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Asia-PacificSeptember 2 2007

Opening China’s bank accounts

China’s banking sector will undergo a dramatic transformation by 2015, writes Bambang Moerwanto.
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China’s banking sector is at an historical turning point. Its retail finance sector is set to open up to foreign competition in accordance with China’s World Trade Organization (WTO) agreements.

This will present almost limitless opportunities for expansion and profitability, as well as perilous risks, as domestic and foreign players rush to gain access to the 1.3 billion underbanked consumers in the new super-economy of mainland China.

China, in some aspects, is similar to a typical emerging market with developing capital markets and a huge consumer base that is just starting to understand and embrace credit. Domestic banks are facing intensifying competition among themselves, as well as with foreign players that are trying to enter a vast market that is prime for the picking.

The demand for most retail banking products is already exploding. Growth rates are incredibly high in terms of new customers and new accounts, at about 25% each year. Local banks are doubling their business within three years. Prosperity has boosted the demand for retail lending products, such as car loans, credit cards and mortgages.

Developing trends

So, what will the sector look like in 2015? It is difficult to make estimates of where the banking sector is heading because it is in the middle of unprecedented growth and huge stock market gains. Still, there are trends now that could develop in the near future.

Chinese bank profits are aided by an unusually wide margin between lending and deposit rates. However, these traditional areas of banking in China will decline even as the Chinese government continues to deregulate interest rates in a shift from corporate to retail banking. Pricing competition among banks will kick in and banks will be forced to seek other revenue streams.

By contrast, almost all the future growth and profitability will come from retail, small-business lending and fee-based businesses to the tune of 30% a year over the next eight years (see interview with ICBC’s chairman Jiang Jianqing in this month’s The Banker).

In the new world of China retail banking, the ‘Big Four’ state-owned giants already dominate, controlling more than half the country’s total banking assets. The Big Four are Bank of China (BOC), China Construction Bank (CCB), the Industrial and Commercial Bank of China (ICBC) and the Agricultural Bank of China (ABC).

There are, in addition, 12 joint-stock commercial banks owned by local governments, domestic investors or foreign investors; an estimated 35,000 rural credit co-operatives; three policy banks, which focus specifically on economic development; more than 100 city commercial banks, which are restricted to doing business in their base city only; and numerous rural commercial banks, urban credit co-operatives and finance companies.

Market watchers would not be surprised if some of the second tier banks – given their hunger to grow – consolidated and took over the retail business from one of the Big Four.

Reaching out to the Chinese

The population segment that will continue to be an attractive target for banks in 2015 is the high net worth individuals and the mass affluent. These affluent customers are easy to reach because they are poorly served by domestic banks. And with the bigger presence of foreign banks by that time, such customers will be increasingly attracted to personal financial products and services offered by the foreign alternatives.

Given the fact that the foreign banks have more capital to attract China’s growing mass affluent, and the ability to serve customers better and more efficiently through the help of superior (though possibly old) technology, Chinese banks will find their market share progressively infringed upon by their foreign counterparts. Consolidation is expected to occur as a result.

The foreign banks will not be the only channel that is offering customers more choices and options by 2015. The internet will also serve as the customers’ window to the world of wealth management. Customers will therefore become more savvy and more educated in the area of financial services. They will ask the banks for what they want in terms of product, and be more assertive when evaluating the offerings from different banks. Essentially, they will become more analytical when they choose a bank’s services.

That is why China’s banks will need to have a deeper understanding of their customers than ever. Competing on pricing alone will not be sufficient. They will have to deliver higher value offerings that are flexible and customised to each customer segment’s or individual’s needs.

To leapfrog the competition and prepare themselves for this emerging landscape, Chinese banks will require the latest technology to streamline their operations and optimise their operational efficiency. A flexible and agile IT platform, like one that is based on service-oriented architecture, and allows their IT infrastructure to grow and adapt to their business needs accordingly, will be ideal.

Foreign intervention

Although retail banking in China will still be dominated by domestic banks in 2015, there will be many areas in which foreign banks will make their presence felt. This includes credit card issuance, mortgage lending and wealth management.

Partnerships, alliances, joint ventures, and taking minority equity stakes in domestic banks will continue to be the principal routes by which foreign banks will enter the market. Many large foreign banks, anxious to get a head start in consumer banking before the opening, have and will continue to ally themselves with Chinese banks to offer more sophisticated products, such as wealth management, credit cards, and mortgage, auto and other consumer loans.

Many foreign banks have found city banks especially attractive investments. Restricted to operating in a single city, city banks often have close customer relationships. And there are 34 cities in China with more than one million inhabitants, so city banks can provide substantial penetration. The China Banking Regulatory Commission has also said that it may eventually allow city banks to expand into other areas of the country.

Foreign banks have also begun to move into the credit card area through investments in domestic banks. For instance, Citi purchased 5% of Shanghai Pudong Development Bank, the ninth largest commercial bank in China, with 270 branches in major cities. The joint venture recently started to offer Chinese consumers international credit cards, denominated in renminbi within the country and in US dollars outside of China. The card carries Citi’s logo. In another similar partnership, HSBC has aligned itself with the Bank of Shanghai, of which it owns 8%, to offer credit cards.

Non-banking entities, primarily foreign-based, will also make an appearance and will probably offer more commoditised products, such as credit cards and loans.

Liberalisation

Chinese banks have historically invested a large portion of the country’s significant bank savings in state-owned enterprises, though rarely in an efficient manner. This has resulted in a significant build up of non-performing loans. This situation will change significantly as the liberalisation of China’s financial market takes place.

The government will encourage the domestic banks to lend to private firms and individual retail customers. As a result, the retail banking business will be expected to grow more rapidly in China, and it is expected that Chinese banks should look for better risk management processes and systems to be able to improve the quality of their loan asset portfolios and remain competitive.

For example, as of June 30, 2006, ICBC had assets of Rmb7055bn ($893bn), 18,764 outlets, including 106 overseas branches, and 1165 agents globally. Then in July this year, as a fresh sign of China’s financial strength, ICBC became the world’s most valuable bank after a strong gain in its share price, with a market capitalisation of $254bn, overtaking Citigroup.

It will be interesting to see how the relationship between foreign banks and their local partners evolve. Will foreign banks be able to increase the stakes and take over their local counterparts? Or will the Chinese government cap the foreign banks’ participation in local institutions, which could lead to sell-offs? Will they allow foreign banks to buy the smaller banks or even the bigger banks? Will they encourage local consolidation, which could happen, too.

It is still earlier days. China’s retail banking market holds tremendous potential, offering great opportunity to those who are willing to make business investment and leverage the help of IT.

Bambang Moerwanto is director of business development, Global Banking Line of Business, SAP Asia Pacific.

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