At face value, that was not a big step but the bank’s move encapsulates the main themes governing banks in the Special Administrative Region. Although profitable and still full of potential, the Hong Kong story is inseparable from the mainland China story. And the Chinese authorities, intent on maintaining Hong Kong as a showpiece, have made concessions that are helpful to the banks incorporated there.
Mainland banks are intent on upgrading their financial systems to world standards and foreign banks have a major role to play in this. Under the 2003 Closer Economic Partnership Agreement, Hong Kong banks receive a number of privileges to help them do business on the mainland, including having to hold fewer assets than other foreign banks.
“Do not underestimate the Chinese government’s resolve to reform the banking system,” says Peter Wong, group general manager at HSBC in Hong Kong, in charge of developing the bank’s China strategy.
Amid the recent flurry of deals, with foreign banks buying stakes in Chinese institutions, those with a Hong Kong arm have another decisive advantage: their executives are familiar with the market. As time goes on, this familiarity will prove its worth.
Take the Royal Bank of Scotland’s (RBS) surprising acquisition of a 5% stake in Bank of China, the largest bank in the country with assets of $516bn. RBS reassured investors that the August agreement includes guarantees to protect it against a sudden deterioration in the state lender’s finances.
Commentators in Hong Kong, including analysts and bank executives, expressed incredulity at the RBS guarantee, pointing out that the Edinburgh-based bank was wrong to believe that when new loans turned sour the bank could get away with telling the Bank of China board that it would not put its hands in its pockets to help solve the problem. This would ruin the relationship and RBS’s strategic objectives in China.
The possibility of new non-performing loans (NPLs) in the mainland banking system – following the sale of existing NPLs to special vehicles and injections of capital from the government – are seen as a near certainty when loan growth is so high.
“There is a flow problem with 20% annual growth in loans. There could be another NPL [problem],” says Nicholas Kwan, regional head of economic research for north-east Asia at Standard Chartered. “The concern is how to put in place a mechanism to stop the hole getting bigger,” he says.
One well-informed local commentator called the balance sheet of banks in China “radioactive”.
Local circumstances
Banks based in Hong Kong, however, such as HSBC, have a different vision based on a more realistic appreciation of local circumstances.
Interviewed in the HSBC building in Central, Hong Kong’s financial district, Mr Wong is one of two HSBC directors on the Bank of Communications board. The fifth largest bank in China with assets of $138bn but the largest of the joint stock commercial banks, Bank of Communications has declared NPLs of 3% of total loans. In 2004, HSBC bought a 19.9% stake in the bank.
HSBC’s strategy is among the most developed among the foreign banks operating with Chinese banks. It aims to develop the partnership so that in 10 years’ time the model will be similar to that of HSBC in Hong Kong – offering a range of products in areas from consumer to wholesale.
“To be able to do that we have to put in a lot of resources and lot of planning,” says Mr Wong. He points to their joint venture in credit cards, to their co-operation agreement under which HSBC is sending its risk management experts into Bank of Communications to implement its risk management model, and to HSBC’s Dickie Yip’s secondment to the post of deputy CEO for Bank of Communications while running consumer banking.
HSBC itself has 12 branches in China and six sub-branches. Although it plans to continue opening branches, it expects to have only about 20 in five years’ time. Bank of Communications has 2600 branches in 137 cities. That is why, even though under World Trade Organisation rules foreign banks can do business in the local currency with local customers from 2007, the Chinese bank is crucial to HSBC’s strategy. HSBC’s stake in Ping An insurance will provide it with another network of customers.
In Hong Kong, HSBC’s personal financial services business has been growing strongly on the back of an improvement in the personal circumstances of consumers, due to higher property prices and the knock-on effect of 20 million high-spending mainland tourists. On the wholesale side, it has been dealing with advisory and investigative work from Chinese companies going abroad.
The China effect
The other international bank with a Hong Kong base, Standard Chartered, posted record first half profits in 2005. Pre-tax profit from its Hong Kong operations rose 27% to HK$2.8m ($360.9m) compared with the first half of 2004. The decision to cut 200 staff from the Hong Kong retail unit in late 2004, which was controversial at a time of rising profits, has proved its worth. The bank has invested strongly in marketing, because the opportunity to sell more savings and wealth management products is “phenomenal”, according to Ben Hung, chief operating officer. The average Hong Kong resident has three times his annual salary deposited in a bank in simple deposit accounts.
Standard Chartered’s results were buoyed by the wholesale side, with double-digit growth in trade finance benefiting middle market corporates, one of the bank’s strong suits. Almost all of those companies are doing business in China, especially in the Pearl River Delta area, which makes it almost impossible to separate out the China effect from Hong Kong.
Strategic approach
Standard Chartered’s China strategy is three-pronged. It is expanding organically via its 10 mainland branches and foreign representative offices, which is being done through its Hong Kong incorporated bank to take advantage of the 2003 Closer Economic Partnership Agreement.
Second, it has acquired a 19.9% stake in Bohai Bank, a new joint stock bank set up in September in association with mainland corporate heavyweights including COSCO Shipping and Shanghai Baosteel Group.
It will appoint three main board directors and take responsibility for risk management, again through its Hong Kong bank. This has advantages and disadvantages: on the one hand, as a new bank, legacy issues such as inefficient staff and NPLs do not exist; on the other, there is no network and no brand name in place.
However, the third prong of Standard Chartered’s strategy is more traditional: the planned acquisition of a 20% stake in another, as yet undeclared, Chinese bank.
“We will consider [buying stakes in medium-sized banks],” says Mr Hung. “But we have been in China for 150 years. We won’t join the bandwagon. We take a longer term view.”
Limited partners
The problem for all foreign banks looking for a local partner in China is that there are a limited number of attractive partners (see ‘Best banks to buy in China’, The Banker, May 2005). A top French bank in the region is, according to market rumour, about to sign a deal to take a 20% stake in a Chinese bank.
Citigroup, which has been operational in Hong Kong for many years, is in negotiations to increase its stake in Shanghai Pudong Development Bank to 19.9% from 4.6%, according to market rumours. China’s eighth largest bank has a joint venture in credit cards with the US bank. Some see this possible increased stake as a change in strategy on the back of Citi’s decision not to buy an equity stake in China Construction Bank, one of the ‘big four’ state banks, which resulted in its June ousting from an advisory role on the bank’s overseas listing, according to press reports.
TC Chan, Citigroup country officer for Hong Kong and head of Greater China corporate and investment banking, refused to comment on the allegations. Shanghai Pudong holding does not mark the end of its acquisitions in China, however. “We will expand. If the right opportunity comes along. China remains a top strategic focus for Citigroup. We remain strongly committed to growing our business there,” says Mr Chan.
Amid all the enthusiasm about China, one Hong Kong-based banker advises caution: “[The stakes in Chinese banks] I would consider long-term investments to establish a position. On the other hand, look at the actual profit contribution of banks with branches in China. They have improved but they are not that important.”
