Ministry of Finance, with little oversight or regulation,” comment the authors of China’s Superbank.
In the context of China’s bureaucratic merry-go-round, it was unusual for one man to run a major institution for 15 years (even the president and prime minister only have 10-year terms). And the first threat to Chen’s authority may have resulted from his Barclays purchase, which some senior government figures viewed as a case of overreach.
The initial indication that the authorities wanted to rein Chen in came soon after: in December 2008 CDB was officially designated as a ‘commercial bank’. This was an indication that its special ‘hybrid’ status (and the associated privileges) were under threat.
The next sign of trouble: in 2010 CDB’s vice-president Wang Yi was sentenced to death for taking bribes (this was later commuted to a jail sentence). Wang granted a Rmb2.5 billion loan to Henan’s tourism industry, reports the Economic Observer, of which only Rmb200 million went to the projects intended.
The Wang case would also have a broader political significance (or so it would later emerge). The disgraced official had formerly been secretary to Bo Yibo, another of the founders of the People’s Republic. This connection became more potent a couple of years later when Bo Yibo’s son – Bo Xilai – was purged as Party boss of Chongqing.
Chen and Bo were on friendly terms – indeed CDB had helped with the finance for Chongqing’s own infrastructure splurge. The fall of a key ally was another sign that Chen’s position on China’s political chessboard was weakening. (His links to the Bo family don’t appear to have receded. Sing Tao reported that Chen was seen visiting the grave of Bo Yibo in Babaoshan during last week’s Qingming Festival.)
Black clouds as Chen departs?
Officially, CDB’s bad loan ratio is about 0.3% and has stayed below 1% for 31 consecutive quarters. But analysts wonder whether this healthy rating masks more serious lending risks. There are two main areas of concern. The first is the bank’s enormous exposure to Chen’s creation, the local government financing vehicles. China’s banking regulator estimates that CDB has Rmb2.3 trillion of loans to these entities, making it the most exposed of any bank in the country. One of CDB’s senior executives Jia Tingren has even estimated that the institution holds a quarter of all LGFV loans.
There is increasing anxiety about whether these vehicles will be able to repay even a fraction of their loans. For example, when Bo fell from power last year, CDB was forced onto the defensive over its Rmb100 billion of lending to Chongqing’s LGFVs. With foreign media like Reuters questioning whether the money would need to be written off, CDB replied vehemently that the financial risk was “under control” and that the borrowing entities had the capacity to service their debts.
But the fears have not receded, with one of China’s leading accounting bosses raising the spectre of mass defaults in the Financial Times this week. “We audited some local government bond issues and found them very dangerous,” noted Zhang Ke, the founder of accounting firm ShineWing. “Most don’t have strong debt-servicing abilities. Things could become very serious.”
Nor is this CDB’s only questionable exposure. As reported in WiC187, China’s solar industry is now in serious trouble, with top player Suntech filing for bankruptcy. 21CN reports that the bank has Rmb50 billion of loans outstanding to the sector. You’d have to take a very rosy view to assume that they will all be repaid in full.
All of this suggests that CDB’s NPL ratio of 0.3% can only go in one direction: up.
Enter the new boss…
Xinhua has confirmed that Hu Huaibang will be replacing Chen at the helm of CDB. Hu formerly ran Bank of Communications, the sixth biggest bank and the South China Morning Post has noted that the 58 year-old is “a rare finance veteran” having worked at the central bank, the banking regulator and the soverign wealth fund. He also had a stint as dean of the Chinese Academy of Finance.
The newspaper quotes one local analyst as saying, “Hu is widely regarded in financial circles as a strong advocate of market reforms.” This suggests Chen – a champion of state capitalism – is being replaced with a figure more associated with a freer hand for market forces. If so, this is likely to have major implications for CDB. The hybrid institution that Chen built could perhaps be reshaped into something resembling a more ‘normal’ commercial lender in the coming years.
The personnel shift might therefore signal a period of reform beckons for China’s most powerful bank – eroding its role as a financier to SOEs and infrastructure-obsessed local governments. Indeed, given CDB’s importance, it’s arguable that the long heralded ‘rebalancing’ of China’s economy cannot happen unless the reform faction is able to restructure Chen’s creation.
The first thing to watch is CDB’s credit status – which makes the timing of Chen’s departure all the more interesting. Another of the other unique things about China Development Bank is how it is funded: entirely through the bond market (it is one of the biggest single issuers). State-owned banks recycle their cheap deposits through CDB by purchasing its bonds, and then making money on the spread. This funding mechanism is only possible because CDB carries sovereign credit status. That means it has a zero risk-weighting, allowing state banks to buy the bonds without setting any capital against them.
However, when CDB was redesignated as a commercial bank in 2008, its credit status became a bit murkier. The State Council extended its sovereign status but indicated this would not be an indefinite arrangement, with annual reviews.
Last April CDB got a one-year extension to its current terms, but there has been no announcement this month as to whether its top-rated status will be renewed.
Clearly, CDB’s competitors would like to see its privileges rescinded and the bank pushed in the direction of a more traditional institution. But the danger of not renewing CDB’s sovereign status is that some analysts predict it could cause chaos in the country’s bond market. For that reason Hu may argue against such shock therapy and ask for more time to gradually reform CDB before it loses it credit privileges.
What’s happening to Chen?
Last year Chen proposed the idea of a BRICS development bank, to be funded by China, Brazil, Russia, India and South Africa. Chinese officials told the Wall Street Journal that the 68 year-old has been asked to lead the efforts to set it up. Of course, China would like Chen to get the top job, but the other countries are yet to agree to this appointment.
Netizens have been discussing Chen’s new role and the consensus is that it’s a face-saving way to dislodge him from his CDB fief. One potential sign of his dissatisfaction is rousing comment: Chen penned an article last week for the People’s Daily praising former president Jiang Zemin’s policies on electronic banking. While the subject may sound esoteric, it was interpreted by some as Chen playing factional games and shoring up his personal support.
Meanwhile sections of the local media have attempted to burnish his reputation. “From financing state-backed mega infrastructure, to the pioneering of the financing models of local government financing vehicles, to the battleship escort of Chinese firms venturing overseas, the past 15 years have proven that Chen has the correct strategies for CDB,” wrote 21CN.
Of course, it may be a bit premature to trumpet Chen’s legacy, especially if the LGFVs turn out to require a huge bailout.
Then again, it might also be too soon to close the chapter on his legacies. Over the past 15 years – much like his father before him – Chen has had a huge impact on the Chinese economy. In the decade ahead he could still enjoy great sway if he gets to run the new international development bank. CBN says the BRICS institution could be the largest bank in the world, and by pushing for Chen to get the top job, the Chinese government is demonstrating its implicit confidence in his abilities.
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