The growth of China's economy is slowing, and with it the profit margins of its leading banks. However, with an increasing focus on SME lending, opportunities opening up in wealth management and the capital markets, and the renminbi edging ever nearer to achieving international reserve currency status, the mood among the country's bankers is still one of optimism, albeit of the more cautious variety.

The global economic downturn is creating new realities in China, as well as opportunities to realign and rebalance the economy on a more sustainable growth model. The new, lower annual gross domestic product (GDP) growth target of 7.5% announced in the recent draft budget not only reflects the financial realities facing China, caused by the ongoing troubles in the global economy, particularly Europe, but also Beijing’s long-term goal of seeking more balanced growth with less reliance on investment and net exports and a greater role for domestic consumption. 

The new lower growth target is in line with the lower 7% annual target in China’s 12th Five-Year-Plan (2011-2015) and is understood to be part of a new era of financial sector reform and liberalisation. With new political leadership coming later in the year, the groundwork is being done for a rebalancing of the economic structure, a new round of strategic reforms and greater private sector participation.

As is something of a tradition in China, the reforms are likely to be slow and steady, rather than rushed, but in a sign of the approaching new era, China and Japan announced in late May the commencement of direct trading of their currencies in a move to boost trade and to bypass the intermediary use of the dollar. Such direct trading is part of ongoing procedures that will in time bring the renminbi to international trading status, which will in turn see it used as a reserve currency.

In another new move, on June 7 China’s central bank cut interest rates by 25 basis points to 6.31%. The cut, the first since 2008, is a clear sign of the desire to stimulate the world’s second largest economy and go for growth driven more by consumption than investment.

Emphasis on quality

For banks and bankers, there are considerable new challenges in adjusting to the new banking environment. As Dr Ma Weihua, CEO of Shenzhen-based China Merchants Bank (CMB), China’s largest private sector bank, notes: “China has to say goodbye to growth at speed and focus on quality and efficiency; we have to slow down a little and raise our level of management.”

Mr Ma, who has made CMB one of the most profitable and best-known brands in China, believes his bank is undergoing a second transformation in exiting from the low margins of financing big business and concentrating on supporting small and medium enterprises (SMEs) and focusing on pricing and cost. 

Mr Ma worries, along with Microsoft chairman Bill Gates, that banks could become the dinosaurs of the 21st Century and is concerned that a ‘Facebook’ model using the internet could threaten the traditional intermediary role of banks in financing transactions. Whether a ‘Facebook’ model could threaten banks remains to be seen but Mr Ma believes it is one of the clear challenges ahead.    

Financial sector reform is crucial to China’s ability to better allocate capital and enhance its sovereign credit profile 

Moody’s

While both CMB and China’s ninth largest bank, China Minsheng Banking Corporation, see their future in SMEs and what Minsheng refers to as MSEs (micro and small enterprises), the country's big state-owned banks are also heading in this direction. Jiang Jianqing, chairman of China’s largest bank, Industrial Commercial Bank of China (ICBC), which has 287 million individual customers, explains that major adjustments are being made in credit distribution. “We are now focusing our business on SMEs and microentrepreneurs and more than 60% of our loans are going to SMEs.”

Li Lihui, president of China’s third largest bank, Bank of China (BoC), says his bank is adjusting its business structure accordingly. “In the future, we hope to increase lending to SMEs to 50% of our loan book, up from the current one-third of the book at the end of 2011. We believe SMEs have higher growth potential and create higher returns,” he says.  

Wang Hongzhang is the new chairman of China's second largest bank, China Construction Bank. He says that the bank is trying to build its MSE lending capacity up from its current 9% level, and emphasises the new batch process model which is proving effective across the bank’s network of 13,000 branches.

Guo Shuqing

There is an optimism that the China Securities Regulatory Commission, now under the stewardship of Guo Shuqing, will usher in a more sophisticated capital markets and investment infrastructure

Financial sector reform

Another new and important development in China’s banking sector is the emergence of a wealth management sector, and with the recent appointment of the former chairman of China Construction Bank, Guo Shuqing, as head of the China Securities Regulatory Commission (CSRC), the development of a more sophisticated capital markets and investment infrastructure.

New investment products are in big demand and rating agency Moody’s notes in a recent report: “Financial sector reform is crucial to China’s ability to better allocate capital and enhance its sovereign credit profile. Such reform would include commercialising the banking system, allowing the market to set interest rates, deepening domestic financial markets – including the establishment of a municipal bond market – and developing the sector’s legal and supervisory framework.” The CSRC has a busy road ahead as Chinese savers and investors turn away from standard bank deposits to more remunerative products.

Mr Li at BoC says that six years ago most households held 60% of their savings in bank deposits, but now that figure has dropped to less than 50%, and with this trend there are huge opportunities for asset-based security products that will satisfy customer needs and improve fee income.  

Mr Jiang at ICBC says there is a significant shift from deposits to wealth management products and he expects in a few years savings will be broken down to 50% in deposits and 50% in wealth management products. He notes that ICBC’s product offering has grown from 830 products in 2006 to 3200 products in 2011, adding that in 2011 personal wealth management product sales almost doubled to $656bn while personal deposits rose by 11.4% to $937bn, giving ICBC the largest market share in the personal deposit market.

Private banking is another high-growth sector in China for some banks such as CMB and Minsheng. CMB’s Mr Ma says private banking is highly profitable and growing at 30% per year. With 17,000 customers with assets in excess of Rmb10m ($1.58m), 50,000 with assets of Rmb5m and 800,000 customers with more than Rmb500,000 in assets, Mr Ma sees challenges but also opportunities in a growing, increasingly sophisticated and better regulated investment sector, especially with the expansion of the offshore renminbi market.

Renminbi market development

Many banks are looking to the development of the renminbi market, but the bank with the largest market share in cross-border renminbi, Bank of China with 30%, is very positive but takes a conservative estimate as to how long it will take. Mr Li believes the renminbi is still far from becoming an international reserve currency. “I believe it will take five to 10 years to become an international currency; it must take a gradual process. To be a real international currency it must have free convertibility and at this stage it is only convertible on the current account; it must also be convertible on the capital account. So it still has a long way to go,” he says.

It will take five to 10 years [for the renminbi] to become an international currency; it must be a gradual process 

Li Lihui

In 2011, China and its trade partners conducted cross-border renminbi trade settlements valued at Rmb2580bn, more than four times the 2010 total and covering nearly 10% of China’s total trade. Many in China believe that the renminbi's status as a global currency must be driven by market forces. However, as shown by the deal with Japan, this process is already happening. In terms of further opening up the currency to foreign investors, China has been using Hong Kong as a springboard to internationalise the renminbi while taking gradual steps to reform markets on the mainland.

Mr Li, however, believes that Hong Kong is insufficient to handle all of China's needs and that Singapore and London will be called upon to play a role in the expansion of offshore renminbi markets. Mr Jiang agrees that the renminbi will take a long time to become an international currency and require more mature markets. However, he is confident that by 2020 the cross-border settlement role will be much bigger than 2012.

Looking ahead

So how have China's banks performed in 2011 and early 2012, and what are their prospects going forward? A report by accountant Ernst & Young at the end of May of 17 Chinese banks listed on the mainland or Hong Kong said the aggregate net profit for 2011 stood at Rmb886.7bn, up 29% year on year. However, this growth is four percentage points lower than the 33% profit growth achieved in 2010 because of a slowdown in asset expansion.

The Ernst & Young report also noted that, according to 2012 quarterly reports shown by 16 listed banks, average profit growth slowed to 13% in the first quarter of this year with the profits of two of China’s ‘Big Four’ banks expanding by less than 10%. While the report said Chinese banks are facing increasing difficulties in making profits by heavily relying on net interest income it also noted a continued rapid increase in net fee and commission income at the 17 listed banks, with their contribution to operating income, rising to 18% in 2011 along with the fast development of asset management businesses such as investment banking, custody services, wealth management and private banking. 

Looking ahead, Mr Jiang at ICBC concludes: “When the economy is good, the banking business is good.” Clearly the economy is experiencing a slowdown but even at 7.5% growth the chairman and others believe that this lower rate will be good for sustaining banking growth at a viable level. 

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