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Asia-PacificJune 4 2006

Chinese banks step up drive for modernisation

For the first time ever, The Banker publishes a Top 100 banks in China listing, demonstrating the country’s growing financial sophistication.
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In this issue, The Banker publishes for the first time a ‘Top 100 Banks in China’ listing, which follows on from the initial Top 50 that ran in conjunction with the article ‘Best Banks to Buy in China’ in the May 2005 issue. Information was obtained as part of The Banker’s annual Top 1000 World Banks survey augmented by additional research in the UK and on the ground in the People’s Republic of China.

State-owned banks

Not unexpectedly, the list is dominated by the four major state-owned banks, China Construction Bank, Bank of China, Industrial and Commercial Bank of China (ICBC) and Agricultural Bank of China. These four between them account for 73.2% of the aggregate Tier 1 capital of the Top 100, which stands at Rmb1039.8bn ($128.4bn), 70.8% of the aggregate assets of Rmb26,171.7bn of the Top 100 and 65.0% of the aggregate pre-tax profit of Rmb155.8bn. China Construction Bank, following its initial public offering (IPO) of shares last year that raised $9.2bn, has seen its Tier 1 capital rise by nearly 48%.

Bank of China, the next to come to market with an IPO, commenced its public offering in Hong Kong on May 18, while ICBC in March this year appointed Lehman Brothers as financial adviser with Goldman Sachs, Merrill Lynch, and Credit Suisse Group among a group of five appointed as underwriters for an IPO scheduled for later in 2006. These two banks have yet to report 2005 annual results having been preoccupied with preparations for their individual IPOs.

In the meantime, the China Banking Regulatory Commission (CBRC) announced on May 17 that it would require that the top four state-owned banks and Bank of Communications, the leading joint-stock commercial bank, maintain their bad debt ratios below 5% in the wake of their restructurings and maintain their capital adequacy at a minimum of 8%. This latter condition formerly applied to Bank of China and China Construction Bank only. Agricultural Bank of China is the only one of the five yet to undergo restructuring.

Commercial banks

The second largest group of banks in the Top 100 in terms of share of the aggregate Tier 1 capital, assets and pre-tax profit if not in numbers, are the 12 joint-stock commercial banks, led by Bank of Communications, which account for 18.8%, 21.8% and 26.7% of the respective aggregates.

Of these, Bank of Communications went to market last year and numbers HSBC among its significant investors while Huaxia Bank signed an agreement with Deutsche Bank and Sal Oppenheim Jr & Cie for these two banks to acquire a 14% shareholding (Deutsche 9.9%, Sal Oppenheim 4.1%, with Deutsche having a time-limited option agreement with Sal Oppenheim to buyout its share).

Other banks within the group have also indicated that they are interested in raising additional capital through IPOs either in Hong Kong or elsewhere. These include CITIC Industrial Bank, China Merchants Bank, China Minsheng Banking Corporation and Industrial Bank.

However, it is thought likely that these will be held back until the Bank of China and ICBC have completed their offerings. The delay may be prolonged as many international fund managers are wary of holding stock in too many Chinese banks at once.

Meanwhile, the saga of the sale of Guangdong Development Bank rumbles on, with the bank being told by the CBRC that the rules limiting foreign investment to a maximum of 25% for consortia and 20% for individual entities would not be changed to enable a Citigroup-led consortium to acquire 85% of the troubled lender. Citigroup was planning to take a 40% stake as part of the Rmb24.1bn deal.

The group of 12 commercial banks became 13 in February this year with the official opening of China Bohai Bank, based in Tianjin, in which Standard Chartered Bank has a 19.9% interest.

City commercial banks

The third largest group of banks within the Top 100 in terms of share of the aggregate Tier 1 capital, assets and pre-tax profit are the city commercial banks headed by Bank of Beijing and these account for 6.4%, 6.0% and 6.1% respectively of the aggregates.

However, numerically this is the largest group in the list with 65 banks. There are currently 117 city commercial banks in the Chinese banking system, none of which are rated by any of the international ratings agencies. This is mainly because public financial reporting for these banks only started in 2003 and is currently to Chinese accounting standards.

It may well be an opportunity for a ratings agency to introduce a national rating scale as Standard & Poor’s has done with Russia and more recently with Turkey. These banks remain private and are largely owned, directly and indirectly, by local government although foreign investors have acquired, over the years since 2000, shareholdings up to the maximum allowed (see The Banker, April 2006, p15).

Sector assets at end-2005, as reported by Moody’s, was Rmb2040bn, an increase of 19.4% on the previous year. However, this represents only 5% of the national banking assets and in most cities these banks come behind the big four state banks in terms of retail deposits. The city commercial banks have had to look elsewhere for business and have found a focus in servicing local small and medium-size enterprises (SMEs).

However, asset growth of city commercial banks has varied depending on the banks’ location, with banks on the east coast, where economies and SME sectors are more vibrant and local governments as a consequence enjoy a stronger fiscal position, showing greater growth than those in central and western China.

In these other areas, banks have less potential in terms of profitability and asset quality while the potentially weaker fiscal positions of local government in these areas can lead to pressure being applied to the bank to support local economic growth by making uneconomic loans.

Lars Thunell, executive vice-president of the International Finance Corporation, the private sector arm of the World Bank, said in a recent interview with the Financial Times that it would extend its investment in the Chinese financial sector into banks in the west of the country and the rural cooperatives. It currently has investments in six Chinese banks, most of which are located on the more prosperous east coast, and says its experience in helping them become genuine commercial lenders will help in western China.

Asset quality remains a problem for a large majority of city commercial banks that continue to be hampered by bad assets inherited from the city credit cooperatives that were the precursors of the current city commercial banks. Related-party loans still figure highly in a majority of loan books.

However, the best of the city commercial banks can match the best listed state and shareholding banks in terms of profitability and asset quality. Foreign investors have been attracted to the city commercial banks because stakes can be acquired at a relatively low cost, although such investment should be seen as one for the long term as the city commercial banks do not just require additional capital they also require products, risk management and systems.

Rural commercial banks

The fourth group in our listing are the 11 rural commercial banks, which are among the first to be formed under a similar government initiative to that which produced the city commercial banks, but this time by the amalgamation of rural credit cooperatives. This process is ongoing with the Beijing Rural Commercial Bank, formed from rural credit cooperatives in the suburbs of the capital, being a recent addition to this group.

In our current listing they contribute 1.1% to aggregate Tier 1 capital, 1.2% to aggregate assets and 1.9% to aggregate pre-tax profit.

Closed-stock companies

The final group are the eight banks that could best be described as closed-stock companies, including among their number banks majority owned by overseas investors, banking subsidiaries of overseas banks and specialised domestic commercial banks. Their contributions to the aggregate Top 100 figures are 0.6%, 0.1% and 0.3%.

Within the Chinese banking system, the major problem still remains asset quality and the recent acceleration in lending may not help, as injudicious loans are still likely to be made. While the economy is booming, this may not be a major problem but should economic growth falter then defaults could rise and the situation return to that of past years.

The sector remains ripe for consolidation, especially among the city commercial banks, where the creation of more nationwide banks to compete with the major state-owned banks and the joint-stock commercial banks could be achieved if the vested interests of the local government owners could be put to one side.

Meanwhile, the government and the CBRC should look again at the limits on foreign investment in individual banks as the process of modernisation can often be hampered if the foreign investor lacks the level of control necessary to implement the radical changes demanded.

By the same token, the foreign investor should recognise that they are there for the long term as changes in business culture take time to take effect.

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