Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Asia-PacificJuly 1 2015

Beyond the big four: Bank of Nanjing and China Zheshang Bank

The problems facing China's small, province-focused banks – the country's economic slowdown, deteriorating asset quality, increasing costs – are much the same as those facing the 'big four'. However, smaller banks are also having to contend with enormous debt problems run up by their provinces. Stefania Palma looks at how two of them – Bank of Nanjing and China Zheshang Bank – are faring.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

China’s economy is undeniably slowing down. At 7.4%, its gross domestic product (GDP) growth in 2014 was the slowest it has been in 24 years. This has sent ripple effects through the country's economy and into the banking sector, all the way up to the big four banks – China Construction Bank, Agricultural Bank of China, Industrial and Commercial Bank of China (ICBC) and Bank of China. 

China’s banking sector varies enormously, so much so that even local bankers struggle to quantify the size difference between the gargantuan ICBC and China’s smallest lenders. So, if the country's economic slowdown is challenging the big four, what about province-focused small to medium-sized banks? 

In this case study, The Banker looks at the challenges facing Bank of Nanjing in Jiangsu province and China Zheshang Bank in Zhejiang province.

The big and little of it 

Considering their provinces of origin are in the more developed coastal areas of China, Bank of Nanjing and Zheshang Bank are in relatively strong positions. And while the two lenders are considered to be small in China, they are in reality substantial institutions by global standards. In The Banker’s 2015 Top 1000 World Banks ranking by Tier 1 capital, Zheshang Bank is placed 199th, up from 208th in the 2014 ranking, while Bank of Nanjing is 201st, up from 214th in 2014. In the The Banker’s ranking of Chinese banks by Tier 1 capital for 2015, Zheshang Bank is in 25th and Bank of Nanjing is in 26th place. 

But to continue growing, province-focused banks such as Bank of Nanjing and Zheshang Bank will need to navigate a choppy environment. Asset quality deterioration caused by decelerating economic growth is a key concern. Bank of Nanjing’s non-performing loan (NPL) ratio has grown from 0.83% in 2012 to 0.94% in 2014. Zheshang’s has risen more dramatically in this time period, from 0.46% to 0.88%, according to The Banker Database. 

To minimise repercussions on their banking sectors, provincial governments are also having to address their own key macroeconomic issues, including slowing GDP growth, drops in property prices, high indebtedness and sluggish budget revenue growth. 

Local government debt 

In Deutsche Bank’s ‘China Provinces: Mapping the way forward’ report, Asia economist Hannah Levinger says: “Provincial finances are at the root of China’s fiscal risks.”  

Chinese local governments (provinces, prefectures, counties and townships) have accumulated considerable debt. Total debt (including direct debt and explicit and indirect guarantees) reached Rmb17,900bn ($2834bn) by the end of June 2013. Local government debt rose by more than 60% between 2010 and mid-2013, meaning it accounted for more than half of China’s overall government debt. Provincial debt-to-GDP ratios range from below 20% to a maximum of 80% for Guizhou – a landlocked province in the less developed south-western part of China, according to Deutsche Bank’s report. 

The key reason for this development, according to many analysts in China, is that local governments face the highest expenditure needs in the country, but a dysfunctional allocation of public funds leaves them bereft of resources. 

“Administratively, China is a unitary country, and its constitution formalises all power in the central government. However, the administrative set-up is highly decentralised,” says Christine Wong, director of University of Melbourne’s Centre for Contemporary Chinese Studies in her evaluation capacity development paper published by the World Bank.

Budget revenue growth

Stricter rules 

The Chinese central government’s small capacity (the Ministry of Finance had only 1000 employees in 2009) means it only has the staff to adopt a level-by-level transfer system for public fund allocation, and it can only monitor the transfer one level down, to the provinces. This leaves vast room for inefficiency, say analysts. 

In addition, though facing relatively low expenditure needs, the central government’s contribution to national expenditure is small. This leaves lower levels of government, with the highest expenditure needs, scrambling for money. “The central government itself spends less than one-quarter of the national budget, and this share has fallen from more than 50% at the outset of transition [in 1979] to 18% in 2010,” says Ms Wong. 

Ms Levinger adds: “[Local governments] either relied on the central government to issue bonds on their behalf or resorted extensively to off-budget channels.”

These channels include special purpose financing vehicles (which in turn borrowed from banks), wealth management products, trusts or the bond market – all part of the unregulated shadow banking sector. 

Local governments also often use land as collateral or land sales to prop up budget revenues. And with China experiencing a drop in property prices and slowing sales as a result of low demand and lethargic real estate development, local governments could be about to witness a key source of revenue dry up. In fact, sale of state-owned land use rights account for 85% of government fund revenues, according to Deutsche Bank’s report. 

Due to concerns regarding local governments’ ballooning, high-cost borrowing, the central government imposed stricter rules on shadow banking starting in 2014. In May 2015, China’s Jiangsu province kick-started the country’s Rmb1000bn local government debt swap programme by issuing a Rmb52.2bn four-tranche bond. 

This programme aims to reduce the weight of interest payments on local governments. It includes 36 regional and city governments in China and it will be completed by August 31, 2015. State banks are set to buy about 70% to 80% of the programme’s bonds.  

Zheshang Bank's rise 

Notwithstanding local governments’ problematic finances, Zheshang Bank has experienced an impressive growth trajectory since its founding in 2004. The bank’s total assets have grown from Rmb100bn in 2004 to Rmb670bn in 2014. 

“In 2015, we plan for total assets to break through the Rmb800bn mark – about 20% growth on 2014 – and total deposits to break through the Rmb450bn mark – about 25% growth on 2014,” says Zheshang chairman Shen Renkang. 

Given Zhejiang province’s strong private enterprise base, Zheshang Bank has put small and medium-sized enterprises (SMEs) at the centre of its strategy. “Zhejiang is famous for its private firms and especially SMEs… Loans to SMEs in 2014 accounted for 35% of all loans [at Zheshang],” says Mr Shen. 

The total number of private enterprises active in Zhejiang province reached 936,000 by the end of 2013, up from 406,000 in 2006, and they accounted for about 40.4% of Zhejiang’s total gross industrial output in 2013, according to Hong Kong Trade Development Council (HKTDC) research. 

To Mr Zhang, the key impact of China’s slowdown will concern asset quality. “Obvious obstacles include asset quality problems. More enterprises will go bankrupt and have debt crises. This will affect the banking sector. But it can push banks to reform too,” he says. 

China's new deposit insurance policy, which covers deposits up to Rmb500,000 and was implemented in May 2015, could also be a test. “Different banks will be affected in different ways. Generally small and medium-sized banks will be affected more because financing costs are increasing and the interest margin is going down,” says Mr Shen. 

This policy is seen by the market as a prequel to liberalising interest rates, which will provide both business opportunities as well as new pressures. “Deposit-to-loan ratios and the credit volume will have a bit of an adjustment after the interest rate liberalisation. We will therefore raise more funds from capital markets,” says Mr Shen.

Real economy focus 

To face this transitioning environment, focusing on the real economy is more important than ever. “We should support the development of the real economy, which is closely linked to China’s growth. As a bank, we have a social responsibility towards Zhejiang province and to support its own entrepreneurs during this period of reform. China’s economic reforms are also creating new industries, which we want to focus on,” says Mr Shen. 

Setting up new business lines will also help the bank sustain its performance. Zheshang Bank aims to expanding its retail bank offering, which Mr Shen finds is very closely related to the bank’s strong SME business. As wealth in China continues growing at a quick pace, asset management is another frontier the bank is targeting. 

Additionally, the lender is looking to launch an initial public offering (IPO). “We plan to launch a project to list in Hong Kong. A plan to also list in China is being taken into consideration,” says Mr Shen. Prior to the IPO, Zheshang Bank is hoping to launch an asset securitisation deal, national policies permitting, to increase its lending capacity before the capital increase. “In the past 10 years, policies have been very strict, but they have opened up recently. We will follow reforms to start our asset securitisation process,” says Mr Shen. 

As the bank enters its second decade of operations, Mr Shen finds it is ready to venture abroad. The first step will be setting up a branch in Hong Kong, ideally in 2015. “We can take advantage of Hong Kong’s capital markets because the cost is comparatively lower than the mainland. We can help enterprises willing to do outward investment to get cheaper funding and minimise costs for trading and investment,” he says. 

The Association of South-east Asian Nations (Asean) is another interesting prospect for Zheshang Bank as China pushes to set up foreign trade zones in the area, and several central banks in the Asean region have already signed bilateral currency exchange agreements with China, which could benefit renminbi internationalisation, according to Mr Shen. Zheshang Bank’s key clients – Zhejiang SMEs – already have a foot in the Asean door. “Zhejiang entrepreneurs have already set up companies and have injected capital in Asean to start up businesses. We want to provide financial services for these firms,” says Mr Shen. 

The bank is also keen to improve its domestic network coverage, which could be beneficial to other provinces as well. It will soon open a Guanzhou branch in 2015, and is on target to open a Wuhan branch by the end of the year. 

breakdown of Chinese provincial debt

Bank of Nanjing grows stronger 

The leading bank in Jiangsu province’s capital, Bank of Nanjing performed strongly in 2014. Its total assets grew by 32.04% to Rmb573.15bn, total deposits grew by a staggering 41.58% to Rmb368.33bn, and loans grew by 18.86% to Rmb174.69bn.

Bank of Nanjing also specialises in SME services and microfinance. “SMEs have an irreplaceable strategic significance for the development of our bank,” says Bank of Nanjing chairman Lin Fu. Jiangsu had the second largest number of private enterprises in China – at 1.45 million – as of the end of 2013, according to HKTDC research.

Despite Jiangsu province’s real GDP growth in 2014 being well above the national average at 8.7%, the country’s economic downturn will undoubtedly affect the bank, according to Mr Lin.

“Compared to state-owned banks and joint-stock commercial banks, small and medium sized banks are facing greater pressure on asset quality," says Mr Lin. "On the one hand, because smaller banks’ basic management is relatively weaker, risk management and control capacity need to be strengthened further… and since most small banks have a strong regional focus, the effects on the regional economy and business sector could be quite strong and affect its own banking sector.” 

Like Mr Shen at Zheshang Bank, Mr Lin believes that the main challenge China's banks face concerns pressures on asset quality, which could lead to a rise in NPL ratios. But Bank of Nanjing has been preparing for this problem. The bank, which has an independent entity purely focused on SMEs, applied the credit scoring system used for larger corporates to SMEs back in the mid-2000s. This was followed by the creation of an SME-focused risk management technology platform in 2012.

Expansion plans 

In line with banks across China, Bank of Nanjing is looking to expand in scope to expand its revenue base, and the lender has recently established an asset custody company. “The asset custody company had a good start. It obtained trusteeship qualifications for securities investment funds and insurance funds,” says Mr Lin. 

Bank of Nanjing is also strengthening its investment banking offering. It has launched the first phase to issue its debut Rmb8bn asset securitisation transaction, which has been approved by Chinese regulators. “This will take the scale of bond underwriting and structured finance to new highs,” says Mr Lin. Bank of Nanjing has also acquired a licence to issue interbank deposit certificates. 

An expansion of the bank's network is also under way. It has already opened 14 branches since being founded in 1996, and its number of active outlets is now 134. But this year it wants to grow its presence further to cover key provincial cities in Jiangsu, says Mr Lin. 

Small and medium-sized banks in China face the same challenges that larger institutions are up against: deteriorating asset quality, increasing costs and decreasing margins. But for smaller firms, overcoming these hurdles can be more painful. Many provincial banks are also under pressure due to local governments’ enormous debt problem.

But if these banks keep on growing in scope and focusing on servicing the real economy – and the central government effectively tackles local governments’ unsustainable debt levels – the smaller lenders’ bulky asset and Tier 1 capital bases could provide crucial support in helping China navigate through its economic slowdown. 

Was this article helpful?

Thank you for your feedback!

Read more about:  Asia-Pacific , Asia-Pacific , China , Regulations