A serious romance is developing between some of China's comely small banks and lusty overseas institutions. The foreign bankers are queuing up for the chance of being able to prize-open the Chinese banking market under WTO obligations which come into force in 2007. Theoretically, the newcomers would be able to sell a raft of new products and access the US$1.3trn lying around in savings deposits.
The latest suitor is the Commonwealth Bank of Australia, which is buying 19.9% of the Hangzhou City Commercial Bank in Zhejiang province, south of Shanghai. Subject to a nod from the regulators, CBA, Australia's biggest home lender, will add this investment to an 11% holding in Jin'an City Commercial Bank purchased a few months ago. The plan is to develop mortgage business in the hot spots along the prosperous eastern seaboard.
Another Australian bank, ANZ, is now building the maximum allowable stake of 19.9% in Shanghai Rural Credit Cooperative, and it has its sights on a yet-to-be incorporated bank in another major Chinese city. At issue is the future of the more than 100 city banks that were cobbled together in the 1990s by municipal governments out of the rubble of failed urban credit cooperatives.
Their lending is government-directed, and virtually all customers are municipalities. The best of them have ambitions to break out of that cycle and grow into regional or even national banks. That is a big task, given that the collective assets of the city banks amount to only 5% of China's total banking assets. Foreign partners help by bringing management expertise, technology, retail banking skills and money.
The rules of attraction
The attraction of city banks to overseas buyers is that they offer a quick and relatively cheap way of getting a commercial window into China. The stake in Hangzhou City Commercial, which sits in a region of 46m people, is ranked high among the top 10 banks in its sector, only cost Commonwealth Bank US$73m. Its Jin'an acquisition came at a knockdown US$17m.
Citigroup, which boasts of having been in China since 1902, bought an 8% slice of the Shanghai Pudong Development Bank for US$112m. US private-equity fund Newbridge Capital got its holding in Shenzhen Development Bank for US$150m.
So far a dozen foreign institutions have successfully finished in this pool, including the Dutch conglomerate ING group. It paid US$215m for 19.9% of the Bank of Beijing, which has 116 branches in the capital. The regulations allow two foreign entities to go to a maximum of 25%. International Finance Corp, the financing arm of the World Bank, stepped up for the extra shares. The Dutchmen are rubbing their hands in anticipation of the 2008 Beijing Olympics.
Chinese officials seem solidly behind the changing face of the city banks, hoping that an international favor will help reduce reliance on local political support, hoist efficiency and bring discipline to the operations. There are at least four more banks in negotiations – Deutsche Bank, Morgan Stanley and UBS have still not found a seat at the table. Once you get to the heavyweight "shareholder" banks, the cost of buying chips to play the game begins to spiral.
HSBC stumped up US$1.7bn last September for $19.9% of Shanghai's Bank of Communications, China's fifth-largest lender with 2,800 outlets in 86 cities. From the word 'go', that was seen as a cornerstone stake for the world's largest bank, greasing the runway for a simultaneous flotation of Bank of Communications shares on the Hong Kong and Shanghai stock exchanges. But with the Shanghai market still on the skids, plans for holding China's first dual market bank IPO were scrapped turning attention back on the Hong Kong float. Arrangements call for HSBC buying a sufficient number of additional shares to maintain its holding.
The big prize for the big foreign banks is nationwide access to the Chinese market without the bother of building big branch networks of their own. That is a strategy HSBC has pursued successfully in other parts of the world. It first hung up its shingle in Hong Kong and Shanghai in 1865. Bank of Communications, in what should give Citigroup pause, can trace its roots back to the latter days of the Qing dynasty.
It is seen as the pick of the pack among Chinese banks. Its loan book is dominated by major industrial groups including a number of blue chip borrowers around Asia.
Fixing China's banks
China is battling to repair its wounded financial system. Its banks are burdened by bad loans estimated at between US$200bn to US$400bn, or almost 40% of economic output. The biggest chunk of debt saddles the balance sheets of the Big Four – China Construction Bank, Bank of China, Industrial and Commercial Bank of China and Agricultural Bank of China.
The first two nurture IPO ambitions, having had a collective US$45bn government injection to bolster their balance sheets. But there seems no way they will be dressed up and ready for the party, or prepared for competition from a flotilla of foreign competitors by 2007.
Perhaps they need not be. The China Banking Regulatory Commission has indicated it would manage the pace and geographical expansion of the foreign banks. Recently it was mooted foreigners may not be barred from buying equity in more than two large banks. Most encouragement will be given to those who want to bring services to the underdeveloped northwest and northeast of the country. That does not sound unreasonable, given how WTO rules could be interpreted.
In the three years since China signed on to the WTO, foreign banks have more than doubled their holdings of Chinese currency assets, to the equivalent of US$13bn. They have set up 211 operational entities and 220 representative offices, but the bulk of the operations and assets are clustered around Shanghai where they already have a 12% market share.
Really stiff competition will only come when foreigners can buy or control first-tier big banks, or open their own branch networks. That will take years, by which time China's banks could be punching closer to their own weight with their shares listed on a number of stock exchanges.