Come mid-December, any Chinese person, whether he be in Xi’an, Shanghai or Shenzhen, will be able to walk into a local branch of a foreign bank and open up a yuan-denominated account.
Five years after China joined the WTO, Beijing will finally open up its retail banking market, taking another step towards liberalizing its financial services sector, one of the few areas still largely untouched by foreign firms.
Previously restricted to foreign currency business and local currency lending to Chinese businesses in 25 cities, the likes of HSBC, Citigroup and Standard Chartered will have full access to the US$4.15 trillion or more currently deposited in domestic banks. Bank accounts, mortgages, credit cards, wealth management services – the Chinese consumer is now fair game.
"We look forward to the full opening of the banking industry in China and have made due preparations to capture the opportunities," said Katherine Tsang, China CEO for Standard Chartered.
"Foreign banks will have a more relaxed business environment and both corporate and personal banking stand to benefit by growing in leaps and bounds."
That is the theory, anyway. In practice, the run-up to the December 11 deadline has seen foreign banks grappling with regulators over requirements they must meet in order to participate. These conditions were finally published by the China Banking Regulatory Commission (CBRC) in mid-November
Not playing fair
"While China has met the letter of its WTO obligations, there have been some instances where it has not acted in the full spirit of these obligations," said John Dearie, senior vice president for policy and research at the Financial Services Forum, which comprises the CEOs of the world’s 20 largest financial institutions. "There are a number of non-prudential restrictions and these have the effect of slowing down or frustrating foreign institutions that are trying to take advantage of opportunities to which they are entitled."
First and foremost, to offer the full range of local currency services, foreign banks must incorporate their China subsidiaries locally rather than controlling operations from a foreign base.
This will involve greater administrative costs and have legal and tax implications, but it’s not an insurmountable barrier. Tsang said Standard Chartered has benefited from incorporating elsewhere and has applied to do so in China. HSBC has also announced plans to incorporate locally.
"The intentions are fair and reasonable," said John Wadle, head of Asia banking at UBS. "You don’t want foreign banks to have a 15% tax rate when all the local players are paying something like 32%. Most likely there will be a unifying tax rate between the two."
Additional measures are also intended to act as a means of bringing foreign banks in line with their domestic counterparts.
These locally-incorporated subsidiaries will have to put down minimum registered capital of US$127 million and carry operating capital of at least US$12.7 million in each branch. The same requirements are made of local lenders.
Similarly, overall lending will not be permitted to exceed 75% of deposits and banks must have been operational for three years and profitable for two consecutive years in order to qualify for a domestic retail banking license.
Foreign banks that don’t incorporate locally will have to hold twice as much in capital. In addition, they won’t be allowed to take deposits of less than US$127,000 or issue credit and debit cards.
It is the loan-to-deposit ratio that some analysts believe will create problems for locally incorporated foreign banks. Given their limited access to the local currency lending market, the only real access these overseas lenders have had to renminbi is by borrowing from domestic banks.
"With the possible exception of HSBC and Citigroup, few of these banks have a big deposit network," said Charlene Chu, director of Fitch Ratings China.
According to CBRC statistics, the foreign banks’ loans exceeded deposits by US$54.9 billion to US$33.4 billion at the end of September. However, they are likely to be given time to conform to the ratio.
Whether the measures – or the timing of them – are unfair or not, it is generally agreed that some degree of control was always likely. Analysts argue that China is no exception to the rule and any foreign government would look to protect its banks.
"I can’t believe for one second that the Chinese government will give the foreigners an easy ride," said Alistair Scarff, director for Asia Pacific financial institutions research at Merrill Lynch.
He expects these so-called barriers to entry will shift from the explicit to the implicit as, for example, foreign players encounter hold ups when applying to the regulator for new product licensing.
"Foreign banks will be able to offer sophisticated foreign currency products but all the local stuff has to go to the CBRC for approval. From there it will probably find its way into the hands of other banks."
These risks have not put off the foreigners. HSBC – which has financial sector investments in the likes of Bank of Communications (BOCOM), Bank of Shanghai and Ping An Insurance, in addition to 26 of its own branches and sub-branches – has announced plans to expand to 30 own-brand outlets by the end of the year.
Tsang said Standard Chartered, which has the maximum permitted 19.99% stake in Bohai Bank, will open two sub-branches before the end of 2006, taking its complete roster of branches, sub-branches and representative offices to 22 across 14 cities.
"We expect our total number of outlets to be at least doubled within the next 18 months," she said.
Citigroup, expected to increase its stake in Shanghai Pudong Development Bank from 4.2% to 19.99% in the coming year, and also looking to gain equity plus management control in Guangdong Development Bank (See: Poor but popular: The battle for GDB), and Bank of East Asia are also seen as potential high achievers.
However, none of the foreign players expect to be able to match the domestic banks in terms of client coverage.
As of the end of 2005, the Big Four state banks – Industrial and Commercial Bank of China (ICBC), Bank of China (BOC), China Construction Bank (CCB) and Agricultural Bank of China (ABC) – controlled US$2.6 trillion of the US$4.9 trillion banking system assets. They were responsible for 50.5% of lending and 58.7% of deposits. Between them, they have more than 70,000 branches.
The foreign banks control assets of just US$105.1 billion, a 1.9% market share.
"Many people are portraying December 11 as when the gates will be opened to the foreign wolves, but it’s just not that easy," said Chu. "The branch networks of domestic banks are by far their biggest advantage – they represent access to customers."
Foreign banks will look to leverage their global scale, technical expertise, top notch business products – including foreign currency products – and strong customer service skills.
In doing so, they will target what Wadle describes as the 2-3 million high-net worth individuals concentrated in 10 major cities and high-value corporate clients. For example, HSBC is only really pushing its "Premier" service in China, leaving the mass market to its partner BOCOM.
Chasing the top end
This strategy will bring them up against not only smaller local operators that have carved out a niche serving top-end clients (See: Top dog: The rise of CMB), but also the Big Four, all of which are keen to grow their retail banking business as they move away from the non-lucrative, legacy practice of lending to state-owned enterprises
"It’s already a competitive environment out there and it’s only going to get more competitive as they are all going after the same clients," said Chu.
The question is: do the foreign banks have systems in place to identify the high-end customers and, once they achieve this, can they tailor their services to Chinese customers in order to outmaneuver the domestic players?
For most analysts, there is no clear cut answer. "There will be different kinds of high-end customer with different needs," said May Yan, senior analyst for Moody’s Hong Kong. "It’s a growing market and everybody can get a slice of the pie."
Foreign players are desperate to put credit cards in the hands of Chinese consumers. But when will they start using them?
A hastily-erected stage in a Shenzhen hypermarket car park was the location of choice for the launch of China’s latest dual-branded credit card at the end of October.
After all, for Shenzhen Development Bank (SDB) and Wal-Mart, whose names appear on the new Changxiang Visa/China UnionPay card, and GE Money, which is supplying the processing operation behind it, this venture is not about plush hotel conference rooms. It is about retail.
"The product will focus on the consumer retail experience," Michael Barrett, CEO of GE Money China, said at the launch. "The actual benefits are tailored around the Wal-Mart shopping experience and we will make sure there are strong rewards for customer loyalty."
The initiative will see cardholders earn a rebate of up to 1% on payments which can then be redeemed at Wal-Mart stores.
China, where only 5% of the population are credit card holders, is a focal point of GE Money’s Asia expansion strategy.
Last year, GE’s consumer finance arm agreed to spend US$100 million on a 7% stake in SDB. Although approval for the deal depends on SDB shareholders agreeing on a plan for non-tradable share reform, the company is active in SDB.
Because GE Money partners Wal-Mart in several other countries, bringing the retailer to SDB was a natural step.
"GE has a worldwide relationship with Wal-Mart and really introduced SDB to them," said Frank Newman, chairman and CEO of SDB, which is 17.9%-owned, and also managed, by foreign venture capital firm Newbridge Capital.
"We have gone through the numbers and not only will the business be profitable but, with SDB’s brand displayed in Wal-Mart stores, it will also be great advertising."
GE Money is not alone. A host of foreign players are queuing up to enter China’s credit card market, offering to combine their credit management know-how with the local banks’ client bases in order to pitch standard or dual currency cards.
Independent credit card ventures, which are supposed to be permitted from December under China’s WTO accession commitments, are not feasible without a readymade pool of consumers to tap.
The strategic investor agreements drawn up between China’s banks and their foreign counterparts invariably feature the establishment of a business unit to run credit card operations.
Citigroup and Shanghai Pudong Development Bank (SPDB) were the first to issue a dual currency credit card in 2004, closely followed by HSBC and Bank of Shanghai. HSBC has since started issuing cards with Bank of Communications too.
Royal Bank of Scotland’s credit card operation with Bank of China has signed up one million customers in its first year of business, and American Express reaffirmed its commitment to an existing credit card arrangement with Industrial and Commercial Bank of China (ICBC) when it bought into the bank as part of a Goldman Sachs-led consortium.
According to Bank of America, which is a strategic investor in China Construction Bank, negotiations are ongoing over a credit card venture.
A study by consultancy McKinsey & Company concluded that China’s consumer credit market – credit cards, mortgages and personal loans – will account for 14% of banking sector profits by 2013, up from around 4% now. Credit card revenues from interest income and merchant fees will rise by more than 50% per year, reaching US$5 billion by 2013.
No quick returns
While the payoff could be huge in the long term, financial institutions face a long and largely unprofitable wait. At present, the Chinese just aren’t credit friendly.
Research carried out by AC Nielsen’s Personal Finance Monitor shows that credit card ownership in China is on the rise. In Shanghai, 32% of the population own real credit cards, up from 13% in 2004, while ownership has reached 28% in Beijing and 29% in Guangzhou, from 16% and 19% respectively in 2004.
However, 49% of Shanghai’s credit card holders use their cards once every two to three weeks at most. The same is true of 65% of Beijing-based card holders and 47% of those in Guangzhou. Furthermore, most people pay off their bills quickly, so interest earnings don’t stack up.
"The interest rate is regulated at 18% flat, which makes it very attractive for foreign banks," said Charlene Chu, director of Fitch Ratings China. "But the idea of living in debt has yet to sink in. People tend to pay off their balances in a very short period of time."
"At first, it is not going to be as profitable as in other countries where people are less frugal," echoed Newman. "You want people to pay their bills, but not too fast."
In a business that depends on scale and building up a substantial payment processing and credit checking mechanism, the onus is on banks to find a way of encouraging people to see the benefits of a credit line. The answer could lie in linking credit more strongly to consumption so that the Chinese see using a credit card as a logical means to an end.
"They don’t use credit cards in the traditional sense – you need to create a product that is more concrete and consumer related so that they think they are borrowing money in a responsible way," said John Wadle, head of Asian banking at UBS.
"We think it is going to be a consumer-based instalment model – someone comes in and buys a fridge and pays for it over several months with their credit card."
In this way, the co-branded card issued by SDB and Wal-Mart is seen as having potential because it conveniently slots in as part of the user’s lifestyle. Similar thinking has driven efforts by foreign and domestic banks to team up with airlines and other retailers on co-branded cards.
There has also been growth in demand for specialist VIP packages as sweeteners for potential cardholders (See: Feeling pampered: The VIP package).
This lifestyle focus may convince Chinese consumers to accept credit more quickly but culturally-driven spending habits won’t change overnight.
"The consumer credit market may be worth US$10 billion in three years and US$30 billion in 30 years," said Wadle. "You will end up with US$50-100 billion in consumer financing but only 25% will be revolving credit, high margin business."
For this reason, a number of foreign bankers place mortgages, which account for the vast bulk of consumer credit, higher on their list of priorities.
"Mortgages are much more powerful simply because the size of the transactions is much larger," said Newman, who is developing SDB’s mortgage products. Central to his plans is building ties with local real estate agents who often recommend banks to their clients, endorsing those that have a reputation for getting the job done.
"One of the things real estate agents hate is when they direct someone to a bank and then the bank takes 10 days to get back to them," he said. "Thanks to the work of SDB and GE people, this is now down to about one to three days at SDB."
Richard Williamson, general manager for China banking at Commonwealth Bank of Australia, which has made investments into the city commercial banks in Hangzhou and Jinan, is also positive about long-term growth in the mortgage market.
"I know there is a lot of enthusiasm for credit cards in China but we are more interested in mortgages," he said.
"The credit card business requires fairly intensive capital investment. If you are partnered with a PRC bank with a national license, fair enough. We are an investor in tier three city commercial banks and this involves a different financial equation."
All quiet on the home front?
Helped by foreign investors, the big domestic banks are making efforts to reform. It is not an easy process
Not all foreign banks are rushing into the China market equipped with ambitious plans to plaster their logos across as many high streets and shopping malls as possible.
For overseas banks like Bank of America (BOA) and Royal Bank of Scotland (RBS), investments in some of the country’s larger domestic players have come at the expense of their own brand business.
"We believe that retail banking is local and wholesale banking is global," said Bob Stickler, senior vice president for communications at BOA, which has a 9% stake in China Construction Bank (CCB).
"In retail banking you need to be one of the top players in the market in order to control your own destiny. We would rather have significant stakes in market leaders than try to be one of the also-ran players."
BOA, which is in the second year of a seven-year investment agreement with CCB, can’t sell its stake until 2008 but has the option of doubling it before 2010.
Similarly, RBS, which led a consortium that bought a 10% stake in Bank of China (BOC) last year, has committed itself to be BOC’s exclusive partner in a number of commercial areas.
Given the two foreign banks’ lack of experience in the China market, Alistair Scarff, director of Asia Pacific financial institutions research at Merrill Lynch, believes this is a fair deal.
"Part of the strategic investment is getting an understanding of what works and what does not work. You cannot replicate the distribution power of the domestic banks. It’s like RBS going into the US – how could it compete unless it took over a major player?"
No time for takeovers
Foreign investment in China’s banking sector is capped at 25% per institution, with no overseas player allowed to exceed 20% ownership of a single bank. The government’s unwillingness to relent in the case of Citigroup and Soci? G?rale’s bids for Guangdong Development Bank suggests these caps will not change soon.
"The best these banks can hope for is they get to access a wonderful university in which to learn about the market," said John Wadle, head of Asia banking at UBS.
Having bought in ahead of the local banks’ initial public offerings, the foreign players have also made a lot of money.
CCB’s IPO last year raised US$9.2 billion, pushing BOA’s stake from US$2.5 billion to more than US$9 billion; RBS has seen its US$1.6 billion holding grow to US$4.7 billion following BOC’s US$11.2 billion offering in May; and Industrial and Commercial Bank of China’s (ICBC) world record US$21 billion IPO in October has taken Goldman Sachs’s US$2.5 billion investment and turned it into around US$7 billion. These gains are still on paper only.
In addition to agreeing to a share lock-up period, the foreign investors also pledged to help the domestic banks in their transition from government policy props to commercial, consumer-oriented lenders.
Risk management and corporate governance, consumer banking services that target high-end customers, foreign currency products and IT systems – all these areas are to be graced by foreign expertise.
Foreign investors can also appoint one or two board members to ensure proper oversight. But it is here where the extent of their influence comes into question.
"A seat on the board does not get you control," said Jamie Allen, secretary-general of the Asian Corporate Governance Association. "As with most Chinese enterprises, you have to accept that the [Communist] Party Committee has the power."
All the major banks have taken steps to strengthen their corporate governance at board level, putting in committees to oversee everything from auditing to risk management, and introducing independent directors. But whatever the commitment to best practice on paper – and the influence of the party committee inevitably varies from company to company – key business decisions and senior managerial appointments tend to be taken by a higher power.
"A government bank in which the chairman is a government official is not a problem, but if the CEO, who is responsible for running the bank, is a political appointee that is a problem," said Wadle.
"They will make compromises and only think about their personal future rather than implement change."
"We had one joint venture where a senior executive was acting improperly and we just could not shift him," said one banker, who asked not to be named. "Past a certain level, it becomes a party decision."
Such lapses in the professional corporate culture can have knock-on effects throughout the company and for the Big Four state banks – ICBC, BOC, CCB and Agricultural Bank of China – reform is ultimately dependent on implementing change throughout their branch networks.
BOC devoted 30 pages of its IPO prospectus to explaining its revamped risk management structure.
It detailed improvements made to risk monitoring (now done independently), risk management and risk alert systems, as well as pointing out that loan approval powers were being put under central control.
However, ensuring good behaviour in 11,000 branches is no easy task. BOC said it had received reports of 141 criminal acts allegedly carried out by staff between 2003 and 2005, involving US$166 million.
Warning investors of the difficulties of centralizing management where branches had traditionally enjoyed significant autonomy, the prospectus admitted: "Our head office may not be able to ensure that various policies are implemented effectively and consistently across the organization."
Wadle thinks the Big Four need to compromise, and focus on the most profitable branches in their networks. He said BOCOM was doing well on the back of this kind of strategy, having "identified the 300 branches [out of 2,600] that matter".
As part of this, he advocates getting rid of the older middle managers that can’t respond to change. "Often you just have to get rid of them and bring in new staff. Are Chinese banks willing to take that strong step forward and fire people?"
Similar challenges of scale are attached to upgrading the banks’ IT systems.
"The technology setup at a number of these banks is now quite advanced but the full structure has yet to be fully implemented," said Scarff. "A computer credit culture takes time to develop and is more than putting a PC on a desk. You have to make people understand how credit works."
Even when relevant data is available – analysts say Shanghai’s credit bureau is currently the best – the fragmented nature of the Chinese economy means income figures will be difficult to verify.
There is also the issue of the banks using the data correctly.
"Having data doesn’t solve problems," said Wadle. "You have to study behaviour and everyone has to use the data consistently. In Taiwan, some banks didn’t use the data properly; they were replicating it, and this destroyed everyone."
The danger is that the progress China has made in financial governance, working from a low base, will be undermined by continued foolish lending, whether through poor management and information or from being pushed by the state into making suspect loans (See: Loans: Hidden risk?).
There is still a long way to go before the banks are fully commercialized entities with world class checks and balances.
"As an investor in the China banking sector there are a few key risk areas: credit quality, interest rate liberalization and managing liquidity," said Williamson. "All markets go through down cycles, and we are working with our banks to give them the best chance possible to outperform the sector in the event of a downturn."