China Development Bank reinvented the rules of financing for local government projects, before rolling this model out to domestic Chinese companies, enabling them compete in, and then dominate, certain global markets. They are financing enormous deals in parts of the world where many others have failed, have become China’s biggest overseas lenders of foreign currency and are now nearly three times the size of the World Bank. Along the way they have helped to drag millions of people out of poverty. This has occurred over a 14-year period under the guidance of one individual. The bank remains state owned.
China’s Superbank: Debt, Oil and Influence – How China Development Bank is Rewriting the Rules of Finance, written by Henry Sanderson and Michael Forsythe, shines a light on this financial powerhouse and reveals the extent of their influence, both domestically and globally. It could prove to be one of the more important books written about China’s financial system to date.
“This bank is a great lens through which to view the evolution of China, financially and socially, because it has been at the heart of so many things that have impacted China and the world, and has also helped stoke economic development in China.” Michael Forsythe
The spark that ignited the interest of Sanderson and Forsythe was a 2011 visit to the small town of Loudi in Hunan province, which was undergoing a real estate boom. Significantly a large stadium and sports complex had been built in the centre of the town, replete with Olympic rings.
The incongruity of this structure in such a small, previously agricultural town prompted Sanderson and Forsythe to do some research. What they ultimately discovered is that the local government in Loudi had built the stadium, where the money came from was the question that caused them to dig further.
Back in 1998, in the midst of the Asian financial crisis, China’s economy was in a precarious state and CDB was basically in ruins with a non-performing loans ratio of nearly 40 per cent. It was a “zombie bank” as Sanderson and Forsythe call it in their book. It was at this time the bank was taken over by Chen Yuan, a hugely powerful and influential figure — Chen’s father, Chen Yun, had been integral in the formation of the People’s Republic — who set out to rebuild.
Chen and CDB came up with a solution to the issue of government lending. It’s become known as the ‘Wuhu Model’, named after the first town where this type of financing took place.
“To sum up this model, it really allowed local governments to borrow by by-passing the rules, because they weren’t supposed to borrow, that was really the whole point of the 1994 law,” explains Sanderson, “What they did was, they formed a company, a ‘Wuhu company’, an LGFV [local government finance vehicle], and they put all the good assets into this company. The company gets loans from CDB, and the city guarantees the loan from the budget or maybe from land sale.”
It was the ‘Wuhu Model’ that had been applied to Loudi and, as it turns out, thousands of other towns and cities across China.
CDB raises its funds by selling enormous amounts of bonds: “Chinese banks buy them and they’re then considered zero risk, so they don’t have to put any capital against them,” says Sanderson. The fact that the Chinese Government is standing behind this debt that has been raised by CDB over the last decade is incredible. A few defaults on major loans and it is plausible that the whole financial system might unravel. Although today CDB’s non-performing loans ratio is less than 1 per cent, by the end of 2011 their outstanding loans were in the region of RMB 2.4 trillion.
The book also explores CDB’s flair for nurturing domestic companies before taking them global. With a typical flash of innovation Chen was able to heed the government’s call for Chinese companies to go global, and use it to make CDB a more international bank. One example is their relationship with Chery Auto which, coincidentally, was founded in Wuhu.
Chery was actually founded the year before the LGFV model was introduced, however the assets of main ownership of Chery is in LGFVs, so they became a big client of CDB. As of 2011 the total line of credit extended to Chery Auto by CDB was RMB 23.7 billion.
“So we’ve got the local government part of CDB, and now we’ve got the going global part, because Chery is expanding into Africa and Venezuela and it’s supported by CDB funding.” Says Forsythe, “and that’s the good side.”
This illustrates what Sanderson and Forsythe believe lies at the heart of CDB’s success:
“We say in the book that it’s a great fallacy of the free-market systems that they think innovation can’t take place in a state-planned system,” says Sanderson. “I think what makes CDB special is that it is state-owned, innovative and so far hasn’t made huge losses in the form of non-performing loans. In terms of guiding philosophy, I think that’s the real reason for its existence.”
Special attention is reserved in the book for Venezuela, with whom China enjoys a unique relationship. Over the last four years China has loaned them more than USD 40 billion — an unprecedented amount of money. The structure of this deal is in the form of an oil-for-loans programme.
In that China has a huge thirst for oil and Venezuela is able to quench that thirst, it seems to be a win-win situation. In that the money is used by Venezuela for financing infrastructure projects, contracts for which have been handed back to Chinese companies to the tune of about USD 11.6 billion over the last four years, it appears that “China wins twice”, says Forsythe.
So what’s the downside? Well, Chavez’s health for one. He is not a well man, and as Forsythe rightly asks, “Will the new Venezuelan government be as good a friend to China?”
The West’s financial system completely failed in 2008/09 leaving tax payers with enormous burdens. CDB and their new model of financing, while financially risky, are having an enormous impact on China and, increasingly, the rest of the world. As the West struggles to deal with the way they operate, it will be interesting to see if they can accept CDB, or whether CDB will be forced to adapt to the rest of the world. That, however, is a book yet to be written.
By Carl Hayward
Henry Sanderson and Michael Forsythe are both journalists for Bloomberg. Their book, China’s Superbank: Debt, Oil and Influence – How China Development Bank is Rewriting the Rules of Finance is currently unavailable for purchase in China, but it can be downloaded as an ebook.