The Path to Prosperity is State Sponsored

May you live in interesting times

The concept of ‘Path Dependence’ explains how our current decision making capabilities are shaped by previous events and experiences, even though past happenings may no longer be applicable. At One Road Research, we have deciphered that the path to the supposed economic prosperity in Asia is dependent and deeply rooted in the origins of the state, central banks and banking reform.

Asia presents hybrid features of commercial banks, and the power of the state to intervene in the economy to orchestrate positive economic outcomes. It should also be noted that there are no two economies which follow identical banking models and practices. After credit is created its features become unique to that individual country, in part due to historical circumstances. That means it is difficult to escape the previous formative influences of the state.

Take for example, China under Mao Zedong’s leadership during the period 1949 – 1976, there was no requirement for commercial banks. The Peoples Bank of China (PBOC) was established in 1949 and all previous banks of the old Republican era were wound up and consolidated into the PBOC.

The PBOC provided the funding needed to carry out the central economic plan, which we refer to as Asian Capital Development (ACD). Gradually the mono-banking system was extended and the PBOC and the Ministry of Finance created four nationwide state banks: the Bank of China (BOC), the China Construction Bank (CCB), the Agricultural Bank of China (ABC) and the Industrial and Commercial Bank of China (ICBC).

 Industrial and Commercial Bank of China in Beijing. (Shutterstock)

Industrial and Commercial Bank of China in Beijing. (Shutterstock)

 

These banks provided the necessary funding for the planned economy. They disbursed money, not based on credit analysis or efficient capital allocation, but based on government suasion. They loaned to state-owned enterprises (SOEs), most of which were inefficient and loss-making.

Moreover, banks did not understand how to manage the risks associated with lending. The state companies, in turn, were not fiscally responsible due to being granted gratuitous amounts of credit.

The state effectively protected and subsidized their domestic banks (like in many regions across Asia) via interest rate repression (a government policy keeping interest rates below market rates, penalizing savers as well as consumers, and subsidizing borrowers and investors).

Through implicit guarantees of state-owned enterprises (SOEs), and intervention to prevent troubled industries from defaulting on their bank debt, China’s banks transformed rapidly.  These emerged alongside the highest economic growth rates of any major economy in world history. During this period bank assets grew at very high rates by lending into a high growth low-risk economic environment.

In 1992, the Chinese finance industry made the brilliant move to list many of their prized companies on international securities exchanges. This brought not only fresh capital but also effective outsourcing of employment, improved balance sheet quality, profitability and corporate governance.

Central banking policies have lumbered some Asian countries with eye-watering levels of government debt.

Let's examine how that debt has been used to influence development. Commercial banks have the power to balance a country’s development, like in China where we see the surplus capital from advanced sectors being transferred to rural agricultural regions to boost overall economic activity.

Ever wondered why Asia is home to many of the world’s largest banks, or how you can profit from Asia’s booming financial services industry?

As you can see in the chart above, profitability in Chinese banks is on the up.

Buying shares in Asia’s biggest banks would seem like the straightforward option, but before you rush to start buying bank shares it’s important to understand why this is, and what components are contributing to big bottom line results...

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