a b s t r a c tThis paper analyzes empirically what explains the low profitability of Chinese banks for the period 1997-2004. We find that better capitalized banks tend to be more profitable. The same is true for banks with a relatively larger share of deposits and for more X-efficient banks. In addition, a less concentrated banking system increases bank profitability, which basically reflects that the four state-owned commercial banksChina's largest banks -have been the main drag for system's profitability. We find the same negative influence for China's development banks (so-called Policy Banks), which are fully state-owned. Instead, more market-oriented banks, such as joint-stock commercial banks, tend to be more profitable, which again points to the influence of government intervention in explaining bank performance in China. These findings should not come as a surprise for a banking system which has long been functioning as a mechanism for transferring huge savings to meet public policy goals.

The Chinese banking system, characterized by massive government intervention, poor asset quality and low capitalization, has started a reform process based on the three main pillars: (i) bank restructuring, through the cleaning-up of non-performing loans (NPLs) and public capital injections, particularly in the four largest state-owned banks; (ii) financial liberalization, with the gradual flexibilization of quantity and price controls, the opening-up to foreign competition and cautious steps towards capital account liberalization and (iii) strengthened financial regulation and supervision, coupled with efforts to improve corporate governance and transparency. Although the reform is still ongoing, our preliminary assessment indicates that there has been an improvement in the soundness of the Chinese banking system. However, changes in the reform strategy are needed for it to be fully successful. Asset quality has improved, particularly in the recapitalized banks, but there is a high risk of a new build-up of NPLs. Capitalization has increased in the largest banks, as a consequence of the government capital injections, which generally remains low, as well as profitability. China's huge financing needs, to maintain high economic growth, and its commitment to fully open up its banking system to foreign competition urgently require a more comprehensive and time-bound strategy, with a long-term vision of the desired structure of the Chinese banking system. Bank recapitalization should be completed immediately, not only to ensure bank soundness, but also to increase profitability, which could be further hampered as the competition increases with full financial liberalization. Bank recapitalization, however, needs to be accompanied by a radical improvement in corporate governance, which would clearly be facilitated by a change in the property structure. (JEL classification: E44, E66, G2, G21)

This paper analyzes empirically what explains the low profitability of Chinese banks for the period 1997-2004. We find that better capitalized banks tend to be more profitable. The same is true for banks with a relatively larger share of deposits and for more X-efficient banks. In addition, a less concentrated banking system increases bank profitability, which basically reflects that the four state-owned commercial banks -China's largest banks-have been the main drag for system's profitability. We find the same negative influence for China's development banks (so called Policy Banks), which are fully state-owned. Instead, more market oriented banks, such as joint-stock commercial banks, tend to be more profitable, which again points to the influence of government intervention in explaining bank performance in China. These findings should not come as a surprise for a banking system which has long been functioning as a mechanism for transferring huge savings to meet public policy goals.

The Chinese banking system, characterized by massive government intervention, poor asset quality and low capitalization, has started a reform process based on the three main pillars: (i) bank restructuring, through the cleaning-up of non-performing loans (NPLs) and public capital injections, particularly in the four largest state-owned banks; (ii) financial liberalization, with the gradual flexibilization of quantity and price controls, the opening-up to foreign competition and cautious steps towards capital account liberalization and (iii) strengthened financial regulation and supervision, coupled with efforts to improve corporate governance and transparency. Although the reform is still ongoing, our preliminary assessment indicates that there has been an improvement in the soundness of the Chinese banking system. However, changes in the reform strategy are needed for it to be fully successful. Asset quality has improved, particularly in the recapitalized banks, but there is a high risk of a new build-up of NPLs. Capitalization has increased in the largest banks, as a consequence of the government capital injections, which generally remains low, as well as profitability. China's huge financing needs, to maintain high economic growth, and its commitment to fully open up its banking system to foreign competition urgently require a more comprehensive and time-bound strategy, with a longterm vision of the desired structure of the Chinese banking system. Bank recapitalization should be completed immediately, not only to ensure bank soundness, but also to increase profitability, which could be further hampered as the competition increases with full financial liberalization. Bank recapitalization, however, needs to be accompanied by a radical improvement in corporate governance, which would clearly be facilitated by a change in the property structure. (JEL classification: E44, E66, G2, G21)

Rationale The share of non-marketable assets (mainly bank loans) pledged as collateral in the Eurosystem’s monetary policy credit operations has increased in recent years. The Banco de España’s corporate credit assessment system (ICAS BE) has contributed significantly to this development and may lead to these assets playing a greater role in the future. Takeaways •In the wake of the COVID-19 crisis there has been a considerable increase in the share of non-marketable assets in the collateral pledged by Spanish counterparties in Eurosystem financing operations. A significant proportion of these non-marketable assets are loans to firms rated using the Banco de España’s in-house rating system, called ICAS BE. •There is ample scope to increase the volume of pledged loans with an ICAS BE rating, especially in the case of loans to SMEs. •Spanish firms’ ICAS BE credit ratings have remained relatively stable in the past year, except in the sectors most affected by the COVID-19 pandemic, which have seen a notable improvement.