While China’s lifting of restrictions on the operation of international banks will not result in branches opening on every Chinese high street, it does present significant opportunities, says Stephen Green.

A new chapter in the modernisation of China’s financial system started this year when the final restrictions were lifted on foreign banks operating in China, five years after China joined the World Trade Organization.

Until 2007, foreign banks in China had been unable to offer local banking services to personal customers. Now foreign banks that choose to incorporate locally will be able to provide a full range of banking services to mainland Chinese citizens.

While the headline opportunities are great, the lifting of restrictions does not mean that one billion-plus bank customers are simply there for the taking. But it does mean that another important step has been taken in the transformation of China’s financial system from a state-planned banking system to a market-oriented one.

Leap forward

In the past few years, China’s biggest banks have been through a major restructuring. This started with recapitalisation, and was followed by the removal of bad loans to specialised asset management companies. These actions mean that most of China’s major banks have significantly improved capital adequacy ratios, in line with international standards. It has also paved the way for the introduction of foreign strategic investors and, subsequently, partial stock market listings.

The most recent and largest listing, of Industrial and Commercial Bank of China (ICBC), catapulted it into the top five banks in the world by market value.

As well as bank reform, China has overhauled the regulatory system, creating the China Banking Regulatory Commission in 2003 and enhancing the role of the People’s Bank of China as guardian of overall monetary policy. As a result, China’s financial infrastructure has been significantly strengthened, both by the increased competition in the market and by the improved regulatory and institutional environment. International investors have also brought much-needed know-how and expertise into the financial system.

The 64,000 renminbi question today is: what are the implications of full market access for foreign banks in China?

There are two common misconceptions. The first is that the requirement for foreign banks to incorporate locally to gain full access to the retail market is an unwarranted barrier to entry. In fact, in our experience, this is not an unusual condition for access to a retail banking market. Many countries where HSBC operates – including Canada, Mexico, Australia and Malaysia – have similar requirements.

We see local incorporation as a positive development for China’s financial system overall. It will stimulate further competition, reformation and innovation when international banks – HSBC included – incorporate locally.

The second misconception is that foreign banks will be able to establish broad-based retail banking coverage throughout China. They will not and, on a practical basis, they cannot.

As a result of recent reforms, China’s domestic banks have emerged as effective competitors. They have huge distribution networks, strong local knowledge and massive customer bases that would be impractical, if not impossible, to replicate. ICBC alone has nearly 20,000 branches, while the total number of foreign bank outlets in China is less than 200. And international banks hold just 1.9 per cent of the total assets of the banking sector.

However, significant opportunities exist for international banks. But these will only be realised if they build their businesses in ways that create a sustainable competitive advantage.

Looking ahead, China’s banking landscape will remain a challenging one for domestic incumbents and international banks alike. On top of increased competition, other challenges include the need to continue to improve corporate governance and a shortage of experienced banking professionals – a problem for any market growing as fast as this one.

The Chinese authorities are well aware of these issues, and are tackling the reform process with enormous skill and determination. I have every confidence that China’s financial system will emerge stronger and more effective in supporting its economic development. That is good news for Chinese consumers and companies – and for the domestic and international banks that serve them.

Stephen Green is group chairman of HSBC Holdings.

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