China's economic growth is slowing and its banking sector is having to adapt to new policies aimed at bringing the market closer to the final reform of liberalising interest rates. Even the largest banks in the country have had to reconsider their strategies to face this evolving environment. How will they reinvent themselves? Stefania Palma reports.

China’s leading banks remain gargantuan on a global scale. In The Banker’s 2015 Top 1000 World Banks ranking by Tier 1 capital, four of the top 10 lenders are Chinese, and Industrial and Commercial Bank of China (ICBC) tops the ranking for the third consecutive year. In 2010, it was the only Chinese bank in the top 10, in seventh place with $91.11bn of Tier 1 capital. By the end of 2014, that figure had almost tripled to $248.61bn.

Agricultural Bank of China (ABC), China Construction Bank (CCB) and Bank of China, all of which feature in this year's top 10, have had an equally impressive rise. CCB is the second largest bank in the world for the second year running, Bank of China has jumped from seventh to fourth position and ABC has also climbed three places, taking it to sixth position. Despite this significant growth, the environment that Chinese banks are operating in is far from straightforward. Local market participants say China has entered a 'new normal', with its gross domestic product (GDP) growth having slowed to between 7.3% and 7.7% in the past three years – the lowest level since 1999, according to the International Monetary Fund's World Economic Outlook Database – from 9.3% growth in 2011. 

This is putting pressure on non-performing loan (NPL) ratios, which are creeping up, even for China’s 'big four' banks. ABC’s NPL ratio grew from 1.22% to 1.54% between 2013 and 2014; Bank of China’s from 0.96% to 1.18%; ICBC’s from 0.94% to 1.13%; and CCB’s from 0.99% to 1.19%, according to The Banker Database.

Facing challenges

China's liberalising financial sector policies implemented this year, which the market sees as a stepping stone to interest rate liberalisation, are also challenging banks. Deposit insurance – which covers deposits of up to Rmb500,000 ($81,454) – is increasing banks’ costs, while deposit rate liberalisation – which allows the upper limit of deposit rates’ floating band to increase by up to 1.5 times – is squeezing net interest margins. This is problematic for a banking sector whose lenders rely heavily on net interest income, and have relatively low net non-interest income.

Though Chinese banks perform strongly in the Top 1000 World Banks ranking by Tier 1, they fare less well in a global ranking by net non-interest income, based on 2014 figures. Using this comparison, ICBC, with $23.45bn, is the top Chinese bank in 11th place globally, with Bank of China one place lower with $22.31bn. ICBC’s and Bank of China’s net interest income total $80.65bn and $52.47bn, respectively. By comparison, US-based JPMorgan Chase tops the net non-interest income ranking with $50.56bn, which is even higher than its net interest income of $43.99bn, as of 2014. 

Meanwhile, new competitors – privately owned, tech-savvy online banks, including Tencent’s WeBank and Alibaba’s MyBank – are also keeping China’s largest banks on their toes.

“China’s economic slowdown, the interest rate market and the [rise of] internet banking are making us face unprecedented challenges, which have affected the bank's development in the past two years. Our growth rate and profit growth have declined,” says an official at Shanghai-based Bank of Communications.

To offset these pressures, Chinese banks are looking to expand their scope and diversify revenue sources. In an unprecedented move, they are working towards universal bank models – a strategy historically adopted by the largest Western lenders. Chinese banks are also strengthening their fee-based business (investment banking), and retail and private banking, as the country moves from an investment to a consumption-driven economic model to offset GDP slowdown.

Insurance blow 

Bankers across China largely agree that customers will benefit the most from deposit insurance and that, while it will be beneficial to these institutions in the long run, the smallest and largest banks will be hardest hit by the measure in the short run. Large banks will face extra costs, even though they hitherto did not need insurance to gain customer trust and attract deposits. “Before this [policy], we didn’t necessarily have to pay insurance on our deposits,” says Shen Si, former general secretary of Shanghai Pudong Development Bank (SPDB).

Costs could be significant for banks such as ICBC, whose deposits account for Rmb7000bn.

Banks could also see clients start transferring portions of their wealth to other lenders, as a way of getting around the insurance’s Rmb500,000 cap. “We could lose deposits,” says Mr Shen.

Meanwhile, smaller banks might struggle to pay the insurance now that funding costs are rising and profit margins are narrowing, says Hou Funing, the president of Shanghai Rural Commercial Bank (SRCB). However, he recognises that small and medium-sized banks, such as SRCB, will benefit from the new rule in the long term. “Small and medium banks will particularly benefit from the deposit insurance scheme, which can improve banks’ credit rating and ability to attract deposits,” says Mr Hou.

New competition

Privately owned, tech-savvy online banks, including investment holding company Tencent’s WeBank and e-commerce company Alibaba’s MyBank, are also challenging China's traditional lenders. Although these new entrants do not have top banks’ enormous deposit or asset bases, data from their existing customer or user networks, combined with their technological prowess, means that they have very efficient credit scoring systems – something larger banks with older technology systems are struggling with.

“Credit scoring is quite a challenge for us… we need to choose wisely, evaluate and control risk,” says China Minsheng Bank's chairman, Hong Qi.

One Chinese economist says that traditional banks have issues with credit scoring because the country's legislation on public companies gathering personal data remains unclear, to the point that banks could be prosecuted for collecting such information. Sources have told The Banker that several top banks have tried to collaborate with new banking sector entrants, but that these companies have refused to share their invaluable customer data.

Universal bank model

So with many of China’s larger lenders  shifting towards a universal banking model, relying heavily on lending is no longer feasible, since interest margins are being squeezed by the liberalising of financial sector policies. And regulators seem to be supporting this new trend. In March 2015, the China Securities Regulatory Commission announced that it was considering issuing brokerage licences to commercial banks.

“We want to adjust our business model to focus more on individuals, small and medium-sized enterprises [SMEs] and higher yielding business. We also want to… focus on asset management, private banking, international and leasing businesses, enterprise business and insurance,” says Jiang Jianqing, chairman of ICBC.

Bank of Shanghai – a joint-stock commercial bank set up in 1995 – established an asset management company in August 2013. Liaising between the traditional commercial banking arm and the new company was not easy, according to Bank of Shanghai chairman Jin Yu, but, he says, the new venture turned in a profit in its first year. To maximise its customer pool, the bank shares its customer base and channels with the asset management company, and it has combined the new arm with its investment banking business.

To expand its scope further, Bank of Shanghai has also applied to the China Banking Regulatory Commission (CBRC) to set up a consumer finance and a financial leasing company. “This will help us reach our universal banking objective,” says Mr Jin. 

Elsewhere, China Minsheng Bank – the first majority privately owned bank in China – has applied to the CBRC to become a financial group. “China Minsheng Bank is pressing ahead to build a financial group. This will help increase the contribution of the fees and commission business to total income,” says its chairman, Mr Hong. 

Bank of Communications is also looking to enhance cross-departmental relations. With the support of its new online financial centre, it aims to interconnect all of the bank’s services, which focus on man-powered branches, e-banking and personal client managers, says a bank official.

Investment banking push

Developing fee-based business such as investment banking is another priority for China’s top banks. ICBC will base investment banking growth on its existing 5 million corporate clients, according to its chairman. 

Bank of China’s chairman, Tian Guoli, says he wants to boost the bank’s fee-based business. Indeed, global news agency Reuters has reported that, according to data from Thomson Reuters and Freeman Consulting, Bank of China and its subsidiaries earned more arranging international bonds for Asian issuers than Goldman Sachs in the first five months of 2015. The data tracked underwriting fees on dollar, euro and yen bonds from Asia, excluding Japan and Australasia.

Bank of Shanghai is also in the race for investment banking business, having received approval from the Hong Kong Supervisory Authority, in January 2015, to set up Bank of Shanghai International, its investment banking arm. “It will mainly serve corporate clients, engage in merger and acquisition [M&A] business in mainland China and initial public offerings [IPO] services for mainland clients wanting to list in Hong Kong,” says Mr Jin. 

China Minsheng Bank recently set up its investment banking business in Hong Kong, under the name Minsheng International Corporation. It will focus on M&A, IPOs and securities services.

In terms of equity, China’s willingness to make mainland-listed A-shares (shares in renminbi purchased and traded on the Shanghai and Shenzhen stock exchanges) accessible to foreign investors could offer additional opportunities for fee-based business. Development on this front faced a momentary setback, however, when, in early June, US index provider MSCI announced that China must liberalise its capital markets further before it will include A-shares in one of its global benchmarks.

The development of Chinese banks’ investment banking businesses will go hand in hand with growth in private banking and wealth management. Asia-Pacific is home to the fastest growing high-net-worth wealth in the world, of which China is a strong driver. “China’s per capita GDP has exceeded $7000 so there are many high-net-worth individuals needing services,” says Mr Jin.

Refocusing on SMEs

Analysts have often accused China’s largest banks of underserving the SME sector, in order to prioritise larger, more lucrative state-owned corporate clients. But China’s leading banks have renewed their focus on SMEs, now that they need to expand their revenue base. 

China Minsheng Bank’s Mr Hong admits that the volume of loans to SMEs in China is still relatively low, but he is committed to continue focusing on this client group. “We were the first bank in China to develop a strong customer base of small and micro enterprises… When we did this, many banks started following us,” he says.

Bank of Shanghai's Mr Jin believes that commercial banks will have a strong role to play now that SMEs are increasingly utilising equity and debt markets for funding. As SMEs grow and accumulation of wealth increases consumption and consumer financing opportunities, Mr Jin predicts that Bank of Shanghai’s assets will consist of more credit to SMEs and personal consumption. 

Elsewhere, as a community-focused bank, SRCB says that it has always focused on serving community residents: SMEs as well as customers in rural areas, the agricultural sector and farmers. It has set up 56 special branches dedicated to SME services and has focused on specialising and increasing products dedicated to these firms. Henceforth, it will use internet and mobile banking to improve SME service delivery, according to Mr Hou.

Bank of China also plans to focus more on loans to SMEs, micro businesses and individuals, as a way to react to market changes and refine the bank’s credit structure, says Mr Tian.

International expansion

Expanding abroad will also help increase banks’ revenue bases, especially now that the Chinese government has actioned its 'one belt one road' initiative. The initiative, which includes 65 countries in the land-based Silk Road Economic Belt and the Maritime Silk Road, aims to foster connectivity and co-operation among economies. 

ICBC reports that it is aiming for its international profits and assets to account for 10% of these respective totals in the next five years. 

As the top Chinese bank for international renminbi settlement and clearing, Bank of China wants to promote renminbi services through the new initiative. The lender's overseas business experienced its strongest ever growth in 2014. The group’s overseas assets increased by 18.11% year on year, and accounted for 27.41% of overall assets. Total overseas profits grew by 29.91% and accounted for 22.98% of total profits in the same time period. Mr Tian says that the bank aims to provide at least $20bn in credit and to generate $100bn in revenue on the back of the 'one belt one road' initiative in the next three years. 

Small and medium-sized banks, such as Bank of Shanghai and SPDB, have only recently started expanding abroad. The former only has foreign operations in Hong Kong, but it will look to Association of South-east Asian Nation countries as its first choice if it decides to expand further, says Mr Jin.

SPDB also has a Hong Kong branch, and will open branches in Singapore and London soon. Singapore was chosen by the bank because it offered language and culture similarities, as well as exposure to a strong international shipping industry, according to Mr Shen. The London business, he says, will focus on corporate banking, initially servicing Chinese enterprises expanding abroad and eventually extending to multinational corporations.

“It was relatively easy for us to set up a branch in London. The UK government has been very welcoming,” says Mr Shen.

China Minsheng Bank is also targeting London for a representative office and Singapore for a new branch. 

Declining GDP growth, structural reforms, liberalising financial sector policies squeezing net interest margins, and new tech-savvy financial services companies are all challenging China's banks. Their traditional corporate models and business lines no longer match the environment in which they operate. But, as China’s economy and financial sector evolve, so too will the country's key banks, whose enormous Tier 1 capital and asset bases will be key in supporting their adaptation to the country’s 'new normal'. 

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