Meeting the challenge

The slow move towards profitability may be too little too late for China’s banks, which need to make far greater use of the Yn14,400bn in savings sitting in their reserves in 2001. Positive headline figures for 2001 – Yn26.6bn in profits at the big four for 2001, compared with Yn14.7bn in 2000 – are deceptive. For example, the ICBC’s pretax profits of Yn5.9bn are to be judged against actual profits of Yn34bn. It set Yn17.5bn aside for bad loans and it wrote off Yn10.6bn for earlier losses. The profitability of BOC’s core activities declined in 2001, only partly accounted for by the global economic slowdown. While its mainland branches raised profits 4.7 per cent to Yn2.3bn, overseas operations witnessed a fall of 9.9 per cent to Yn8.6bn equivalent.

Claims that NPL ratios are coming down at the top banks, for both old and new lending, are unreliable for lack of transparency. Outstanding loans at China’s banks were posted at Yn11,200bn for 2001, a rise of 11.6 per cent on 2000. The quality of these loans is questionable. For example, lending to agriculture, one of the slowest growing sectors of the economy, has been high.

Since 2000, China’s banks have come under closer scrutiny as they open themselves to National Audit Office (NAO) and foreign auditing. Tens of BOC employees have been netted along with former bank head Wang Xuebing for serious irregularities at branches in China and New York, where the bank is being heavily punished by the US authorities for misdemeanours throughout the 1990s. The NAO spotlight moves to the CCB this year, while Ernst & Young is to audit ICBC branches in Shanghai and Zhejiang province. Further revelations at China’s banks would jeopardise listing plans, which are key to their continuing recapitalisation. They would also raise doubts in the minds of prospective foreign partners, which are key to domestic banks’ long-term strategies for modernisation and survival.

The cost of restructuring and modernisation will be heavy. BOC’s books took a major one-off hit when the bank restructured its Hong Kong operations last year. BOC has just 25 overseas branches, well short of an HSBC or a Citibank’s global reach. Other mainland banks lag the BOC in rolling out abroad to become global players.

China’s banks know what they must do, but they do not have much time. They can be expected to remain focused on internal reform and restructuring, improving corporate governance, expanding operations and services, targeting new clients (especially foreign enterprises), raising profitability, reducing substandard loans, upgrading technology, and retrenchment. Adding to earlier cuts, the BOC alone intends shedding 5,000 staff in 2002 when it shuts 88 branches. The big four banks employ around 2m people, an enduring legacy from the days of the centrally planned state.

Unfortunately, many of the people who will go will be the ones they can least afford to lose. Low rates of pay mean that top staff are vulnerable to being poached by foreignfunded banks. Three economists quoted by China Business Times last month predicted that the top four banks could be expected to lose about a third of their most qualified staff. Alliances will remain a core strategy, as encouraged by government. Bank of Shanghai (BOS) has sold minority stakes to the HSBC, Hong Kong’s Shanghai Commercial Bank and the World Bank’s International Finance Corporation. BOS is now 18 per cent foreign-owned. The Bank of Communications, China’s fifth largest commercial bank, has been scouting for foreign partners. Other banks can be expected to tighten collaboration with foreign banks. All 10 shareholding banks are looking for sell stakes to overseas institutions.

Foreign banks will not find everything in their favour now that China is in the WTO. Few state-owned enterprises make for an attractive lending proposition, so market penetration is likely to be well short of the 15 per cent share predicted by the central bank for 2006. Nicholas Lardy, a senior fellow and China specialist at the Brookings Institution in the US, is cautious about the prospects for foreign banks. He predicts their market share will only grow from about 1.5 per cent today to 3-4 per cent by 2005.

Domestic banks will compete aggressively in developing new markets and for private sector and foreign clients. Already, a number of leading banks have signalled their intention to tackle the foreign multinationals on their own turf. Chinese banks are known to be active in offering direct loans to foreign corporations operating in China. ICBC says it has already made large direct loans to Sony and Kodak.

The big four domestic banks and four second- tier banks are all backing a foreigndenominated US$1.8bn loan facility for BP. With large US dollar deposits at their disposal, the Chinese banks were able to offer more competitive rates than most foreign lenders wanting to take part in the consortium.