As Chinese banks race against time to transform themselves into ingenious commercial ones before the sector fully opens to foreign competitors in 2006, corporate governance has become the buzz term.

Although planned initial public offering (IPO) is still at the top of the agenda of major State banks for now, a consensus has been reached that good corporate governance is key to China's banking reforms, according to participants of the China Conference: Capital Markets and Corporate Governance.

The forum, organized by Euromoney last week in Beijing, was a leading annual capital markets event for China.

"Development of China's capital market, to a large extent, hinges on the quality of listed companies, which, in turn, is defined by how corporate governance runs," said Zhou Xiaochuan, governor of the People's Bank of China, China's central bank.

The history of corporate governance in China is quite short. The concept was first introduced to China's economic reform in 1993 and officially recognized a major goal in 1999, when the government began to encourage the establishment of a modern enterprise system in State-owned enterprises (SOEs).

By definition, according to the Organization of Economic Co-operation and Development (OECD), corporate governance refers to the correlation between management, board of directors, shareholders and other relevant interest parties. There are different models of corporate governance.

After many rudimentary debates about this imported concept, the country realized there was no "one size fits all" approach to corporate governance standards.

"China should base its decision on which corporate governance model it will learn from in specific aspects of its national conditions," said Zhou, the central banker.

Since China's capital market was developed during the country's transition from central planning to a market economy, sound corporate governance is yet to take root in most SOE-turned listed companies, preventing the capital market from playing its role in resource allocation.

"But in my view, listed companies, as a whole, still boast the best corporate governance in China," said Zhou. "Experience has proved that share-holding reform is a major way to boost corporate governance."

This logic underpins the country's ongoing banking reform.

Given the overwhelming role the banking sector has played in financing domestic enterprises, its reform once lagged behind most other sectors.

But as the country agreed to open its banking sector by 2006, rapid market-oriented reforms became a must for domestic banks, especially the four major State-owned commercial banks.

China's economic policy-makers and regulators have thus made use of overseas IPO to encourage State banks to meet international benchmarks.

"Improving corporate governance is the core of State-owned commercial banks," said Jiang Jianqing, chairman and president of the Industrial and Commercial Bank of China (ICBC), the country's largest commercial bank.

At the moment, the two key tasks State banks face are share-holding reforms and corporate governance improvement. The two tasks are closely related to each other, but the former is only a means, not an end.

Going public will not automatically improve banks' performance. Instead, it is sound corporate governance that will attract foreign investors and thus facilitate the bank's IPO.

As the proportion of foreign shares increases to a certain level, foreign investors will help strengthen supervision of these banks and consider exporting technology and expertise to them out of their own interest, Jiang said.

Better corporate governance can also help keep reducing non-performing loans, suggested Jiang.

A huge amount of bad assets accumulated by State banks over previous years once not only dented foreign investors' interests in these banks but also menaced the country's overall financial fitness.

Nevertheless, since domestic banks are urged to pursue better corporate governance, the quality of their lending has been substantially improved.

For instance, most of the ICBC's outstanding bad loans took form before 1999, and the ratio has been reduced to less than 2 percent for all new additional lending since then.

After the financial reorganization of the Bank of China and the China Construction Bank, the two forerunners among the four major State commercial banks in their bid for IPOs, the two banks' double-digit bad loan ratio has been lowered to 3 to 5 percent.

The ICBC chairman was confident that his bank could achieve a similar result if it had a shot in the arm from the government as the other two banks have had.

But Jiang admitted that how to keep the bad loan ratio down was the real test of the Chinese banks' corporate governance.

"Improving corporate governance is also crucial to enhancing the banks' competitiveness," said Jiang.

On the one hand, shareholders will demand higher returns on equity and assets.

On the other, external changes like liberalization of interest rates, a narrowed interest rate gap between loans and deposits and intensified competition will constitute challenges to domestic banks.

How to respond to them will depend on the corporate governance structure the bank has.

The ICBC chairman offered four suggestions on improving corporate governance.

First, domestic banks should set up an effective check and balance system among themselves.

Second, management reforms are needed to replace the original separation of operation by regions with a business-centered management system.

Third, technological innovation should be facilitated. There are many members of staff in China's State-owned commercial banks. It is necessary to strengthen internal controls with high-tech means to forestall the formation of bad loans.

Last but not least, organizational culture should be changed to encourage professionalism among the staff, because risk control is related to everyone's work.

Corporate governance improvement also involves reforms in many other aspects of the banking sector like personnel policies and the role of boards of directors.

It certainly is a long-term and difficult task for Chinese banks to find a corporate governance structure that suits them best.

But the unprecedented emphasis domestic banks lay on the significance of corporate governance nowadays, in itself, can justify a sense of optimism.

(China Daily December 8, 2004)