By Michael Laris
Washington Post Foreign Service
Tuesday, January 12, 1999; Page A14

BEIJING, Jan. 11—Despite warnings from some of the world's biggest banks that China's financial system could lose access to international credit markets, one of China's most prominent government-backed financial institutions has announced it will file for bankruptcy. Lenders were told Sunday the company has $4.4 billion in debts and only $2.9 billion in assets.

The bankruptcy of the Guangdong International Trust and Investment Corp. (GITIC), the country's second largest financial-trust company, could change the way international lenders do business in China, Western bankers said today. One banker warned that it is possible that virtually no credit would be extended to the Chinese financial system.

Foreign lenders had been hoping for a government bailout after the high-flying GITIC was shut down by the central government in October after a string of ill-considered investments in stocks and real estate that left it unable to pay its debts.

Foreign bankers said that as recently as September provincial leaders in Guangdong had been telling them that the provincial government would stand behind the loans the bankers made to the trust company. But central government officials overruled the provincial authorities.

That decision could mark the beginning of a new era of investing in China. By shutting down a provincial government investment house, Beijing has shown foreign lenders that government backing does not necessarily bring protection.

International bankers often lent to projects connected to high-level government officials. The deciding factor has often been the official's connections into the upper echelons of the Communist Party, not the project itself. In China, these relationships are known as guanxi, and for 20 years they have formed the basis of investing in China. Now, suddenly, guanxi has become a risky basis for investment.

"The only way you educate people is to have them burned. Unfortunately, that's the free-market way to resolve the issue," said Frederick Hu, an analyst at Goldman Sachs in Hong Kong.

Hu said that forcing GITIC into bankruptcy will be good for the Chinese financial system in the long run because it will force both Chinese financial institutions and foreign lenders to understand that borrowing must be based on commercial criteria, not connections. Both borrowers and lenders "should not have a mistaken assumption about implicit government guarantees."

But changing the way lenders view risk in China will change the way business is done here, and could bring a shock to the financial system, which has grown accustomed to easy credit lines from international banks.

"If this is the chemotherapy . . . for the ills of the financial system, it's incredibly important," said the vice president of a major foreign bank that is owed money by GITIC. But, he added, "the downside is we do exactly what they are suggesting we should do -- that we treat all loans on a commercial basis assuming no governmental support."

China's state-run banks have long funded the country's inefficient state-owned enterprises. Loan decisions by Chinese banks are usually based not on creditworthiness but on political criteria, which has left the financial system creaking under the burden of heavy debts.

Premier Zhu Rongji has made financial reform a top priority, but so far the government has not shown the political will to allow banks to make loans based on profits and losses. Doing so would mean cutting off credit to state factories and a loss of jobs that could cause higher unemployment and more street protests. The Asian financial crisis has cut into China's growth. Today, China announced that its overall trade fell for the first time in 15 years, dropping 0.4 percent.

Wu Jiesi, an assistant to the Guangdong provincial governor and head of the liquidation and trustee committee set up to handle the dismantling of GITIC, said on Sunday that "GITIC's board decided to file for bankruptcy because of massive internal and external debt, extremely chaotic management and liabilities that seriously exceeded assets."