These problems will be magnified in 2007 when WTO-mandated reforms enable international banks to compete on more equal terms. Against this backdrop Beijing is increasing its efforts to reform the Big Four banks, as well as 14 national banks, 113 city commercial banks and about 3,500 rural credit cooperatives. And what better way to bring about improvements than to list the help of those same foreign banks that are causing concern.
The China Banking Regulatory Commission (CBRC) has gradually raised the cap on foreign ownership, with foreign investors currently able to acquire up to 25% of the major banks, with no single entity surpassing 20%.
For the Chinese banks, foreign investment allows for injections of capital and much-needed management experience. The sales of shares in the major state banks also means that for the first time they will be responsible to their shareholders as well as the government, which should help improve overall transparency and efficiency. Meanwhile, foreign investors gain access to fully established banking networks that stretch throughout China.
As a result, foreign investment reached unprecedented levels in 2005 and shows no signs of slowing. Figures available for the first eight months of 2005 show foreign investors poured around US$5.49 billion into the sector, up from only US$111 million for the whole of 2001. By the end of January 2006, CBRC figures showed 18 domestic banks had received a total of about US$18 billion from overseas investors, accounting for 20% of the sector's total capital.
Key deals in 2005 included Temasek of Singapore and Royal Bank of Scotland acquiring 10% of BOC for US$3.1 billion each, while Goldman Sachs, American Express and Allianz AG were major players in the purchase of a US$3 billion stake in ICBC. A Citigroup-led consortium was also given the go-ahead to hold talks for an 85% stake in state-owned Guangdong Development Bank for US$3 billion, which would make it the first overseas investor to take control of a state-run bank. GDB's desperate need for funds is likely to see the bid receive approval despite Citigroup exceeding the official foreign ownership quota.
In addition to the financial potential of an economy growing by about 9% a year, the banks are drawn by China's US$1.7 trillion household savings and a middle class that could number as many as 200 million. A lack of exposure to consumer banking makes them prime targets for a number of services including wealth management, auto financing and credit cards.
Bank card circulation reached 762 million in 2004, including 98 million credit cards. The credit market, which accounts for less than 3% of consumer loans, is currently dominated by the Big Four and some of the listed banks who together enjoy a 90% share. As lending rates are regulated at 18% and deposit funding costs below 3.6%, the potential profits are huge and foreign entry will see competition intensify. Citigroup, HSBC, and American Express started offering credit cards in China in 2004 and the Chinese credit card market has been predicted to be worth US$5 billion by 2013.
If the state banks are to operate as proper commercial entities, better corporate governance is required to wipe away the legacy of politically driven credit allocation and loan defaults. The CBRC reported that the ratio of NPLs of China's major commercial banks (state-owned and joint-stock commercial banks) has fallen from 17.2% in 2003 to 8.9% in 2005. While this is a welcome improvement, it is still far above the international standard of approximately 1-2%. Furthermore, the asset management corporations set up to dispose of these bad loans for the banks only managed to clear 57% by mid-2005.
Although progress is slow, it is being made. The first of the Big Four to go public was China Construction Bank, whose US$9 billion IPO in October 2005 was the biggest in the history of the Hong Kong Stock Exchange. Industrial and Commercial Bank of China, the country's largest lender, confirmed it had begun preparations for an IPO as early as possible this year, expecting to raise as much as US$10 billion. But it may be beaten to the bourse by Bank of China, which is planning a US$6-8 billion offering.
The prospects do not look so rosy for the final member of the Big Four, Agricultural Bank of China. Described by some observers as a "cesspool" of bad debt, largely due to its ties with rural credit cooperatives, it is unlikely to meet the listing requirements any time soon.
That aside, the gradual opening of the market to foreign competition and the influx of capital and experience that will come as more banks list their shares can only have a positive effect on the financial sector. It is only a matter of time before China's banks show the kind of forward progress that is the hallmark of the rest of the economy.