HONG KONG -- To foreigners, the domestic banking scene in China can look more like the wild West than the Far East - complete with lynchings, boom-and-bust speculation, and institutions teetering on the edge of insolvency.

The march toward a decentralized, market-oriented system holds great promise. But in the short term, it has left regulatory holes that some bankers have sought to exploit through fraud, speculation, or embezzlement.

"This has always been a very concentrated system, where a lot of micro-decisions have filtered up to 10 guys in Beijing," says Harry Wilkinson, regional manager for Chemical Bank. "Now the economy is more complex and the power more disbursed. They haven't found the balance yet."

Off with Their Heads

When he took the reins as governor of China's central bank last summer, Vice Premier Zhu Rongji warned that bankers who had taken advantage of the looser regulations accompanying reform would have their "heads chopped off."

He wasn't kidding. Within two months, nine Chinese bankers were executed for embezzling or. accepting bribes.

But the reforms are about more than symbolic executions. Before they are through, Chinese leaden hope to revamp foreign exchange, commercialize stateowned banks and create a true central bank.

For American bankers, the pace of change will likely dictate just how quickly they can get a bigger piece of the world's biggest emerging market.

Run on Currency Feared

"The Chinese are very afraid that if foreign banks are allowed to do renminbi [local currency] business before they are ready, there will be a speculative run. So they are waiting," explains Tsang Shu-ki, a senior lecturer and banking expert at Hong Kong Baptist College.

Foreign bankers are drooling over one major reform goal in particular: Convertibility of the renminbi, which will allow them to participate more fully in the country's economic explosion. Today, they can do business only in foreign currency.

More significant for the average Chinese banker are plans to turn the nation's largest banks into commercial ones, while modernizing cash clearing systems. The ultimate goal: to create a financial system that can channel liquidity to sectors that truly merit it.

So-called policy loans - essentially government-mandated subsidies for money-losing government projects, such as revamping an old coal mine or steel plant - are being shifted away from regular banks to newly formed development banks.

Toward a Central Bank

At the same time, the People's Bank of China, once the nation's only bank, is taking on the role of a true central bank, and will use modern-day tools to control the economy. It will be aided by a new federal value-added tax, which should help replenish depleted government coffers.

Such shifts will likely create opportunities for foreign banks that can help in areas such as cash management and electronic banking.

"If somebody can create a system that helps them with circulation and liquidity, they can make a lot of money," says Antony Leung, North Asia investment bank head for Citibank.

But the process - one in a number of broad reforms - is being played out against a backdrop of rising social tension and disparity, Which promises to make the reform journey a bumpy one.

"People in China will tell you it will take five or 10 years to commercialize the banks. But I think it's more a question of how many decades," says Richard Mounce, general manager for Chase Manhattan Bank.

Inadequate Oversight

As reform began, branches of the four big state-owned banks - known as "specialized banks" - were given more autonomy in lending decisions. But poor oversight led to corruption.

Last year, bankers made more than $20 billion in unauthorized loans - often to banking colleagues for real estate speculation.

By the time Mr. Zhu made last summer's pronouncement, speculation in big-city property markets was sucking much of the available capital away from important, but less lucrative, rural projects.

Even the central bank has been caught in the shifting sands of reform.

Mr. Tsang recalls coming across a joint-venture jewelry store in Beijing last year at a time when there was a speculative run on renminbi. The People's Bank was a part owner.

"The last thing you would expect is for the central bank to be selling gold on the streets," he chuckles. "It undermines people's confidence."

Since then, the bank has begun divesting those holdings.

Such incidents help explain the long-running distrust the Chinese have for bankers. Although the nation's savings rate is above 30%, many opt to tuck their savings in pillows and mattresses instead of their local bank branch.

It is common for depositors seeking a withdrawal to be told, "Sorry, we don't have any cash today, come back tomorrow," says Mr. Leung.

Officials hope to restore faith by commercializing state-owned banks and making them more responsible for profits and losses.

To help accomplish that goal, policy loans will be shifted to three new government-run development banks - the National Development Bank. the Agricul-rural Development Bank, and the Export-Import Bank - which are being opened this year. The specialized banks will then be encouraged to make lending decisions based on creditworthiness and other market considerations.

Some, including Mr. Tsang believe it is unreasonable to expect that the new development banks can take on the full load of high-risk policy loans.

"If you lump all these policy loans into three development banks, they can't function properly. You would bankrupt them." Mr. Tsang says.

But Mr. Leung does not see a problem. "Why not? Instead of calling them policy loans, you call them subsidies, because that's what they are."

Inherent in the disagreement is the lack of clarity with which Chinese officials have defined their intentions. Although, the development banks are touted as keys to reform. no one seems completely sure of exactly how big a role they will play - and. therefore. the impact they will have on the specialized banks or the sector in general.

The evidence from this year supports Mr. Tsang's assertions, and points to perhaps the biggest short-term impediment to reform:

While industrial production boomed at a staggering annual rate of 19% in the first quarter of this year. the state-run sector grew at only 2%. In response, the government has been ordering specialized banks to pump more money into noncompetitive state-owned enterprises - even as it mouths its commitment to commerciailzation.

"It's a classic clash between cyclical considerations and long-term reform," Mr. Tsang says. "At a time when you're giving more and more administrative instructions to the banks, how can you say, `O.K., I'd like to give you more autonomy and make [lending] decisions based on market criteria?'"

"The timing is bad," Mr. Tsang concludes. "Real banking reform has to wait one or two years, until the macroeconomy gets in line."

Mr. Engen, a 1993 Freedom Forum Fellow in Asian Studies, is a freelance writer living in Minneapolis.

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