By Steven Mufson
Washington Post Foreign Service
Sunday, March 1, 1998; Page A21

BEIJING, Feb. 28—China unveiled plans today to float a $32.5 billion domestic bond issue in an effort to recapitalize its ailing banks and avert the type of financial crisis that has stricken most other Asian countries.

The money would be used to resuscitate China's four giant state-owned commercial banks, which are technically insolvent because of approximately $200 billion in nonperforming loans, most made to state-owned enterprises.

Although the bond issue has been mentioned privately for weeks by Chinese economic planners, its size surpassed the expectations of most foreign analysts. It would be a major step toward buttressing the banking system, which a World Bank report last year called the "soft underbelly" of China's economy.

"The bond issue is very necessary to raise the credibility of state-owned commercial banks and their ability to compete in international financial markets," the Standing Committee of the National People's Congress, which approved the issue, said in a statement issued today through the official New China News Agency. It would "strengthen public confidence in state-owned commercial banks," according to the statement.

In January, China's central bank chief Dai Xianglong said more than 20 percent of state bank loans were nonperforming and 5 to 6 percent of those loans were unrecoverable.

But some analysts still warn that China must do more to fix a banking system laden with deadbeat loans. It also must change the lending practices that were driven by political considerations and ignored the financial risk and credit-worthiness of borrowers.

"It is not adequate to simply provide the banks with capital to make them whole again. The key is on the lending side because the banks have been lending for years to state-owned enterprises at government direction," said Kenneth Lieberthal, a professor of Chinese politics at the University of Michigan.

"Money has been pouring down a black hole" in China's banking system, said Lieberthal. "Until you close it off, it doesn't make that much difference to put a little more money in the pot."

Recently, the government has moved to make it possible for banks to start using their own judgment when making loans. The government announced the end of credit quotas, which were used to channel or limit the flow of funds to certain industries and enterprises. In addition, banks were given the ability to adjust interest rates within a modest band to take risk into account, instead of simply lending at the same rate across the board. There also has been discussion of creating a special agency modeled on the U.S. Resolution Trust Corp., which worked out bad loans from the savings and loan bank collapses of the 1980s.

Today's statement by the Standing Committee urged the four major banks -- the Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, and Construction Bank of China -- to "effectively prevent financial risk." According to the World Bank, the four commercial banks account for more than 90 percent of China's bank assets and two-thirds of all financial assets.

But preventing financial risk will be easier said than done when so few people are trained to assess risk and when proper accounting is rarely found at enterprises that apply for loans.

The bond issue is likely just the first part of a broad package of economic policy initiatives expected during the annual week-long meeting of the Chinese legislature, when China's chief economic policy maker Zhu Rongji is expected to become premier. The session formally opens March 5, but a plenum of the ruling Communist Party this week probably has made the most important decisions already.

Other expected measures include a public works and infrastructure spending program to alleviate unemployment for workers laid off at state-owned enterprises; further layoffs at state enterprises; a streamlining of government bureaucracy with the abolition of major government ministries; and an expanded social safety net.

Economists have said a domestic bond issue is the best way for the government to raise capital for the banking sector. The volume of outstanding government bonds in China is fairly small, running at about 7 percent of gross domestic product, well below the 60 percent or so levels considered normal for developed countries. The new bond issue would equal about 3 percent of China's GDP.

Because of China's high savings rate, the government probably won't have much trouble raising the funds. Newly created pension funds, corporations and individuals all need new outlets for their cash because the stock market is small and volatile and bank savings interest rates are modest. A manager at the People's Insurance Corp. said recently that the Chinese have bought $400 million in life insurance nationwide, and it is difficult to find good investment outlets for the money.