China’s banks are adapting to life in a changed world. The doors have opened to foreign competition; all but one of the heavyweight players are internationally listed, so coming to grips with global investor relations; and a legacy of bad debt has largely been banished.
These days, it seems, it’s hard for the banks not to delight international investors and analysts, either because of their share prices or, more simply, the fact that they serve as points of entry into China’s relentless economic growth story – complete with its soaring levels of personal wealth.
Yet for all the fanfare, considerable challenges remain. The first is maintaining the pace of reform, while devising banking strategies that suit modern and newly competitive China.
But China’s economic boom has also overshadowed problems faced by many banks, which need to avert future bad loans by better risk management. (For a detailed look at China's ferocious growth and its risks see China slamming on the brakes) Chinese lenders have largely purged themselves of their non-performing loans (NPL) legacy with the aid of bail-outs by the state. On January 12, custom-built asset management companies formally completed their original task – the disposal of RMB1.4 trillion of non-performing loans from the big four banks.
Big and small
“On a macro basis, the NPL situation looks significantly better because of the bigger banks,” says Karin Finkelston, associate director of the East Asia and Pacific department at the International Finance Corporation (IFC). The problem is that a shock to the economy could yet uncover further weakness at the core of the banking sector. “We are concerned that if there is a major slowdown in the market there will be some impact on the banks.”
Small financial institutions located in rural regions suffer the most pressing problems in the face of increasing market competition, she notes. IFC has investments in Bank of Shanghai and Minsheng Bank, among other holdings.
According to Liu Mingkang, chairman of the China Banking Regulatory Commission, the impetus now is focusing on improving their operations. “Banks mustn’t waver from the determination to curb new NPLs,” Liu says. “They should pay special attention to risks that may arise from accelerated growth in medium and long-term loans,” Liu notes in a statement on the agency’s website.
Liu’s deputy, Tang Shuangning, said in a recent speech that: “Financial risks, mainly in the form of bad loans, are like rocks on the seashore. They aren’t visible when the economic wave is high but appear when the wave withdraws.”
China should highlight the financial problems still facing the banking system at a time when the country’s economy had maintained double-digit growth for four years in a row, he said. Domestic banks still need to improve in a range of areas, including management, the competency of their staff and internal controls, Tang added.
Test case
The real test of the banks’ ability to prevent non-performing loans has yet to come, says Raymond Fong, head of financial services industry group at PricewaterhouseCoopers in Beijing. “The economy has been growing so rapidly, it has not been a good test of people’s ability to differentiate between a long-term customer and a customer who can only survive because of the flood of liquidity. The biggest threat to banks in the next few years is a turn in the economy.”
China’s economy faces excess liquidity from mounting foreign currency reserves. China’s foreign-exchange reserves topped $1.2 trillion at the end of March, year-on-year growth of 37.36%. China’s M2, the broadest measure of money supply including cash and deposits, jumped 17.3% to 36.41 trillion yuan ($4.72 trillion) at the end of March. Financial institutions added 1.42 trillion yuan in new yuan-backed loans in the first three months, bringing the total to 23.96 trillion yuan China’s central bank has ordered banks to increase the reserves they place at the central bank three times this year. It has also raised interest rates in the bid to curb lending. [See “Slamming on the brakes”]
“We’ve been trying to help banks understand how to look at credit risk more. In China the lion’s share [of collateral] is real estate and hard asset securities, so if property markets come off in certain markets, it can have an effect on the overall collateral portfolio,” says Finkelston.
New strategy
In particular, the banking sector needs a strategy for its next phase – retail products, service delivery and “in the medium term, what to do internationally,” says Fong. “The challenge to the Chinese banks is properly accessing the individual creditworthiness of customers.” (For a detailed look at the growing popularity of asset management funds in China see Chinese retail investors: the next frontier)
Corporate loans have historically compromised the bulk of revenues for domestic banks, but market opening has meant that local lenders are now looking to consumer financing, credit cards and mortgages. “On the commercial side, banks will need to improve the sophistication of their product offerings, playing an increasing role in treasury, foreign exchange, interest rate management, and ultimately following their own clients overseas,” Fong says.
“Five years ago, we were too worried about opening China’s banking sector,” says Zhu Min, vice-president of the Bank of China. “Now we are a little bit over confident.”
Zhu says he expects foreign banks to lift their near zero market share in corporate lending, RMB deposits and credit cards to at least 5-10% in the next decade.
“Chinese banks clearly earn too much money from the interest margin between the rate at which they lend and the rate at which they borrow,” says Kevan Watts, chairman of Merrill Lynch International in Hong Kong. But he thinks China’s banks face other challenges. “They need to develop a wider range of products and a wider range of relationships with their customers.”
Another near-term challenge is compliance with the Basel standards, which in China come into effect in 2010 and 2011. “I do not believe any of them [banks] are yet able to comply,” says Fong, who adds that it is impossible to know from published data just how far away they are from internationally accepted standards of capital adequacy.
Competition
Competition is also on the up, although foreign participation is still minimal. “I don’t expect foreign commercial banks to have a meaningful market share in China for quite some time,” says Merrill Lynch’s Watts. Still, in April, four foreign banks – HSBC, Citigroup, Standard Chartered and Bank of East Asia – were granted local incorporation in China, allowing them for the first time to conduct business in local currency.
But there is also competition from within. In particular, domestic banks are keeping a close eye on the insurers. China Life is part of the consortium that has bought a controlling stake in Guangdong Development Bank. And the other major life insurer, Ping An, has very clearly stated ambitions to become a bank, and has already acquired two: Fujian Asia Bank in 2004 and Shenzhen Commercial Bank in 2006. Their integration into a single banking unit, covering Shanghai, Shenzhen and Fujian, should be wrapped up within a quarter.
“In the long term, we want to be a national banking franchise, a retail powerhouse,” says Louis Cheung, executive director and chief financial officer at Ping An. “We want to cover as much as possible of our 30 million-plus customer base.” The firm will soon be issuing a credit card loaded with protection features provided by the insurance part of the group.