5 WHAT’S NEXT?

The Dilemma of Public Financial Agencies

As semigovernmental, semicommercial agencies, PFAs such as national development banks and ECAs reconcile the state’s public objectives and firms’ business objectives. When firms have difficulties raising capital through commercial channels, they resort to state-backed credits from PFAs to support their business. The state can thus leverage PFAs to affect firms’ lending preferences and incentivize them to undertake infrastructure and industrial projects that the state prioritizes. But as firms develop and grow, they may become more capable of attracting profit-seeking commercial investors and consequently become less reliant on PFAs. PFAs thus face a state-or-market dilemma: if they align with the business goals of firms, their lending would violate fair market competition as they would be competing with commercial lenders that do not enjoy state-granted privileges; if they continue to support policy-serving projects, they make lower profits and their business scope would shrink as firms resort to commercial lenders.

Generality: Declining Export-Import Banks

The history of Japan, which is China’s major industrial precursor, shows how PFAs in the countries of the Organization for Economic Cooperation and Development (OECD) have responded to the state-or-market dilemma. As illustrated in chapter 4, Japan used to practice a “mercantilist” means of development finance. In the immediate postwar decades, Japan’s tied aid supported national exporters in exploring overseas markets. The country’s official aid agency, the Overseas Economic Cooperation Fund, was initially a part of the Japan Export-Import Bank (JEXIM), the country’s ECA, and the two had significant business overlap for over three decades after World War II.¹ However, starting in the latter half of the 1980s, Japan’s aid policy began to change. The Japanese government introduced the New Aid Plan, which sought to integrate “aid, trade, and investment.”² While the mercantilist character of Japanese aid still persisted as the new plan still aimed at supporting national firms’ overseas business expansion, the kind of business to be supported by official development assistance switched from “export” to “investment.” The New Aid Plan highlighted the state’s endorsement for Japanese firms’ direct overseas investment, especially in Southeast Asia, and the import of goods produced in host countries. The rationale behind this new policy was that Japanese aid would not only fulfill Japanese firms’ business interests but also foster the industrial development and upgrading of host countries.³

The new policy was not only an outcome of external pressure from Western economies, which urged Japan to stop using tied aid as self-interest-driven export credits (see chapter 4), but it was also a result of Japanese firms’ business calculations. As the cost of domestic labor and products became increasingly high in the 1980s, many Japanese firms had to relocate their factories to less-developed regions to reduce costs. To build an industrial network in Asia, more and more Japanese firms borrowed from PFAs not to sell their products but to invest directly in the equity shares of overseas projects.⁴ In other words, many Japanese firms had moved up in the industrial chain and become owners (equity investors) of projects, outsourcing the construction of projects to non-Japanese contractors, manufacturers, and suppliers.

Usually, a project owner that possesses shares of the project is more concerned with the project’s profitability than the contractors and exporters that offer construction services and manufactured machineries to the project. The project owner has to estimate the overall costs and benefits of the investment and pay for the services and products of others. As discussed in chapter 3, firms may be able to profit more by investing to become a project owner than merely offering contracting services and earning a construction fee. However, being an investor comes with more financial risks. Therefore, firms would only choose to invest in a project’s equity shares if they see a great potential for profit. As more firms transform from contractors and exporters to project operators and eventually to equity investors, their dependence on official credits declines because profit-generating projects also attract commercial lenders.

The changing role of Japanese firms in overseas projects has resulted in a natural “untying” of Japanese official development assistance—projects financed by Japanese aid are not always tied to service providers of Japanese nationality. It has also resulted in a shrinking business scope of JEXIM, which became the Japan Bank for International Cooperation (JBIC) in 1999. Even if a project were to be financed by Japan’s PFAs and therefore contracted to a Japanese company, the Japanese contractor might need to outsource part of the work to subcontractors and suppliers of other countries in order to reduce the total cost of construction.⁵ Moreover, firms no longer needed to seek financial support from the export-import bank as much as they used to, because they could collaborate with large Japanese private banks to undertake profit-generating projects.

In fact, the business scope of the export-import banks of many advanced industrial economies has shrunk throughout history. Many of these banks were established at difficult times when private finance was scarce and insufficient. For example, the U.S. Export-Import Bank was established during the Great Depression to foster American enterprises’ exports, and the Japanese and German ECAs were founded in the early postwar years to restore their national economies. Then, export-import banks were crucial to (re-)vitalizing economic growth. But as private finance became available and abundant, whether these state-backed agencies should still play a role in trade and industrial finance turned into a question. After all, the very existence of PFAs indicates the state’s intervention in the market, which goes against laissez-faire logic. The idea of reducing state spending on export-import banks was rather popular in the 1990s, when economic liberalism prevailed and many industrial countries proposed plans to privatize, transform, or suspend their PFAs. In 2000, a group of professionals and scholars gathered to discuss the role of export-import banks in the twenty-first century and whether they should continue to function and receive state support.⁶ The discussion ended up highlighting the role of export-import banks in conferring an advantage in trade competition, which is another rationale that legitimizes PFAs in addition to their role in supplementing private finance. The debate about suspending export-import banks did not end in the 2000s.⁷ For instance, the U.S. Congress refused to renew the Export-Import Bank’s charter in 2015, which forced it to suspend its operations for five months.⁸

In fact, in many advanced industrial countries, firms seeking low-cost export credits to finance their overseas business currently choose to borrow from private commercial banks and purchase an insurance from an official export/investment insurer instead of requesting export credit loans directly from an export-import bank. Official export/investment insurers—namely, Germany’s Euler Hermes Aktiengesellschaft and Japan’s Nippon Export and Investment Insurance—are another kind of ECA regulated by the OECD Export Credit Group (ECG). Some of their insurance products are seen by commercial banks as supported by the state’s credibility. If a company buys an official cover from an insurance ECA for its project, commercial banks would offer loans with more favorable terms and conditions to the borrower, because the ECA’s cover lowers the risk level of the project. On the list of ECAs regulated by the OECD ECG, many are insurers instead of providers of direct loans (see chapter 4). This implies that for many OECD members, export-import banks are no longer financiers of last resort.

The China Development Bank (CDB) and the Export-Import Bank of China (China Exim) are currently facing the same dilemma as the export-import banks of OECD countries. As more Chinese commercial banks enter the international market of infrastructure and industrial finance and more Chinese firms start pursuing profitable projects in relatively well-developed regions, the business scope of the policy banks has been squeezed. At the beginning of the twenty-first century, policy banks had a significant advantage in financing international projects because they were the few Chinese banks that were “going global.” But large state-owned commercial banks such as the Industrial and Commercial Bank of China (ICBC) and the Bank of China (BOC) have started to expand their overseas business.⁹ According to its annual reports, the BOC had disbursed $185.1 billion between 2015 and 2020 to support the Belt and Road Initiative (BRI), roughly $20 billion to $30 billion every year. The ICBC had disbursed over $100 billion to support BRI projects by April 2019.¹⁰

When competing for profitable projects, commercial banks can sometimes offer loans with more favorable conditions than policy banks do. Because commercial banks are in their business expansion stage, they are willing to offer loans even at a below-cost price in order to obtain market share. Moreover, commercial banks can raise funds by drawing foreign-currency savings in their international branches, which reduces fundraising costs. The ICBC, for example, has established 124 branches in 21 BRI countries.¹¹ Policy banks, on the contrary, rely primarily on bond issuance to raise funds, and their overseas branches do not hold deposits.

Long-term credit agencies typically have an advantage in tenor (length of a loan), but policy banks are increasingly losing to the commercial banks in this respect as well. When capital is scarce, firms tend to secure long-term loans to avoid future uncertainties, but when capital becomes abundant, firms have more choices. The interest rate of a loan is usually associated with its tenor. The longer the tenor, the higher the interest rate a bank would charge. Therefore, longer-term loans are not always the best option for commercial firms. A loan manager at a state-owned commercial bank said in an interview, “The interest rates of some of the policy banks’ 10- or 15-year loans are actually not low. If the project is promising, a firm does not have to borrow a long-term loan from policy banks; it can first acquire a short-term but cheaper loan and refinance the project after the first loan matures.”¹²

At the same time, Chinese firms have been increasingly engaged in equity investment in overseas projects instead of simply exporting machinery, equipment, and construction services. According to data from the China Export & Credit Insurance Corporation (Sinosure), which is China’s official insurer, the total volume of Sinosure’s overseas investment insurance—a kind of insurance covering firms’ direct overseas investment—grew rapidly between 2009 and 2019, far exceeding the volume of medium- and long-term export credit insurance (figure 5.2). The numbers indicate that a growing volume of Chinese outward capital has been used to invest in equity shares rather than exporting products and services.

Chinese construction companies have been seeking to change their role in undertaking overseas projects in order to acquire greater profits (figure 5.3). As described in chapter 3, when Chinese construction companies started their global adventure in the late 1990s and the early 2000s, they worked as subcontractors for the projects’ prime contractors, which were usually companies of other nationalities. Later, they grew their businesses and won prime-contracting deals. Yet, contracting was not the most lucrative portion of business. In the 2010s, many Chinese contractors began to assume the role of project operator—serving as the manager of the project—after they build the infrastructure work. Furthermore, Chinese firms have started to explore business opportunities of directly investing in projects. In China’s International Infrastructure Investment and Construction Forum in 2016, a panel of representatives from financial agencies and business sectors gathered to discuss how companies can “integrate investment, construction, and operation (tou jian ying yitihua)” when undertaking international projects.¹³ The new form of business was encouraged and highlighted over and over again in policy discussions in subsequent years. As Fang Qiuchen, president of the China International Contractors Association, underscored in a 2021 interview with 21st Century Business Herald, the integration of investment, construction, and operation should be the main goal for China’s global contractors seeking to upgrade their business.¹⁴

China’s increasing international commercial banking and changing business practices imply that policy banks are no longer the only financiers available to firms doing business overseas as they were in the early 2000s. Firms engaging in equity investment seek profit-generating projects that tend to attract commercial lenders. Consequently, their reliance on policy-bank loans has declined. This change indicates that the Chinese PFAs are going through the same processes that their industrial precursors have undergone.

China’s Solution: Two Competing Approaches

In fact, even before criticisms on policy banks’ overseas lending arose, the CDB has been facing the state-or-market dilemma with its domestic projects. As discussed in chapters 1 and 2, competition between the CDB and state-owned commercial banks emerged in the first decade of the twenty-first century. After a decade of continued market-oriented reforms since its establishment, the CDB became financially independent and expanded its business scope rapidly, getting involved in projects that were both policy-oriented and commercially profitable. Commercial banks thus accused the CDB of violating fair competition with state-granted privileges—enjoying zero-risk weighting in issuing bonds and having close relations with subnational governments and state-owned enterprises. The issue of repositioning and reregulating policy banks in China’s financial market has entered top-level policy discussion since then.

An examination of how China’s policymakers have responded to the domestic version of the dilemma provides clues to the future of policy banks’ overseas finance. As discussed below in greater detail, China’s policymakers have employed two different approaches to reregulating the policy banks: a general approach and a Chinese approach. The general approach suggests that the Chinese PFAs be regulated the same way as their Western counterparts, so policy-oriented business and commercially oriented business should be clearly demarcated. The Chinese approach, which has been advocated primarily by the CDB, underscores that a state-supported, market-based means of finance should be sustained. China’s rounds of reregulation of policy banks demonstrates a tension between the two approaches.

The Chinese government’s first attempt to reregulate policy banks can be traced to 2005. Zhou Xiaochuan, governor of China’s central bank between 2002 and 2018, advocated the separation of different kinds of policy-bank business. In his article for the official journal of the Party School of the Central Committee of the Communist Party of China in November 2005, Zhou put forward several guidelines for policy-bank reforms, which included (1) that each of the three policy banks should be repositioned and reregulated in their own way (yi hang yi ce, or “one bank, one policy”) and (2) that the policy banks should separate their accounts for state-led projects and self-run projects and manage them separately (fen zhang guan li).¹⁶ Zhou’s article called for a two-step solution to the state-or-market dilemma faced by policy banks. First, each of the three policy banks should be identified either as policy-oriented financial institutions or commercially oriented financial institutions and be regulated in accordance with their given category. This was because the three policy banks differed greatly from one another in terms of their financial performances and their relations with the state. According to data from China’s official media, by 2006, the CDB had a nonperforming loan rate of 0.72 percent, much lower than that of the other two policy banks—3.47 percent for the China Exim and 7.65 percent for the Agricultural Development Bank of China.¹⁷ Moreover, the CDB was able to finance itself without receiving the state’s fiscal subsidy, whereas the other two policy banks still relied more or less on budgetary funding to maintain a financial balance.

Second, the projects financed by policy banks should also be labeled; those serving policy purposes (that is, state-led projects) could be subsidized by tax revenue, whereas those serving business purposes should not. This proposal reflected a common way of managing PFA projects, which has been practiced by many other countries. For example, Germany’s Credit Institute for Reconstruction (better known as KfW) separates development financing from export financing; the two types of business are managed by two distinct banks under the KfW Banking Group using separate accounts. While the KfW Development Bank receives budgetary funding from Germany’s federal government to finance development-oriented projects, the KfW’s export-import bank (IPEX) only receives funding at a market rate from the parent bank, thereby preventing unfair competition between IPEX and private banks in undertaking export finance as well as domestic and international project finance.¹⁸ In the same vein, in Japan, financial agencies have to “line up” when they select projects. Private commercial banks have a priority in project selection; JBIC, the export-import bank, can only undertake projects that Japanese private banks consider commercially nonviable; Japan International Cooperation Agency (JICA), the aid agency that receives budgetary funding, can only undertake projects that JBIC considers nonviable.¹⁹ The rationale underlying these rules is what theoretically legitimizes the existence of PFAs—that they are created and supported by the state to address market failures and supplement private investors, not to crowd them out.

However, the implementation of Zhou’s guidelines has not been easy, because huge controversies exist with regard to how the policy banks should be identified and how their projects should be labeled. In July 2006, the central bank hosted a meeting to discuss regulatory reforms of policy banks, gathering representatives from policy banks, commercial banks, and various relevant central government ministries such as the National Development and Reform Commission, the Ministry of Finance, and the China Banking Regulatory Commission. Representatives expressed starkly different opinions in terms of how the policy banks should operate. While some of them believed the CDB should be further “marketized” and be deprived of its state-granted privileges, others argued that it should refocus on policy-oriented finance to avoid competition with commercial banks. The China Exim agreed to set up two separate accounts for managing policy-oriented and commercially oriented projects, but argued that it should be allowed to do some commercially viable projects.²⁰

Bank officials at the CDB, nonetheless, sought to challenge the general approach of regulating PFAs by creating a third category of its own—a development-oriented bank (kaifaxing yinhang) that lies in between a policy-oriented bank and a commercial bank. Chen Yuan, the governor of the CDB from 1998 to 2013, raised the notion of “development-oriented finance” (kaifaxing jinrong). In many of his published articles and books, Chen described how “development-oriented finance” differs from “policy-oriented finance”: both serving the state’s policy objectives, development-oriented finance is based on market mechanisms, relying on market instruments and methods to conduct public-serving projects in a commercially viable way; on the other hand, policy-oriented finance relies on government subsidy.²¹ As discussed in chapters 1 and 2, Chen’s idea was core to understanding China’s peculiar means of development finance, which allowed rapid urban and industrial development to take place in an era when fiscal revenue was insufficient and full-fledged markets were absent.

However, the CDB’s proposal to be identified as a unique third category was largely opposed by other representatives in the meeting because labeling the CDB as a “development-oriented bank” would allow it to continue undertaking commercially viable projects that commercial banks also seek to undertake while continuing to enjoy state-granted privileges at the same time. As a result, the central bank did not accept the CDB’s proposal.

In the end, the meeting reached a conclusion that because the three policy banks had accomplished different degrees of marketization, they should be regulated distinctively. As the most “marketized” of the three, the CDB should undergo a “trial” in the next round of policy-bank reregulation. In its final report submitted to the State Council, the central bank stated that the CDB should be treated as a “commercially oriented financial institution.”²² In January 2007, the State Council announced the final decision at the Third National Financial Work Conference: the CDB would be the first of the three policy banks to go through reregulatory reform with the goal of transforming into a “commercial bank” (see chapter 1). The decision, of course, was against the CDB’s will.

The “commercialization” of the CDB did not proceed as the document stated; on the contrary, it was slowed down by the global financial crisis. Since 2008, all three policy banks became main instruments of the state in financing economically vital sectors and revitalizing growth. This meant that if the CDB or the other policy banks were to be further commercialized, there might not be sufficient financing for policy-oriented projects. Meanwhile, the CDB did not give up lobbying the central government for special treatment, opposing the 2007 decision to fully commercialize the bank and insisting that it should be regulated as a “development-oriented financial institution.” In 2013, against the backdrop of announcing the BRI, the government finally accepted the notion of creating a special category. The third meeting of the 18th Central Committee of the Communist Party of China announced the decision to “comprehensively deepen the Reform,” stating that a “development-oriented financial institution” should be created to facilitate infrastructure connectivity with neighboring countries and regions and promote the Silk Road Economic Belt and the Maritime Silk Road.²³ Two years later, the State Council decided to further reform the policy banks and stated that the CDB should be identified as a “development-oriented financial institution,” whereas the other two policy banks were identified as “policy-oriented financial institutions.”²⁴

This decision did not mean that the government’s intention to curb the power of the CDB had been abandoned. While it gave the CDB special treatment, the government also imposed a restraint on it and the other policy banks by placing a minimum requirement on their capital adequacy ratio, which is the ratio of a bank’s capital in relation to its risk-weighted assets. The ratio was set up in accordance with the Third Basel Accord (also known as Basel III), which includes international standards on the capital adequacy of banks. Before 2015, the China Banking Regulatory Commission only required commercial banks to stick to a minimum capital adequacy ratio, whereas the policy banks were allowed to expand their business volume without being constrained by such a requirement.²⁵ In fact, whether PFAs, like commercial banks, should be subject to Basel III is still under debate.²⁶ The reregulation therefore implied a deprivation of another state-granted privilege of the policy banks. “When policy banks’ proportion of self-run business becomes considerable, capital control becomes important,” commented Zhou Xiaochuan in an interview with Caijing on the new regulation.²⁷

The reregulation in 2015 reflected policymakers’ complicated attitude toward policy banks and a mixed adoption of the general approach and peculiar approach in regulating these PFAs. On the one hand, the central government sought to take back some privileges previously offered to the policy banks and separate policy-oriented lending from commercial lending; on the other hand, it could not deny that the sui generis means of development finance created by the CDB had facilitated domestic growth for decades and may continue to play a crucial role in the post–global financial crisis era. This struggling attitude was partly a result of an external change. Since the 2008 financial crisis, governments of both developed and developing countries have been facing certain levels of fiscal shortages and have begun to leverage blended finance to tackle economic challenges. As discussed in chapter 4, official aid agencies have (re)vitalized a mercantilist approach to development finance and practiced public-private cooperation; multilateral development banks have been using market instruments to mobilize and burden-share with private enterprises.²⁸ Policymakers in China took this change into consideration. In an interview discussing policy-bank reform, Zhou Xiaochuan highlighted the major shift in the global development finance landscape: “After the Asian Financial Crisis, public financial agencies around the world were declining. The German Post Bank was privatized. Japan’s Koizumi administration proposed a full privatization of Japan’s Postal Savings system. The European Investment Bank also embarked on a transformation, scaling back infrastructure lending and transitioning to supporting small- and medium-sized enterprises.” But since the financial crisis, the landscape has reverted. Zhou said, “Public projects with some degree of externality, namely infrastructure projects, public facilities, and projects of some important strategic areas, have had difficulties finding investors. Countries that originally planned to privatize their development finance institutions started to hesitate, and some rolled back.”²⁹

In the context of a changing global development finance landscape, the decision to allow the CDB to keep practicing its “development-oriented finance”—a means of finance that can lower the state’s fiscal burden—was formally institutionalized. In 2017, the China Banking Regulatory Commission issued three official documents, respectively, identifying the business mandates and regulatory details of the three policy banks. A comparison of the three documents shows that the CDB is recognized as a more commercialized bank than the other two. While all three banks are mandated to “establish a complementary and collaborative relationship with commercially oriented financial institutions,” the CDB is mandated to “undertake development-oriented business mainly, supplemented by commercially oriented business,” whereas the other two banks are mandated to undertake “policy-oriented business primarily” and conduct “self-run business.”³⁰ These nuanced expressions imply that, while the China Exim and the Agricultural Development Bank of China were discouraged from competing with commercial banks, the CDB was still given some space to undertake some commercially viable projects.

The regulatory documents issued in 2017 were a first step in resolving the state-or-market dilemma faced by the three policy banks, as they repositioned the banks as policy-oriented and development-oriented financial institutions and, to some degree, set up a boundary between policy banking and commercial banking. Yet some fundamental questions still await answers: How are policy-oriented, development-oriented, and commercially oriented projects identified? What about development-oriented projects that are commercially viable? Will government revenue subsidize the policy-oriented projects? If so, to what extent? More importantly, who will decide the category of projects—the banks per se or other state authorities?

In 2021, the discussion of separating accounts for policy-oriented business and commercially oriented business was once again under discussion. In the State Council’s press conference held in July, the China Banking and Insurance Regulatory Commission announced that account separation would be the core issue of a new round of policy-bank reregulation. Criticisms emerged against this “new” regulatory reform, as the same solution has been raised and debated over and over again for more than a decade and yet no substantial progress had been made on an implementation level.³¹

Account separation is difficult to implement for a political reason—it affects the interests of not only the policy banks but also relevant state agencies and commercial banks. It is difficult to satisfy all parties. If the policy-oriented projects are to be singled out and subsidized by government revenue, the Ministry of Finance (MOF) will need to allocate extra funding to the banks and perhaps bail out some of the nonperforming loans, but the ministry has been reluctant. Eligibility to receive fiscal subsidy may also incentivize the policy banks to label as many projects “policy-oriented” as possible to reduce their fundraising costs. Moreover, if a project were to be subsidized by the state, another government authority will likely make the final decision to finance the project, as is the case with the China Exim’s concessional loans.³² This would essentially weaken the policy banks’ autonomy in project selection. Fundamentally, subsidizing projects with government revenue implies a resurgence of an old practice in which the state determined credit allocation for economic development, and the policy banks have made strenuous efforts to move away from this practice since their establishment.

Identifying policy banks’ commercially oriented projects is even more complicated, not only because it would affect the interests of commercial banks but also because many policy-relevant projects can in fact be financed in a commercially viable way. Most importantly, the core idea of the CDB’s development-oriented finance is to use financial instruments to make development-oriented projects bankable. Repositioning the CDB as a development-oriented financial institution while requesting that the bank separate development-oriented business from commercially oriented ones contradicts the banks’ lending rationale.

As a result of these complexities, concrete measures to label different types of projects do not yet exist. However, regardless of what emerges from the 2021 round of reform, the decades-long regulatory reform of policy banks demonstrates China’s difficulty in choosing between two approaches to resolving the PFA dilemma: follow the general approach of how advanced industrial countries regulate PFAs and manage policy-oriented and commercially oriented business separately or keep practicing the peculiar means of Chinese development finance that blends the two. Essentially, this struggle reflects the challenges facing China as it transitions from a late-developed economy with limited fiscal revenue and newly built capital markets to one that has some of the world’s most competitive enterprises and full-fledged domestic markets for financing development.

Challenges to the “Chinese Pathway”

The examination thus far on how the Chinese government has been reregulating the policy banks and their relations with domestic competitors sheds light on how it will regulate the banks’ overseas lending in the future. It is likely that the policy banks will need to distinguish different kinds of projects according to their policy relevance and commercial viability and manage them using separate accounts; at the same time, the policy banks may also be allowed to keep practicing China’s development-oriented finance to a certain degree. In other words, China will gradually converge toward the dichotomous means of credit management that most of its industrial precursors have been practicing—financing/subsidizing nonviable projects with fiscal revenue and financing profitable projects with commercial loans. At the same time, China will continue financing commercially nonviable projects in low-income regions through its unique practice, requesting that host governments enhance their projects’ creditworthiness with state support. Yet successful implementation of the latter approach, as chapters 2 and 3 suggest, is contingent on the role of the state. This means that in the case of overseas financing, the host government has to offer constant support for the projects and play a powerful role in facilitating the policy banks’ lending process. This condition, however, does not always hold.

To clarify, the policy banks’ peculiar means of development finance is not applied to all the projects they finance. Policy-bank financed projects can be generally divided into three categories, according to their level of profitability: (1) those that are commercially promising and attract profit-seeking commercial banks, (2) those that do not necessarily meet commercial banks’ criteria but are viable according to the policy banks’ own appraisal criteria, and (3) those that cannot pass the policy banks’ regular financial appraisal and therefore require additional support from the host government to “enhance the creditworthiness” (zeng xin) of the projects.³³ Only when financing the third kind of projects, which are the least profitable ones of the three, would the policy banks request that the host government offer state-backed revenues as guarantees or collaterals. In other cases, policy banks function like regular ECAs in supporting firms’ business pursuits.

As illustrated in chapter 2, in a domestic context, the financial sustainability of the “CDB practice” is contingent on the long-term industrial and urban development of the region. Ideally, loans to domestic projects would kick off economic development, increase tax and land revenue of subnational governments, and enable them to repay the bank (see chapter 2). In order for this virtuous circle to complete, consistent support by the subnational government, which is the de facto borrower, is a necessary condition. The CDB thus needs be involved in the development planning process of the municipality/province and design a proper financial scheme with local stakeholders before lending takes place; likewise, the subnational governments have to support the CDB’s projects to make sure that they generate revenue and pay back loans. Close bank-government relations are commonly observed across China, as banks and subnational governments rely on each other to fulfill their respective objectives of business expansion and growth in gross domestic product (see chapter 2). This, however, is not always the case in an international context, where there are political uncertainties in the host countries.

In fact, China has been dealing with economic and financial losses caused by regime changes in some host countries. Projects negotiated with the previous government administration were no longer supported by the successive administration. For example, China reached an agreement with Malaysia in 2016 to fund the East Coast Rail Link, a 688-kilometer railway connecting the country’s eastern and western regions. The project was announced jointly by China’s prime minister Li Keqiang and Malaysia’s former prime minister Najib Razak during the latter’s official visit to Beijing, and it was strongly endorsed by the two governments.³⁴ The China Exim would cover 85 percent of the project cost with a loan of 3.25 percent interest rate guaranteed with Malaysia’s sovereign credibility.³⁵ Led by the China Communications Construction Company, the project started in 2017, but construction was soon halted following a shocking election win by Mahathir Mohamad in 2018. Once in office, the new leader alleged that the terms and conditions negotiated by the previous administration was too costly and unmanageable. To revive the project, China had to renegotiate the deal with the Mahathir administration. The negotiation ended up rerouting the railway, lowering the total cost by a third, and pushing back the completion date of the project for two more years.³⁶

In addition to offering constant support, the host government may also need to have a certain degree of control over some of the key sectors in the host country. This is a necessary condition for financing some of the third kind of projects—those that cannot pass the policy banks’ appraisal even if the host government offers sovereign guarantee. The sovereign guarantee of a borrowing country would not be considered credible if the host government has already borrowed largely from international financiers and is in bad fiscal condition. To finance those projects, policy banks would request that the public borrower offer future receivables of various forms to protect themselves from potential losses. In order to meet the policy banks’ financial requirements, the host government has to either own or be able to mobilize domestic stakeholders, such as large oil companies, mining companies, public transportation companies, and electric providers, so that it can collateralize future revenues generated from oil, mines, highway tolls, electric utilities, or other sources to borrow from the Chinese creditors. In China, land and key industrial sectors are dominantly state-owned. The CDB can collaborate with subnational governments and state-owned enterprises relatively easily to design financial schemes for domestic projects (see chapter 2). But this may not be the case in other countries, where major industries and land are privately owned and the government is not able to leverage those revenues to borrow from Chinese banks.

Further, even if the government of a host country managed to use future receivables as collateral to acquire loans from Chinese banks, there is no guarantee that a sufficient volume of receivables will be collected to repay Chinese loans. A typical example is the CDB’s oil-backed lending in Venezuela, which was discussed in chapter 3. Because of fluctuation in the price of oil, Venezuela was not able to gain sufficient revenue from selling oil and therefore could not make a repayment on time. In other words, when allowing borrower countries to use future receivables as a form of repayment, the lenders are taking extra risks. In fact, the growing debt challenges in the COVID-19 pandemic era have created pressure on China to reconsider the risk assessment of its overseas development finance. China’s President Xi Jinping stated at the 2021 Belt and Road Symposium that Chinese enterprises should control risks more cautiously and avoid undertaking projects in “chaotic and dangerous places.”³⁷

In short, successful implementation of the Chinese approach would require that the host government play a powerful coordinating role and provide consistent support for the project until all loans are repaid. This condition finds its roots in China’s domestic development finance mechanism. As highlighted in chapter 2, the emergence and expansion of CDB lending nationwide in the late 1990s and early 2000s reflects financialization of China’s public spending. Although the financial means employed by the CDB were highly market-based, the original goal of such financialization was to assist China’s subnational governments that did not have sufficient tax revenue to fund local development. China’s subnational governments therefore would naturally support these projects, and they have been willing to use future fiscal and land revenue as collateral to borrow from the bank. Yet such a close and mutually reinforcing government-bank relation is not always present in an overseas context.

Another major challenge preventing the policy banks from continuing to practice the “Chinese way” of development finance is their declining power vis-à-vis other state organs. As illustrated in chapter 3, multiple state actors are involved in the process of implementing China’s overseas development finance, and their preferences do not always align with one another. Large contracting companies have an incentive to explore business opportunities overseas and obtain funding from Chinese creditors to jump-start projects, but as long as the project owner, the de facto debtor, is paying them, they are unconcerned with the repayment of loans. Government ministries such as MOFCOM and the National Development and Reform Commission (NDRC) support China’s international trade and industrial projects, but they are more concerned with the interests of Chinese firms than the financial well-being of Chinese banks. MOFA facilitates high-level official visits and would like to see intergovernmental agreements on large projects signed during the visits, but it is not the responsibility of foreign affairs to evaluate the financial feasibility of the projects. MOF decides China’s government budget for foreign assistance, but it is cautious in expanding budgetary funding to capitalize or subsidize policy banks’ overseas projects because many domestic projects in China’s less-developed regions are bigger priorities. Despite the policy banks’ request for the finance ministry’s fiscal support, the amount of government revenue allocated to overseas projects has been rather limited compared with the amount financed by policy banks’ self-raised funds. Nor does MOF have the expertise to design financial schemes for projects. That is to say, aside from the policy banks, other state agencies that play major roles in implementing China’s overseas development finance are not responsible for ensuring financial prudence. Therefore, if China is to continue supporting the financially challenging projects in low-income regions using the peculiar Chinese means of finance, policy banks need to stay in a crucial position in the process of implementation, designing development plans, financial schemes, and repayment mechanisms and being able to turn down projects that do not pass their financial appraisals.

Yet, as the previous section has shown, the policy banks, and especially the CDB, are losing their privileges and becoming increasingly constrained by other state organs throughout the years of regulatory reforms. In fact, the power of the CDB has largely waned since its governor Chen Yuan, a former central banker and a princeling, left his position in 2013. As explained in chapter 3, in his office at the policy bank, Governor Chen was a ministerial-level official who was raised to deputy national level—equaling the level of a vice prime minister—in his final year at the bank. The political resources Chen owned made the CDB a “superbank” during his tenure, as Henry Sanderson and Michael Forsythe, two Bloomberg journalists who published a book on the bank in 2012, termed it.³⁸ In those years, the CDB was able to make development plans and design financial schemes directly with subnational governments in China and the host governments of other developing countries. CDB lending was not much constrained by other government ministries whose administrative level was no higher than the CDB, unlike the situation today. Sanderson and Forsythe described Chen as a crucial factor in the emergence of the superbank and its rapidly growing development financing both at home and abroad. They concluded their book with a question: “Will someone without the red lineage of Chen Yuan be able to take control of that process [of reforming the bank], with the fantastically rich resources CDB has at its disposal?”³⁹

Events since 2013 have thus far answered the question in the negative. The CDB has never been appointed a governor/president as highly ranked or powerful as he was. The two CDB governors after Chen were governors of large state-owned commercial banks who were promoted to vice-ministerial-level bank officials when they became the CDB governor (see chapter 3). This implies that the CDB is a vice-ministerial bank now, not a ministerial-level one. To practice its unique approach of credit enhancement through state-to-state collaboration with the government of the host countries, it would need the endorsement of China’s government ministries such as MOFA, MOFCOM, or the NDRC, which may oppose the banks’ lending decisions if they do not align with the ministries’ own interests.

Indeed, since Chen Yuan left the bank, the CDB has not been able to internationalize its unique approach and expand overseas projects as much as it did during Chen’s tenure. Multiple informants from the CDB told me that during the administration of Hu Huaibang, Chen’s immediate successor, the bank explored very few new international business opportunities. Instead, the bank has been expanding commercially oriented business loans since Chen’s departure, and, perhaps coincidentally, has experienced a scandal. Hu conducted a purge within the bank to create his own faction after taking over the bank in 2013, which allowed him to leverage his power to approve massive amounts of loans to large industrial conglomerates, including private ones, that had financial issues, causing huge losses to the bank.⁴⁰ Hu confessed in a documentary produced by the Communist Party’s Central Commission for Discipline and Inspection in 2022 that he had made sure to approve the loans before reregulation took place in 2015 after having participated in the regulation process.⁴¹ After being removed in 2018 amid suspicion of corruption, he was sentenced to life in prison in 2021 for graft, having received large volumes of bribes and debt-fueling projects that should not have passed the bank’s appraisal when he was governor. Many high-ranking CDB officials in both the headquarters and the branches were penalized as well. A senior CDB official told Caijing magazine, “There were not many projects that Hu took an initiative to advance. Looking back, the projects that he really cared about and proactively promoted were all problematic.”⁴²

The scandal hit the CDB hard, and the bank has still not recovered from it. The scandal has made the bank extremely cautious in deciding what to finance and what not to finance. In fact, since Chen Yuan’s retirement, the CDB has never managed to bring up new guidelines for its lending strategies, either to continue Chen’s development-oriented finance or to switch to another approach. Facing increasing competition from Chinese commercial banks in the overseas market, Chinese firms’ industrial upgrading and changing preferences, and the rising insolvency rate of debts owed by international borrowers against the backdrop of the COVID-19 pandemic, the CDB needs to adjust its lending strategy urgently to accommodate external changes, making a decision on the extent to which it would support policy-relevant but financially challenging projects. Yet, thus far, no policymakers have been able to lead the bank at this crossroads. Kaifaxing jinrong (development-oriented finance), a concept created by Chen, remains the “official” guideline for the CDB’s modus operandi. However, the guideline and its accordant practices were created to resolve development issues facing China back in the late 1990s and 2000s, when subnational governments lacked fiscal revenue and domestic infrastructure market barely existed. The guideline cannot resolve many of the new problems that have emerged as the Chinese economy becomes more developed and Chinese firms become more advanced.

As discussed in the previous section, the CDB is the only agency that supported the “Chinese approach” and asked to be treated as the country’s sole development-oriented financial institution. The China Exim, despite employing similar financial practices, supported the proposal of separating accounts because it had already been receiving fiscal subsidy from the central government for its concessional loans. Thus, if the CDB slows down its finance for commercially nonviable projects in developing countries that require a host government’s extra “credit enhancement,” the bifurcation of China’s development finance—that is, the separation of policy-serving development assistance and firm-driven export/investment loans—will likely speed up, accelerating China’s alignment with the Western means of credit management.

Re-identifying Policy Banks

Recent years have witnessed a sharp decline in the policy banks’ overseas lending. This decline is partly a result of a dilemma the two Chinese PFAs are facing: to follow the state’s policy imperatives and continue financing the developing world, or to follow firms’ business pursuits and support the financing for profitable projects in more advanced markets. This dilemma is not peculiar to the Chinese policy banks. PFAs of China’s industrial precursors have faced the same dilemma. At a catch-up stage, firms rely on PFAs for cheap capital and therefore can be mobilized by the state through these public financial channels to conduct business in regions that favor the state’s preferences. Development finance and commercial finance overlap to a large extent. Yet, as firms become more developed and competitive, they begin to seek more profit-generating business opportunities and consequently rely less on state-backed funding, because they can raise capital from commercial lenders. On the other hand, as the state’s fiscal capacity increases, it can choose to disburse aid in a less mercantilist fashion, providing more untied grants and concessional lending to developing countries with budgetary funding. As a result, the business scope of PFAs has shrunk. China has been converging with a Western means of managing overseas financing by using more government revenue to support development-oriented projects in low- and middle-income regions and having business-driven commercial lenders finance profitable projects.

The bifurcation of China’s overseas development finance raises the question of whether policy banks will continue to support the developing world using their peculiar means of state-supported, market-based development finance. As illustrated above, it has become increasingly difficult for the policy banks to do so. The overseas replication of China’s domestically originated financial approach requires the host governments’ constant support for the projects and their provision of state-backed or state-coordinated revenues to back up loan repayments. This condition could be hard to meet as many other developing countries do not share the same political-economic institutions and bank-government relations that China has. Moreover, as the policy banks, especially the CDB, becomes politically weaker vis-à-vis China’s other state agencies, the practice of this peculiar means of Chinese finance, which was primarily created and promoted by the CDB, becomes increasingly challenging. Other state agencies do not have the incentive and responsibility to ensure the financial prudence of China-financed projects. If not managed cautiously, this means of finance, which essentially allows host governments to financialize their revenues and borrow beyond their fiscal restraints, would result in greater volumes of nonperforming loans. In the first two decades of the twenty-first century, policy banks managed to reconcile their dual identities as development finance institutions and export finance providers. But it has become harder and harder for them to function as both. China is at a watershed moment where it must make a decision: support the policy banks with fiscal revenue and allow them to continue lending to financially challenging projects in low-income countries, or withdraw state privileges for the policy banks and allow them to follow business interests in pursuit of profitable projects in more advanced markets.