Counter culture

The countdown is underway. By 2007, two years from now, the formal restrictions on where foreign banks can operate in China, and what they can do, will be history. Yet some of China's mammoth state banks are still in such a parlous state that government bailouts remain the order of the day.

Beijing handed out a total of US$45bn to get the Bank of China (BOC) and the Construction Bank of China (CCB) past their problem with non-performing loans (NPLs) – in late 2003 – and about as much, the central government has acknowledged, will be plowed into the Industrial and Commercial Bank of China (ICBC) and the Agricultural Bank of China (ABC) to wash their NPL problems away.

All big four state banks are in various stages of preparing for initial public offerings, but it is getting late in the season to be only this far along on the learning curve. It is now past the halfway point since China's entry into the World Trade Organization (WTO) in 2001, when everyone was put on notice that banking was going to get real one day.

Yes, China's banks all sport smart logos these days, and they've splashed the fake marble around, and it all looks very contemporary.

But compare the customer-first attitude of HSBC staff in Shanghai to the put-upon looks of their counterparts at the state bank down the street. One mindset shouts, "Welcome, friend!", the other "Get lost!" So when consumers and corporate customers are finally given genuine choice, what happens? Money does not operate on the basis of patriotism. So will 2007 be a walkover for foreign institutions?

Frederick Cho, a Stockholm-based consultant and veteran China watcher, does not go that far. But he does predict state banks will probably own only half the sector they once ruled in 10 years' time – down from over 90% now. Don't forget, he says, that the state sector includes, besides the big four, all the city commercial banks around the country. The state is not going to shrivel up and go away.

Cho says foreign banks at that point will probably account for about 10% of business – and most of that will be in the hands of only two players, HSBC and Citibank. The other 40%? He sees China's private banks as the big domestic gainers, and singles out China Everbright Bank, CITIC Industrial and China Merchants Bank as good prospects for grabbing share from the state banks.

ICBC and ABC are most at risk, he says, and could end up as regional players. On the other hand, BOC, buttressed by its strong international operations, and CCB, thanks to strong mortgage and development financing businesses, could both thrive.

Still more competition
But other smaller banks will come to the fore to grab market share, too. China Minsheng Banking Corp, which claims to be China's only private bank, reported a 47% year on year net profit growth in the first three quarters of 2004. Then there are other trends that could hurt state lenders. In the city of Wenzhou, for instance, many businesses have started bypassing the banks and organizing financing among themselves. In Shanghai, entrepreneurs talk about setting up truly private banks – with absolutely no ties to the state.

But all is not gloom and doom for state players. Yes, Cho allows, foreign banks will pick up much of the high net worth business – the big depositors and corporates – and lead in foreign exchange and investment banking. "But it depends on what products and services Chinese banks come up with," he says. "China is China – they pick up these skills quickly."

Personal banking is just taking off in China and is set to keep growing and growing at speed.

The state dominated no-frills era is giving way to an explosion in consumer demand for credit cards, car loans, mortgages, life insurance, mutual funds and other products.

A big mover and shaker in the services arena is HSBC. It moved its China headquarters from Hong Kong to Shanghai in 2000. Today it has the largest China branch network among foreign banks – 10 branches, three sub-branches and two representative offices.

In the China growth-story tradition, HSBC deposits have been rocketing up – up 136% year on year, to RMB23.4bn (US$8.2bn), in 2003. "[That] was driven mainly by business opportunities arising from strong growth in the Chinese economy and the further liberalization of China's financial markets," an HSBC bank official explains. That, and improved management and risk control, helped drive net profit up 108%, to RMB324.7m (US$39.1m).

HSBC's mainland earnings were helped in other ways, too. Licensed to offer foreign currency services, forex activity with private individuals and corporations is expanding quickly. Demand for corporate loans, from local and foreign investors, is climbing fast, too. "Foreign currency transactions, trade finance and credit facilities are key growth areas," the banker says.

The bank has plans to open branches in up to 20 major cities, says another insider at HSBC headquarters in Shanghai. More branches and services are both crucial for growth. But HSBC's reach will go a lot farther than a mere 30 branches, farther than even the 500-branch network some bankers privately predict.

There is the 2,700-branch Shanghai-based Bank of Communications (BOCOM) to consider. After taking a US$1.75bn 19.9% stake in that – the maximum allowable now – HSBC immediately went to work setting up a joint credit card centre, and appointed the managers to run it.

As experience in France, Brazil, the US and other countries shows, HSBC likes to take control of assets it buys. Cho says BOCOM is better managed than other state banks. "If HSBC gets the chance, they will buy it."

He says it is a bank that covers the field – mortgages, car loans, corporate banking, credit cards, forex, the lot. "It's larger than mid-sized commercial banks and has a strong hold in the economic centers in the provinces. I'd say it's better positioned than the big four."

Citibank, yet to see profit in its China operations, claims to be the largest foreign bank on the Mainland, though it has a smaller footprint than HSBC, with nine branches, a sub-branch and two representative offices. "China is a strategic focus," a Citibanker says. "China's individual banking business will grow steadily."

Foreign exchange savings deposits of high net-worth individuals – in Beijing, Shanghai, Guangzhou and Shenzhen – now reportedly account for 60% of bank deposits. Like some other foreign players, Citibank joined a local partner to get a foot into China's credit card market – when it bought a 4.62% stake in Shanghai Pudong Development Bank. The two launched the first credit card in China that can be settled both in RMB and US dollars.

Other foreigners are making moves. Standard Chartered is taking a 19.9% stake in Tianjin-based Bohai Bank. Bohai may be small, but it has what Stanchart needs – a national license. ANZ, Australia's only licensed player in China, is waiting to pick up a 19.9% stake in the Shanghai Rural Credit Co-operative which is set to restructure as a bank. Commonwealth Bank of Australia just got approval to take 11% of Jinan City Bank of East China's Shandong province. HSBC's Hang Seng Bank announced its acquisition of a 15.98% stake in Industrial Bank of East China in Fujian province a year ago.

Standard Chartered has eight branches in China. Like HSBC and Citibank, Stanchart relies on corporate banking for growth. It was among the first foreign banks to win Qualified Foreign Institutional Investor (QFII) status. The bank's Irene Yin says the 2003 net profit was up 31% year on year, to RMB136m (US$16.4m), making China operations profitable for two consecutive years. But much more interesting, to take the longer term view, is the deposit story. Deposits shot up 72% in the period, to RMB11.4bn (US$1.37bn).

Small depositor base
But Ramon Gascon, chief representative of Spanish bank BBVA, says the number of China's significant deposit holders is not large, a point borne out by a recent McKinsey study. According to the research firm, China has only 30m households with annual incomes exceeding $4,300. Of that group, McKinsey says, only 1.2m, or 4%, have savings deposits in excess of US$100,000 – and they alone account for more than half of total individual savings.

These rich Chinese have been heading in significant numbers to the foreign lenders to sign up for international credit cards, wealth management and other services. At HSBC, for example, customers with deposits exceeding US$50,000 are offered packages that include bank cards, international credit cards, tax advice, "free" funds transfers between accounts in different countries, access to a 24-Hour helpline, even booking services for shows and golf courses.

Some Chinese, of course, rail against fees and terms of entry. "I had an HSBC account but I closed it," says Shirley Liu, a US-educated educated Beijing realtor. "When you consider what the Bank of China charges – and they're in Hong Kong, and will be in the USA soon, I think, 'why pay those fees?'" So why did she sign up in the first place? It was the thing to do for young professionals at the time, she says.

Hefty service fees, of course, boost income, but more usefully, separate the wheat from the chaff, in the hunt for high net worth customers. China's banks will inevitably climb the services curve, too.

Getting into the RMB business has been the holy grail for foreign banks, but the rules are still unfair to foreign banks at present, according to a German banker in Beijing. "The limits and capital requirements are unfair and don't compare in any realistic way with what Europe or the US requires," he asserts.

"Foreign banks cannot have RMB debt surpassing 50% of their debt in foreign currencies," he complained. "That makes it difficult for them to draw yuan savings to solve the currency shortage."

But the RMB deposit graph line continues its upward course. Foreign banks' RMB assets increased 49% year on year, to RMB 84.4 billion, by yearend 2004, according to the CBRC.

First allowed in Shenzhen, Shanghai, Dalian and Tianjin in December 2001, RMB business permits for foreign banks were extended to five more cities a year later; then four more in 2003. Last month, three cities, including Beijing, were added to the list. By the end of 2006, it will officially be open season across China for foreign banks engaging in RMB business.

Today, foreign banks assets account for only 1.4% of the financial assets in China's banking industry, according to the CBRC. A commission official predicts the ratio will rise to 30% within 20 years.

Maybe so, but locals are adapting. "Local banks are a lot more sober now than they were three years ago, when everyone was alarmed at the prospect of the foreign 'wolf' coming into the banking sector," says a CBRC official. "The local banks were totally unprepared for it mentally."

Now they can at least see their shortfalls and advantages. "They see the foreigners don't have the network compared to Chinese banks, and that will take time to establish."

Sevices are another thing though. "Chinese banks make their money through interest rates off loans, while foreign banks charge for services," he points out. "Chinese banks will start charging for services. And they will offer a lot more of them."

They will have to get going in other ways, too. In November, the Bank of China announced a full-scale staff review, saying it would be asking management and staff to reapply for their positions. The exercise aims at identifying staff with skills, as opposed to staff with only seniority, so people get paid what they are worth. (Drivers, with years of service at the bank, were known to be paid more than younger managers responsible for businesses worth millions.)

The shake-up, ahead of a planned overseas initial public offering, puts the BOC at the forefront of staff reform in the state sector. But how much of its headcount – currently 230,000 spread across more than 11,600 branches – will ultimately be affected in the end in the third quarter when the review is scheduled to be completed?

Frederic Cho says state banks will get slimmer, but acknowledges there are political pressures that make it difficult to go too far. "Everything is relative. They will be slimmer than they used to be but in the short term they won't be able to shed too many people."

As the market diversifies, mid sized commercial banks will identify niches and come to the fore he says, a view shared by Frances Chang, CEO of ABN AMRO China. Chang set up the Dutch bank's mutual fund joint-venture before moving on to head overall operations.

Chang, who knows the Taiwan market well, sees parallels between the Mainland's opening up and Taiwan's experience earlier. But there is one difference – China's vast area and the huge distribution networks needed to service all parts of the country.

Foreign banks won't be able to mount vast networks, but Internet banking will minimize that handicap, Chang says, as will tie-ins with local banks.

But calm heads are needed, says Ramon Gascon. "Yes, the future looks bright, but there's no reason to get carried away. This is not going to be a free-for-all. Foreign banks have to focus on the long term, and not get side-tracked by concerns about short-term profit," he says.

State banking will certainly get better, however unevenly banks move up the curve. Business consultant Cho says the big four – pressured to become more professional by both the regulator and by the process of readying for IPOs – will focus more on quality instead of quantity as time goes on.

Cho says the pressure on the local banks is intense. "Now with the CBRC pressing Chinese banks to meet Basel capital adequacy ratio (CAR) requirements, the banks will have to be more selective in their lending. All in all, we will see an accelerated intermediation process in the finance sector. Like in other markets, the more developed the market, the more disintermediation you will have."

"I take an optimistic attitude toward the prospect for Chinese banks' development after foreign banks' entry into China," says Sang Yongsong of the Beijing branch of the Shanghai Pudong Development Bank. "Easier access for foreign banks into the market won't have a serious impact on the present Chinese bank structure or situation. Foreign banks mainly operate a few advanced businesses in China, targeting multinationals, Chinese enterprises on global Fortune 500 list and individual financing. [That] does not conflict significantly with domestic banks."

Certainly there is no room for foreigners to be complacent. "The local banks are going to offer very stiff competition in all the services foreign banks offer," says Italian banker Roberto Chiamenti. "Give them 10 years and there won't be much difference."

Chiamenti, chief representative of BNL, Italy's second largest bank, says the Chinese will have to do some consolidating first though – something the CBRC has been urging of late.

"But nobody's going to be taking over. There's a 20% limit on the amount foreign banks can buy and nobody's going to be getting control of China's banks – it's too sensitive a sector, and what country opens its banking sector to foreign control anyway?"

Frederic Cho agrees foreigners never end up dominating a market. But, as he says, things change. China is China.