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Asia-PacificMarch 3 2004

Preparing for the competition

China’s barriers to foreign banks will soon be coming down but their expertise will also be useful to local institutions, says Louise do Rosario.
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It is fitting that this is the year of the monkey, as China will need to be agile and quick if it is to fix up its shaky banking system. At stake is the survival of its half-reformed state banks, which will have to be ready to compete on an equal footing with foreign banks by 2007.

By then, China’s commitments to the WTO require it to dismantle the remaining barriers that have kept largely intact the monopoly of its state banks since 1949. In recent years, it has opened up the market in small measured steps, restricting the market share of foreign banks to less than 8%.

The pace of liberalisation, however, has picked up since the inception of the China Banking Regulatory Commission(CBRC) last spring, headed by the former head of the Bank of China, Liu Mingkang. The ministerial-level body, spun off from the central bank, was created last March in the wake of a spate of scandals involving embezzlement of billions of renminbi by bank managers, including the chiefs of three state banks.

Strong support

The commission, given strong support by the central government, has kept local banks on their feet since its inception. It has introduced stricter rules on lending and more frequent on-site examinations. It is leaning on the banks to reduce further their ratio of non-performing loans (NPL) which stood at an official 15% at end-2003, but which independent agencies say is closer to 50%. It is urging banks to look for private and foreign investors for funding, since the government cannot afford much more after injecting $45bn of capital into two leading state banks, the Bank of China and the China Construction Bank. “It will take the government more than writing a few cheques to bring about a turnaround of the banks. The important thing, though, is that it recognises the magnitude of the problem and is working on it,” says Vincent Chan, chief China strategist at UBS in Hong Kong.

The commission’s other job is to liberalise the market, acting on a clearly defined WTO schedule. At end-2003, the regulator gave the green light to foreign banks to do business in local currency with local corporate customers, auto financing, credit cards and even derivatives. It has also lowered the capital requirements for opening a bank office.

Liu promises that more is in the offing. “We are in process of creating business opportunities for banks in consumer lending, wealth management, asset securitisation and resolution of problem loans,” he wrote in a column for The Banker last December.

In the months ahead, the commission’s most pressing task remains the same: to keep bad loans from rising, a real threat given the rapid growth in lending in an economy growing at a rate of 9%-10%. In the first eleven months of 2003, financial institutions lent a total of Rmb2600bn ($314.1bn), 40% more for the whole of 2002. Lending was concentrated in a few industries related to the ‘hot’ sectors of automobiles and property, steel, aluminium and cement.

Controls tightened

The People’s Bank of China, with vivid memories of how such excessive lending ended up as bad loans in the mid-1990s, has reined in bank lending. On June 13, 2003, the central bank issued rules to tighten up on property loans, especially to developers of high-end housing and luxury villa projects. It raised the reserve ratio of banks by 1% to 7%, from September 21, 2003. The move froze Rmb150bn of reserve money and affected about Rmb700bn of the money supply.

The banking commission followed with orders that banks are to submit a self-appraisal report on their lending to overheated industries by March. It is also enforcing more rigorously the stricter five-category loan classification system on banks, after years of lax enforcement. It promises to issue quarterly non-performing loan data and to include for the first time restructured loans, foreclosed assets, non-credit assets, off-balance sheet items in its health check of the banks. “No matter what it does, it is difficult for the government to assess the real size of the bad loans because it has to rely on banks to provide the data,” says Mr Chan.

Non-performing loans

Crippling loans to ailing state firms have haunted Chinese banks since reform began two decades ago. Standard & Poor’s estimates the level of impaired assets at end-2003 to be 44%-45%, the highest in Asia, adding that this poses “very high risk” to the banking industry.

This is despite the fact that Rmb1400bn of the banks’ bad loans were hived off to four asset management companies (AMCs) in 1999-2000. Disposal of the impaired assets has been slow, though. In 2001 and 2002, the AMCs disposed bad loans of Rmb124.5bn and Rmb141.7bn respectively. Cash recovery rates ranged from 12% to 32% in 2002 for the four companies. At this rate, the AMCs will need more than a decade to resolve all the NPLs.

The four AMCs have signed agreements with Morgan Stanley, Goldman Sachs and other interested investors, to sell the distressed assets, but legal and administrative hurdles have made the process difficult and lengthy. There is now talk of another bail-out of Rmb1000bn or more, to be approved at the upcoming National People’s Congress in March.

Another way to improve the balance sheet quickly is to tap capital in the stock market of Hong Kong, where many Chinese blue chips have their primary listing. The Bank of China was the first to go public, in July 2002, raising $2.7bn from selling stakes of its international operations. It plans to raise more money next year, listing the rest of the bank. Industrial Commercial Bank and the Agricultural Bank have plans to list in 2006 and 2007 respectively.

Head start

China Construction Bank will have a head-start this year, with a plan to raise $6bn by listing assets in the two prosperous provinces of Zhejiang and Jiangsu, as well as the cities of Shanghai, Ningbo and Suzhou.

Brokers expect a good reception from the market to the listing. “Banks are a very good proxy for exposure to economic growth in emerging markets. They are big and provide liquidity,” says Robert Rankin, head of investment banking at UBS in Asia.

To prepare for the listing, the banks need to be restructured into joint-stock incorporated entities and throw away their old top-down management style, which lacks accountability and efficiency. Operating like government agencies, banks have multiple bosses at different ministries but no one to take the blame when things go wrong.

Tang Shuangning, vice-chairman of the CBRC, said at a forum in Beijing in January this year that the Bank of China and the China Construction Bank are to lead the way in the new corporate governance. They have to establish a board of directors and supervisors, a system of shareholder meetings, an internationally approved accounting system and greater transparency.

Another short cut to improve the corporate governance of Chinese banks is to seek help from foreign investors. The CBRC has recently issued well-publicised statements praising foreign banks that have acquired stakes in Chinese banks for their ‘significant contribution’ to these entities.

Call for efficiency

Rebutting criticism that the commission is giving foreign banks too many concessions, Mr Liu said: “There is no evidence that foreign banks in China will destabilise the local market. The important question is not who provides banking services but who can provide them more efficiently?”

Signalling its support for foreign investment, the commission has raised, from January 1 this year, the ceiling of total foreign ownership, from 15% to 25%; a single foreign shareholder cannot have more than a stake of 20%. It welcomes foreigners to take top jobs at Chinese banks, such as chief financial officer and chief technical officer.

It also wants foreign investors to become involved, particularly in smaller regional banks which have fewer resources and expertise. That is why it has demanded that Bohai Bank and Zhejiang Commercial Bank, two province-based banks applying for a licence to operate in more cities, find foreign investors as shareholders before approving their expansion plans.

CBRC has been impressed by the improvements made at the five Chinese banks where foreign banks have a stake. Bank of Shanghai has made remarkable progress in corporate governance, operational and management expertise and internal controls, thanks to the work of the resident foreign director representing the three foreign strategic investors, it said. HSBC, the Hong Kong Shanghai Commercial Bank and the International Finance Corporation (IFC) have between them a stake of 18% in the bank.

Shanghai Pudong Development Bank, in which Citibank has a share of 4.6%, is establishing a credit card centre, thanks to the help of its foreign shareholder. Nanjing Commercial Bank, in which IFC has a share of 15%, is also making notable progress in business operations and preparing for a public listing soon.

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