Put the cart behind horse

According to the China Banking Regulatory Commission, the total net profits of Chinese commercial banks hit 1.04 trillion yuan ($165 billion) in 2011, a 36 percent increase year-on-year. Seven mainland banks rank among the world's top 10 most lucrative banks.

The banks' dazzling financial record is based on their domination of the national financial system and their control of the interest margins between their deposits and loans. Profits from these interest margins accounted for more than 80 percent of the Chinese banks' total net revenue, much higher than the international average.

The loan interest rate is allowed to float in response to market changes to some extent, but the deposit interest rate is still completely controlled by the central bank, resulting in even negative interest rates for depositors. The benchmark rate for one-year deposits is 3.5 percent, but 6.56 percent for one-year loans.

For a floating interest rate mechanism to work the whole system of finance needs to be reformed. The share of direct financing in China's market is quite low. By the end of November 2011, commercial banks controlled 91 percent of the total assets of China's financial industry.

The banks' huge profits are not good news for the Chinese economy, as their profits are generated at the expense of money liquidity and market dynamics.

The overdue reform of interest rates and the long-term imbalance of direct financing and indirect financing have led to the profit mismatch between banks and industrial enterprises.

It is impossible to build up a real financial market in China as long as the banks hold such a strong stranglehold on the market. Any isolated attempt to increase market liquidity may end up triggering a new cycle of credit crises, including credit expansion, capital shortage, refinancing and re-expansion of credit.

It is imperative that interest rates are more flexible and responsive to market needs and the government should consider a special profit tax for banks. This could subsidize relevant industrial enterprises and serve as a reserve fund to rescue banks from any explosion of bad debts, which have all too readily been ignored during nine years of consecutive growth in net profits.

The government's macro control and adjustment of the banking system - which must be carried out step by step - should translate into a quality financial service that serves the real economy and individual consumers.