Wednesday, 6 February 2008

Banking in China: more evidence

In a follow up to the previous post we go Macro. This time I "borrow" my post from China Financial Markets.

Here is just the first 3 paragraphs.

More on why high share prices don’t mean Chinese banks are in good shape [China Financial Markets]

In several earlier entries on this blog (for example see October 3: “Should Chinese banks acquire banks abroad?”), I have used the option framework to value Chinese banks and to try to correct what I believe to be a very widely-held but incorrect assumption – that the high prices investors are willing to pay for Chinese banks indicate that investors have judged the banking reforms in China to have been successful and the banks in good shape. In fact, it is precisely because Chinese banks are still so uncertain and volatile that they are so expensive (and of course the fact that their home market may be experiencing a stock market bubble doesn’t hurt).

As I have pointed out in those previous entries, shares in bankrupt banks are the closest things to call options on a country’s underlying economy, and in a rapidly reforming economy like China’s, these options should be extremely valuable. In those entries I often mention the Mexican banking experience as a very illuminating example for China.

Actually there are dozens of good examples of bad banks with high prices besides the Mexican one, but for personal reason I am most familiar with Mexico. In the early 1990s I headed the Latin American bond and bank debt trading team at First Boston when it was hired in 1990, under the leadership of Pedro-Pablo Kuczynski, to advise the Mexican government on the privatization of its banking system via an auction process. Although the “Chinese wall” between bankers and traders prevented me from being fully involved in the auctions, I was part of the team that advised the government on debt and market-related issues and very close to the whole process.


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