CONGRESSMEN KIRK AND LARSEN MEETINGS WITH CHINA'S CENTRAL

UNCLAS SECTION 01 OF 02 BEIJING 001695 SENSITIVE SIPDIS STATE PASS TO USTR (C O R R E C T E D C O P Y - PARA NUMBERING) E.O. 12958: N/A TAGS: EFIN ECON CH SUBJECT: CONGRESSMEN KIRK AND LARSEN MEETINGS WITH CHINA'S CENTRAL BANK AND BANKING REGULATORY COMMISSION REF: (A) Beijing 1473; (B) Beijing 1500; (C) Beijing 1518; (D) Beijing 1523; (E) Beijing 1675 BEIJING 00001695 001.2 OF 002 (U) This cable is Sensitive but Unclassified (SBU) and for official use only. Not for transmission outside USG channels. ¶1. (SBU) SUMMARY. Congressmen Mark Kirk and Rick Larsen held meetings with People's Bank of China (PBOC) Governor Zhou Xiaochuan and China Banking Regulatory Commission (CBRC) Chairman Liu Mingkang during their visit to Beijing as co-chairs of the U.S.-China Working Group of the U.S. Congress. Governor Zhou urged the U.S. to increase savings, claiming that China had increased domestic consumption and improved its risk management practices in the wake of the global financial crisis (GFC). CBRC Chairman Liu said the U.S. should require banks to divest toxic assets before injecting liquidity. Liu emphasized the need to retain higher capital adequacy and provision coverage ratios. He stated that the CBRC plays a more active role in oversight of lending practices and bankers' incentive packages than U.S. and E.U. regulators. END SUMMARY Zhou U.S. Economy Still Strong, Needs to Save -------------- ¶2. (SBU) In a June 1 meeting with Congressmen Mark Kirk and Rick Larsen, PBOC Governor Zhou acknowledged that "we know the U.S. economy is still very strong" and has recovered from previous crises in the past. He felt U.S. consumers and policy makers should increase savings, and indicated that China looks positively upon President Obama's promise to cut the fiscal deficit in half over the next four years, while stating this is "easier said than done." Turning to Chinese Domestic Consumption for Growth -------------- -------------- ¶3. (SBU) Zhou stated that the GFC's had a less serious initial impact on China, but consumer confidence took a hit and the Chinese economy contracted between October 2008 and February 2009, before starting to pick up in March. Over the past year, China's GDP growth rate has declined sharply, from roughly 10 percent to roughly 6 percent, due in part to a decline in exports to the United States and Europe, as well as to other parts of Asia and emerging markets. Zhou said China must resume a high growth rate to provide jobs. 
¶4. (SBU) He said China is working to encourage domestic consumption and reduce its dependence on exports while also expanding social programs such as social security and health care reform. Zhou said domestic banks need to carefully balance providing loans to expand consumption and avoiding future defaults. He remarked that banks often face difficulties obtaining relevant information in a timely manner to make accurate risk determinations. The central government is looking carefully at how local banks are managing risk as the stimulus packages are doled out. GFC Slows ForEx Rate Reform -------------- ¶5. (SBU) Responding to a question, Zhou said he expects the crisis to slow the process of RMB reform as public opinion in favor of a move to a free-floating currency has waned. Zhou thought China would need perhaps 10-15 years to reach a consensus in favor of fully floating the RMB. Zhou claimed that several ASEAN and south-Asian countries now face a shortage of U.S. dollars for trade, and thus see the RMB as an alternative settlement currency. Inflated Greenback or Inflated Fears? -------------- ¶6. (SBU) If the GFC constrains U.S. consumer confidence, Zhou acknowledged that it would be difficult to see inflation rising. Liquidity injections and a growing money supply, however, could eventually cause inflation. Zhou stated that he does not believe inflation fears will lead China to purchase short-term rather than long-term Treasuries. (Note: According to the latest U.S. government data, recorded overall Chinese purchases of Treasuries did shift to short-maturity bills. The data, however, is incomplete in that it does not include purchases through third-party brokers. End note.) ¶7. (SBU) Zhou suggested that although rating agencies should be strengthened, financial institutions should also conduct internal evaluations. Ultimately, he stated, the rating agency and the financial institution should jointly evaluate risk. CBRC's Liu: Remove Toxic Assets, Then Add Liquidity -------------- -------------- ¶8. (SBU) Congressmen Kirk and Larsen also met CBRC Chairman Liu BEIJING 00001695 002.2 OF 002 Mingkang on June 1. Liu criticized the U.S. Public-Private Investment Program (PPIP) and Troubled Asset Relief Program (TARP), arguing that the government should first ensure that banks divest themselves of toxic assets and then inject liquidity. He said banks would not function properly and would be reluctant to lend money if they were still holding toxic assets. He suggested the United States establish an asset management company like the Resolution Trust Corporation (RTC) that would charge banks a two percent fee to buy their toxic assets. Liu Suggests Lowering Risk with Higher Ratios -------------- ¶9. (SBU) To rein in risk, Liu argued for the United States to reinstate the demarcation line between banks and capital markets and to require banks to maintain appropriate capital adequacy, loan provision, loan-to-value (LTV) and loan-to-deposit (LTD) ratios. He said an 8-10 percent capital adequacy ratio was not enough to absorb risk, pointing out that CBRC now required banks to maintain a capital adequacy ratio above 12 percent. CBRC had also required Chinese banks to improve their provision coverage ratio from 130 percent to 150 percent by the end of 2009. Banks that cannot meet this requirement were not allowed to expand their businesses. Regarding the establishment of a new international regulator, Liu said regulatory decisions should be made through existing structures such as the Basel Committee on Banking Supervision, Financial Stability Board (FSB) and the IMF. CBRC's Active Role Contrasts with U.S., E.U. Approach -------------- -------------- ¶10. (SBU) Liu said 80 percent of China's economic stimulus funding was from bank loans, stressing CBRC's focus on ensuring the quality of banks' lending. He said CBRC had ordered country-wide bank inspections in April and had found that 20 percent of the 5 trillion RMB already loaned out had not gone into the real economy but rather been re-deposited in banks. This 20 percent loan deviation rate "will be corrected quickly and those who play this game will be punished," Liu said. Liu contrasted CBRC's role with that of bank regulators in the United States and Europe, commenting that CBRC plays an active role in regulating the incentive packages of bankers. He said CBRC used "common sense tests" to evaluate the reasonableness and consistency of banker's incentive packages and required a "prompt and full correction" if CBRC found something wrong. ¶11. (U) Representatives Kirk and Larsen did not have the opportunity to clear this message before departing. PICCUTA