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Unformatted text preview: generation process, where a change in base money supply is magnified in the effective money
supply through fractional reserve system. Banks with overhanging NPLs may become less
responsive to carry out desirable changes in monetary policy during different phases of a
business cycle. Second, banks' illiquidity caused by loss of capital and inability to use the lending income to
serve the deposit interest as a result of the large amount in NPLs is likely to prevent them from
executing their critical role to boost the economic growth through supporting and nurturing
creditworthy enterprises. Since the banking system reform in 1998, the enormous amount of
overhanging NPLs have forced the People's Bank to tighten its control over SOBs' risk
Nicholas R. Lardy, China's Unfinished Economic Revolution, 1998, p.26, Brooking Institution Press, Washington
23 management. For example, bank officials would be accountable for their bad lending decisions.
The extra precautions when extending credit slowed down the SOBs' lending activities
substantially, causing inadequate funding to enterprises. In the past four years, the government
had to use active fiscal policies to stimulate the economy by issuing government bonds.
Ironically, 45% of these issued government bonds were purchased by financial institutions 4 . The
logic is that the SOBs reduced their lending activities so they had to invest a significant portion
of the capital in the government bonds in order to serve the interest payment, Third, if a bank is unable to improve its liquidity through asset sales, it may encounter a
premature deposit liquidation which could force the bank into default. Due to interconnections
among banks, scared depositors may rush to withdraw their deposits from banks not in default.
The resulting bank run could trigger a full-scale financial crisis. Finally, a sound banking industry is essential for the development of efficient financial markets.
In turn, efficient markets are crucial for ensuring effectiveness of the market-oriented economy.
Excessive bad debts reflecting inefficient bank management are therefore antithetical to the goal
of building a market oriented Chinese economy. 24 Takeshi Jingu, Moving Forward in Reforming China's Capital Market,01/2002, Nomura Research Institute CHAPTER FIVE: SOLUTIONS Formation of Four AMCs
Between April and October in 1999, four asset management companies (AMCs), Huarong,
Cinda, Orient and Great Wall were set up to resolve China's NPL problems. The AMCs were
designed to take over bad loan assets from the four state-owned commercial banks, the Industrial
& Commercial Bank of China (ICBC), China Construction Bank(CCB), Bank of China (BOC)
and Agricultural Bank of China (ABC) respectively (Table 4). Each of the AMCs with a tenyear duration was capitalized by the Ministry of Finance at RMB 10 billion from the state budget
to cover current operating expenses. The NPLs were acquired from the banks at face value.
Purchase considerations included: 1) loans from the People's Ba...
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