Law to allow financial firms to go bankrupt
By Zhao Renfeng (China Business Weekly)
Updated: 2004-08-16 15:48

China will soon allow financial institutions that run out of credit to file for bankruptcy, said experts and government officials.

Articles have already been written into a draft bankruptcy law, they noted.

Experts, lawmakers and government officials agree China's financial firms should be entitled to go bankrupt, and that the bankruptcy law should also apply to them, said Zhu Shaoping, a senior legal expert and a member of the committee that drafted the bankruptcy law.

"It is widely acknowledged a well-framed legal structure to give economically troubled financial institutions a way to exit the market is essential for the healthy development of the financial industry and the nation's economy," Wang Xinxin, a professor with Renmin University of China's Law School, told China Business Weekly last week.

Wang is also a member of the law's drafting committee. The purpose of the legislation is to provide sufficient protection to creditors and to guarantee a level playing field in all sectors in China.

The draft legislation, after 10 years of work, was submitted, in June, to the National People's Congress (NPC), the nation's parliament, for first review.

The proposed law is expected to be debated two more times by members of the NPC's 10th Standing Committee, the nation's top legislative body, in the year's second half.

"A new bankruptcy law is long overdue," Carson Wen, a Hong Kong-based legal expert and a shareholder in Heller Ehrman, a US-based law firm, told China Business Weekly.

"Under China's existing legal framework, State-owned enterprises, private enterprises and other business entities are subject to different rules. With the fast growth of the nation's private economy, this no longer makes sense."

Wang said the NPC will likely pass the draft bankruptcy law next year, which will greatly affect the nation's companies.

The effect on financial institutions, in particular, will be significant, experts said.

"The law will ... provide a mechanism for the re-structuring of bankrupt enterprises," Wen said.

"This will help facilitate the restructuring of State-owned enterprises and the recovery of some of the non-performing loans (NPLs) that have plagued China's banking system."

"Some debt-laden companies may be resuscitated through re-structuring," Wen said.

Various amendments must be made to the nation's bankruptcy regime before China's huge NPL market can develop, and before foreigners will increase their investments in the country, Wen added.

Lessons can be learnt from Japan and South Korea's experiences. Those nations' markets truly developed only after changes in legislation were implemented, he said.

"Until this is done, international credit-rating agencies may be hesitant to rate papers backed by China's NPLs," Wen said.

"Without an international rating, it will be hard for Chinese NPLs to be securitized for international capital markets.

"Writers of the bankruptcy law must seize the opportunity to redress these issues, and to lay the foundation so Chinese NPLs will be more attractive to international investors, beyond the large houses currently in the market."

Relevant clauses regarding the bankruptcies of financial institutions have long been included in some of China's legislation.

But, to date, only one financial institution -- Guangdong International Trust and Investment Corp (GITIC) -- officially declared bankruptcy. That declaration occurred in January 1999.

GITIC, due to irregularities and poor management decisions became China's largest State-owned enterprise to go belly up. It lost close to US$2 billion (HK$15.6 billion).

There have been few bankruptcies filed in China, but that does not mean all financial institutions in the country are running smoothly.

Some companies, such as Hainan Development Bank and Anshan Securities, were closed due to poor performances. However, they have not gone bankrupt.

China lacks detailed rules that define bankruptcy procedures for financial institutions, although some rules are relevant, experts said.

There have been growing calls for China to consolidate legislation dealing with bankruptcy issues involving financial institutions, and some experts have suggested separate legislation addressing bankruptcies of financial institutions is appropriate, given their expansive influence on the nation's economy.

Wang said there were diverging opinions about how lawmakers should integrate such issues into the proposed legislation.

The drafting committee decided not to write legislation dealing solely with financial institutions.

Some bankruptcy-related clauses are already in the Law on Commercial Banks and the Insurance Law, said Jia Zhijie, vice-director of the NPC's Financial and Economic Committee.

That committee has been drafting the bankruptcy law since 1994.

Considering the special features of financial institutions, whose assets belong to both their clients and themselves, the draft legislation stipulates, in an appendix, the State Council can enact detailed regulations on financial firms' bankruptcies.

Government officials have expressed support for idea of allowing the country's loss-making financial institutions go bankrupt.

Wu Xiaoling, vice-governor of the People's Bank of China, said problem-ridden financial institutions must be dealt with as early as possible.

Bankrupting them, she added, may even be necessary to ensure the nation's financial stability.

To reduce bankruptcies, problematic financial institutions should be ordered to correct their shortcomings, especially by disposing of non-performing assets.

Experts and government officials said limited protection should be extended to bank depositors and investors, even though public debts should be prioritized when bankrupt companies' are being cleared.

Wu said investors should bear most of the risks in the financial industry, as it is a high-risk sector.

But government departments in China have generally overprotected investors. That was byproduct of the former planned economy. That mindset remains deeply rooted, even though China has evolved into a market economy.

That mindset has prevented investors from developing a healthy, sensible awareness of risks. As a result, it is imperative that clear-cut legal responsibilities be set for all parties, Wu said.

China's banking regulators, after years of study and preparation, are also preparing to implement the long-awaited deposit-insurance scheme.

Details of the proposal are being reviewed by the State Council.

Once implemented, the scheme will help China's financial industry cushion risks, and will make it easier for regulators to deal with bankrupt deposit-taking institutions, experts said.

Wang said the committee, which will draft the detailed regulation on financial institutions, has yet to be created.

He said the regulation might be enacted in tandem with the bankruptcy law.

The regulations will not necessarily be implemented at the same time as the deposit-insurance scheme, he said.

Financial institutions will still have to receive government approval to declare bankruptcy, which is a common practice in other countries, Wang said.

"I do not think the Chinese Government is prepared to allow any major financial institutions to fail," Wen said.

"GITIC was an unusual case, born of unusual circumstances.

"By laying the legal framework for NPLs to be effectively dealt with, the law will contribute to the stability of China's financial system."

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