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New Dawn for the Chinese Banking Sector

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The esteemed and preferential treatment recently afforded to David Li Kwok-po, president and CEO of Hong Kong’s Bank of East Asia – significantly the first overseas bank that opened shop in the west of China – can be seen as reflecting the breaking of a new banking dawn within the Middle Kingdom. With the onset of entry into the World Trade Organisation (WTO) once more casting its omnipresent shadow, overseas-funded banks are set to be handed unique opportunities within China’s mainland.

The actual process of establishing branches in the mainland by overseas-funded banks started about 10 years ago and experienced an upsurge in the mid-1990s amid a wide-spread shortage of funds caused by the “hunger for investments,” typical of countries with a planned economy. As the country’s reforms repeatedly reached new heights, businessmen from overseas-funded banks flocked to China to tackle the big indirect investment market brought by the financial industry, overwhelming the officials receiving them. By the end of June 2001, China had 191 overseas-funded banks with assets totaling US$40bn, an increase of US$5bn from the previous year.

In recent months, overseas-funded banks, especially those headquartered in Hong Kong, have expressed strong interest in the mainland market. The current accelerated trend of opening bank branches has run in tandem with China’s journey towards joining the WTO. For example, Standard Chartered Bank, which has already opened seven branches on the mainland, is considering upgrading six of its representative offices to branches. The Hang Seng Bank, for its part, has announced a 2.2% increase in its lending business value on the mainland in the first half of the year to US$10.5bn over that of last year, accounting for 4.7% of its total lending value. It has also filed applications to upgrade its representative offices in Shanghai and Nanjing to branches, besides expressing a willingness to buy stakes in mainland banks.

Aligned to this, HSBC of Hong Kong plans to relocate around 1,000 of its logistics employees to the mainland in the next three years. As its general manager, Ke Qinghui, stated, “HSBC plans to found the second logistics centre on mainland when the first one is set up in Guangzhou. HSBC compounded this intention by announcing in March plans to move its central processing and credit card centres to Guangzhou.

Structurally, there are 3 policy-related banks, 4 stated-owned commercial banks, 10 joint stock banks and over 90 local banks currently within China. Despite the proliferation and increasingly diverse nature of China’s banks the industry has not fared well in terms of business profits. Of the 10 joint stock banks, only the Bank of Communications, Huaxia Bank, Shanghai Pudong Development Bank and Minsheng Banking Corporation posted growths in 1999; all others saw negative growth in the year, and were also dogged by mounting bad debts. To prevent a spreading of debts, China has tactically introduced overseas-funded banks to boost the strength of the banking sector and to minimize financial risks. Along similarly deflated lines, overseas-funded banks have not performed as well as expected in their business activities – around 200 financial institutions have seen their profits drop – mainly owing to various policy-related restrictions.

The fundamental headache for overseas-funded banks is in fact a weaker reserve of capital in comparison with their Chinese-funded counterparts. Logically, quite a few have therefore indicated their willingness to raise funds through depository receipts on the mainland stock market. The Bank of East Asia (BEA) is one of the most enthusiastic among the overseas-funded banks to expand its market reach on the mainland but the lack of capital there has prevented it from expanding as rapidly as it wishes. The BEA hopes that it can become a listed company through issuing A-stock or depository receipts. Given that redefining the BEA’s business operations on the mainland into a listed company goes against their overall operation, so the Bank of East Asia is inclined to go public in the form of depository receipts, an intention outlined by Chen Qichang, the bank’s managing director and deputy executive president. Theoretically, separating its business operations on the mainland would face few difficulties, but to fuse these business operations into a company registered on the mainland would mean that the company would become a subsidiary of the Bank of East Asia. As the company’s ranking could be lower than that of the BEA, it would affect the capital costs of its mainland branches.

Another hurdle for overseas-funded banks to negotiate is the strict requirements imposed by the Chinese central bank on the establishment of branches. Effectively, only those overseas-funded banks with assets of US$20bn or more can open branches on China’s mainland; one bank can open only one branch each year and RMB loans extended by branches of overseas-funded banks cannot exceed 50% of their total loans. Although the Chinese government raised the percentage from 35% to 50% in 1999 when it revised its policies on RMB lending business by branches of foreign-funded banks, the restriction continued to prompt many complaints from the banks. The overseas-funded banks hope that there will be a revision in Chinese central bank policies to lower the threshold. They are currently trying to break through the “one branch a year” policy and the 50% restriction on RMB loans. On a practical level this would see the Bank of East Asia, which successfully opened its branch in Xi’an, elevate its representative offices in Beijing and Wuhan to branches within the coming months.

In accordance with this it does appear that the Chinese central bank is about to relax its policy restrictions. To adapt to China’s entry into the WTO, the central bank reportedly plans to loosen up the provision that requires overseas-funded banks to have assets of US$20bn or more to open branches on the mainland. In addition, the central bank is setting up an expert group together with the Legal Affairs Department of the State Council to review and revise the financial policies and laws promulgated by the central bank in recent years.

There is no doubt that overseas-funded banks have started to feel the relaxation of the restrictive environment on the mainland market. Yu Xueqiang, the BEA’s general manager and head of its China operations, stated that the mainland banks’ retail lending business mainly consists of mortgage loans, but the interest on mainland mortgage loans is about 1.5-2% higher than that of Hong Kong, therefore the BEA is fully confident of defeating mainland competitors. And if overseas-funded banks can engage in all RMB business operations, the Bank of East Asia business volume on the mainland could conceivably exceed even that of Hong Kong within 10 years.

Another factor that greatly interests foreign-funded banks is that the Chinese central bank will allow them to buy stakes in the mainland’s joint stock banks and local banks, a step taken to further economically liberalise the banking industry. China’s Bank of Communications’ plan on attracting overseas funds was approved recently by the supervisory authorities, and overseas-funded banks can control as much as 15% of the mainland bank’s worth. This is obviously welcome news for overseas-funded banks that have been dogged by various restrictions on business operations on the mainland. As a matter of fact, a joint stock relationship between mainland and overseas banks has long been a dream of Chinese-funded banks, and the Chinese government has never objected to such an arrangement. Through equity participation, overseas-funded banks can skip many of the restrictions to enter China’s mainland market. In accordance

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