China should open up its bond markets and liberalize interest rates if its financial reform is to be a success, said Rodney Ward, chairman of Asia-Pacific global corporate and investment banking at Bank of America Merrill Lynch.

"The key components of reform are the liberalization of interest rates, liberalization of the bond market and greater access to equity markets by people, which will put competitive pressure on State-owned banks to be much more responsive to clients and much more definitive in their strategy," Ward said on the sidelines of a recent forum on sustained growth and financial reform in China.

By opening up its bond markets, China will not only give borrowers new sources of finance, but also give big banks new sources of competition, he said.

"At the moment, the big banks do not really support smaller manufacturing and trading companies, which are the heart of China. So the economic slowdown would make me even more keen to have interest rate liberalization pursued and have a more open market for smaller companies to access finance. Otherwise, you'll get the shadow banking systems growing and you'll have all these crises that have occasionally appeared with trust companies," Ward said.

In his view, current financial policies are "too generous" to the big banks. If interest rates were liberalized, some of the banks would pay more to depositors and charge less for loans. So their net interest rate margins would contract, and they would be forced to be more efficient and more selective in their lending.

Big Chinese banks' shares have been trading below book value in the Asian market, which is somewhat unusual for such financial institutions. That is probably because investors do not believe that nonperforming loans have been properly stated, and they also worry that profitability has benefited too much from generous policies that may be removed, Ward said.

State-owned banks have to change their business culture, he said. When people work for a bureaucracy, they operate in a totally different way with little regard to providing service.

"If you could liberalize interest rates and open up the bond markets, you would change the culture quite a lot. Banks would then ... have to worry about which elements of their businesses are profitable and which aren't," he said.

The growth rate of Internet financing has demonstrated the extent to which smaller companies have been starved of access to loans.

He said Internet financing has to be regulated because if there is a crisis, the public will look to the government to put it right. However, the government cannot regulate such activity in the same way it does the big banks. It must take the middle road.

Internet finance "has to be very carefully regulated, but not excessively regulated. There's a balance that's very difficult to achieve", he said.

Ward urged China to establish a national credit bureau as a vehicle for assessing credit risk.

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