There are two sides to every story. The banking
industry in China is no exception. On the one hand, the emergence
of a wealthy Chinese middle class coupled with recent regulations
designed to facilitate growth has the industry poised for massive
growth. On the other hand, Chinese banks are plagued by bad debts
and inefficiency, and more importantly face a huge potential loss
of customers to their foreign counterparts once the industry has fulfilled
it's commitments to the World Trade Organisation (WTO) by 2007. Depending
on whom you ask, banks in China are either on the verge of bust or
boom.
The reality however is that the industry is in a
muddle. A real rotten onion! There's no denying that China's recent
economic miracle could give the industry a much-needed boost, but
there is a long way to go yet. There are plenty of reasons why foreign
business people in China have left the bank seriously wondering how
much things have really changed in the last fifty years. In China,
you really are banking with the dinosaurs.
The Banking System
Despite having undergone significant changes in the last two decades,
China's banking industry has remained highly government controlled
even though banks have gained more autonomy. The country's central
bank is the People's Bank of China (PBOC), responsible for formulating
and implementing monetary policy. As part of the economic reform
programme kick started in the early 1980s, the central bank was
decentralized and restructured, to give way to the formation of
a number of major banking institutions and other depositary institutions.
Today there are several layers to the Chinese banking
system with the PBOC still serving as the central bank and directly
below there are four state-owned commercial banks. Ten shareholding
commercial banks were also set up initially to provide specialised
product niches. However, they have evolved since and now provide a
full range of banking and other financial services. At the local level
there are more than one hundred city commercial banks and a vast number
of city and rural credit cooperatives.
Sometimes described as "the Big Four",
the four state-owned commercial banks hold a overwhelmingly dominant
market share in China's banking sector, accounting for over 70% of
the sector's total assets and loans and over 80% of its total deposits.
The Industrial and Commercial Bank of China (ICBC) is the largest
bank in China and one's of the worlds biggest. China's main international
banking organisation, the Bank of China (BOC) has an extensive network
of branches at home and overseas. It specialises in foreign exchange
transactions and trade finance. The China Construction Bank focuses
on handling the country's capital construction investments and finally,
the Agricultural Bank of China provides banking services to rural
businesses and individuals.
What About the Foreign
Banks?
In addition to the above-mentioned domestic banking
institutions, there are already more than 170 foreign banks operating
in China. Immediately after China's accession to the WTO was approved,
the PBOC announced a specific timetable for the opening of China's
banking business to foreign banks. Foreign banks in China currently
have a 2% market share in China's banking sector in terms of assets
and loans but account for 40% of the country's international settlement
business and 23% of foreign currency lendings. Currently restricted
to providing only foreign currency services to Chinese individuals
and enterprises in certain cities, by the beginning of 2007, foreign
banking institutions will be permitted to provide local currency business
to all Chinese clients.
The activities of foreign banks in China are limited
in order to protect domestic banks, a clear indication that domestic
institutions are in no state to compete with the wide array of products
and efficient services provided by foreign banks. A major problem
with the banking system in China is that it is slow to keep pace with
the current economic environment and lacks the products and services
to attract liquidity for distribution. Chinese banks have traditionally
relied on interest as their main source of income. In 2000, the proportion
of fee-based income in total revenue was about 15% while interest
income accounted for about 70%. In comparison, foreign banks earn
most of their revenue through products, consulting and advisory services
not usually offered by banks in China.
Despite all this, Chinese banks have one very clear
competitive edge over foreign banks and that is their huge domestic
network. This is expected to be a critical factor in the domestic
banks fight to resist the penetration of foreign banks into the Chinese
banking sector. ICBC has some 37,000 branches and sub-branches across
the country, while HSBC, the foreign bank with the largest presence
in China, has just 10. Domestic banks tend to operate at a considerably
lower overall cost structure. Coupled with this is the fact that domestic
banks are rapidly updating their services and employing consultants
and advisors for quick implementation of modern strategies.
Bad Debts
So, do opportunities exist in China for foreign banks
in China? Can those institutions capitalise on the clear advantage
they possess in terms of the services they offer to overcome the distinct
disadvantage provided by their lack of coverage, particularly outside
of China's larger cities. The answer to this question needs to be
looked at in light of how the problems that are currently plaguing
China's domestic banks will play out in the long term. It's fair to
say that the fate of the foreign banks in China will very much depend
on how well the domestic banking institutions can adapt and modernise
to keep pace.
The most obvious problem currently threatening the
long-term ambitions of China's banks is the huge amount of non-performing
loans (NPLs) on their books, around 30% of the total number of outstanding
loans. Until recently banks in China traditionally met government
policy demands by financing the operations of the country's state-owned
enterprises (SOEs), regardless of their profitability or risk. Exposure
to poor-performing SOEs has had a major impact on domestic banks overall
performance.
In a recent book on China's WTO accession, Integrating
China into the Global Economy, the author wrote, "if the
transformation [of the banks] is delayed and banks continue to channel
disproportionate amounts of funds into inefficient state-owned companies,
the leverage of WTO commitments on domestic economic reform will be
largely lost." Clearly then, the argument that Chinese banks
will become more competitive in the face of increased penetration
by their foreign rivals falls flat when it is considered that this
cannot happen if the banking system doesn't work.
The SOEs remain the key to understanding why bank
reform is so difficult. Already faced with millions of unemployed
and increasingly restless SOE workers, it's unlikely that the banks
are going to start recalling their bad debts. Chinese authorities
have attempted to ease this constraint with polices that encourage
banks to shift away from their traditional role as suppliers of financing
to SOEs. At the same time those SOEs are being restructured to improve
their financial condition.
Rise of the Chinese
Consumer
The government has until now hoped that continued
economic growth will solve the NPL problem gradually. This approach
combined with the increased wealth of many Chinese citizens might
just work. As per capita continues to rise and hitherto luxury items
like private homes and cars become increasingly popular, domestic
banks can rely on the fact that consumers make a good deal more reliable
customers than SOEs. With Chinese people's strong tradition of saving,
consumers have become eager to borrow. China's savers are amongst
the world's most conservative with an average saving rate of around
40%. Mortgage lending at ICBC has grown by 32 times in the past four
years. Consumer lending by the big four banks has risen from 1% of
their loan books in 1998 to about 10% in 2003.
Given the likely further growth in the array of services
offered by domestic banks to consumers, it's likely therefore that
foreign banks will have to spearhead their efforts in stealing a lead
in particular areas of the market where they either see a clear competitive
advantage or a demand that is not being met by local banks. Examples
include credit cards, Internet banking and personal financial services.
New Services
Though the first credit card in China was launched
in 1985, issued by the Bank of China, up until now the numbers of
genuine credit cards, where credit is granted not upon a cash deposit
but upon the holder's credit score, has stayed relatively low with
under a million in use today. The majority of the estimated 469 million
cards in China are debit cards. Following an announcement in 2002
by the PBOC to complete a national personal credit record system however
it is expected that in four years time there will be some 10 million
credit cards in circulation.
Earlier this year Citigroup announced a strategic
co-operation with the Shanghai Pudong Development Bank (SPDB) to co-operatively
manage a credit card business through a credit card centre to be established
in Shanghai. It is highly likely that strategic partnerships like
this might be a sign of things to come with banks joining forces to
capitalise on particular individual strengths. This deal gives Citibank
access to nationwide distribution system through 242 branches across
China.
Internet banking made its debut in China in 1999,
when three of the state-owned commercial banks launched Internet-based
banking services. Now, although all the main commercial banks offer
online services, they differ considerably in their scope and are almost
exclusively in Chinese. HSBC was the first foreign bank to introduce
Internet banking in December last year recognising that the development
of online banking services is far cheaper than building extensive
branch networks. In the first half of this year the online banking
business volume of the ICBC nearly doubled. Largely attributable to
the outbreak of SARS in China with many people less willing to leave
their homes, statistics showed a 91 per cent increase over the same
time last year. A leading consultancy firm recently noted that China
was braced for an "e-banking age."
Still in the Jurassic
Age?
Enough of the future. This after all is only speculation.
What practical issues are facing foreign-invested enterprises and
individuals today, a full four years before the advent of a highly
competitive mixture of domestic and foreign banks in China? If banking
in China can be aptly labeled banking with the dinosaurs
then an overview of some of the finer inefficiencies and complexities
is in order. If not quite as old as the dinosaurs, but certainly in
a piece of bureaucracy seemingly lifted straight from the dark ages,
the importance of a chop cannot be overestimated in China.
The company chop is required when any important documents are signed,
issued or changed and is also needed for the opening of a bank account
to be legally binding. In many circumstances an individual's signature
matters for nothing, useless without the accompanying chop.
Transferring money is one area in particular that
causes a lot of headaches. A mainly paper based system means there
are still delays in payments and collections. The introduction of
an inter-bank clearing network at the beginning of 2000 has cleared
some of the problems. There are now over 20,000 direct clearing members
and 80% of the transfers arrive within twenty-four hours. Cheque payments
however can be tricky since they can't be made between cities, can
take more than five days to clear in-city and personal cheques don't
exist. Companies can't write cheques to individuals. Worse still,
cheques cost money, a book of fifty costing as much as thirty renminbi.
Playing Catch Up
Problems exist in the payment of salaries to local
staff. In a hark back an era when Chinese banks existing merely to
fund the incumbent SOEs, all banks need a salary book, without which
staff cannot be paid. The tax situation complicates matters further
since China imposes different corporate income tax rates on foreign
currency business and renminbi business.Consequently, a bank branch
must keep two sets of books and carefully allocate costs accordingly.
Branches also restrict the number of accounts a company can hold at
one branch and even curb the transfer of funds within individual companies
from one account to another. If a company does open a second or even
a third account then there are restrictions on the scope of that account.
The transfer of money from one company to another
is strictly regulated and as far as cash management is concerned related
companies are in fact very much unrelated. Recently companies have
taken advantage of a WTO concession to introduce a new financing scheme
called "entrust loans". Under this scheme, money can be
transferred from one company to another at its own interest rates,
having entrusting a bank to deliver the funds. So financial managers
in China are finding that solutions to some of the problems do exist,
but until now domestic banks have been comparatively slow to offer
such a service. Once again, domestic banks are playing catch up.
Foreign exchange dealings in China are closely monitored
by the State Administration of Foreign Exchange (SAFE). Last year,
the government announced that banks could approve foreign currency
transactions up to US$50,000 without prior approval by SAFE, so long
as those dealings were then cleared with SAFE at yearend. Any transaction
above that figure is subject to prior approval and the complicated
process may cause unexpected delay. Inefficiencies also exist concerning
incoming foreign funds to bank sub-branches, and unless each entity
making payment is chased individually, such transactions usually take
around five days.
Talk to many foreign business people in China and
they will tell you that perhaps the biggest problem affecting banks
in China is one of attitude. The levels of bureaucracy apparent at
many of the local banks can at times reach mind-numbing levels, with
the completion of as many as ten pieces of paper required for a simple
cash withdrawal. Long queues result and the sullen look on many of
the staff members faces doesn't help to lift the spirits dampened
by a one-hour wait. An out of the ordinary request will often be greeted
with a blank stare and a reply that the bank doesn't offer that particular
service, even though a different member of staff offered just that
very service at the same branch last month. Unfortunately, the terms
personal relationship and customer service still aren't included in
most bank clerks' vocabulary.
Dodgy Dealings
An interesting footnote to the tale of the banking
industry in China is that of corruption. There was a joke that went
round financial circles in China last year when it was announced that
the proposed IPO of the Bank of China-Hong Kong (BOCHK) would raise
in excess of US$2.5 billion. In reference to an incident where US$500
million was embezzled from a BOC sub-branch the joke mocked that although
US$2.5 billion might seem like a lot of money, it would only take
five BOC sub-branches to steal it. Despite increased support by the
judicial system in fighting illegal financial activities by threatening
to impose tougher sentences on wrongdoers, bank corruption has hit
the headlines again this year.
The IPO went ahead in July last year and raised US$
2.8 billion. A year later however BOCHK was under investigation for
number of corrupt loans made to a leading Shanghai property tycoon.
Worse still, many of the suspect transactions seem to have taken place
during the preparations for the IPO, precisely at the time when the
bank was supposedly cleaning up its act. It's not exactly the kind
of publicity that is going to have Chinese consumers queuing up to
deposit their savings in the BOC vaults.
Service with a Smile
So, while WTO accession has helped to reform the
banking system and spur it’s growth, it's likely that perhaps
the biggest influence foreign banks will have upon the domestic banking
industry in China will be by providing an example to the Chinese people
of increased transparency and better customer service.
If as predicted the fight for dominance in the Chinese
banking industry really does come down to who can win the hearts and
wallets of the Chinese consumers, then domestic banks, particularly
the Big Four, will have to start offering service with a smile and
a close, and importantly uncorrupt, relationship with their bank managers.
Maintaining public confidence in the banking system will be crucial.
Overcoming the inefficiencies stemming from
old-fashioned bureaucracy and poor customer service might prove to
be the biggest hurdle to domestic banks in China. In the meantime
however, having first sought the help of a suitable financial advisory
firm to help unravel some of the many more complicated intricacies
of banks in China, be sure to bring a good book and a healthy dose
of patience on any trip to your local Chinese bank, otherwise it won't
be onions bringing on the tears.
Michael
Pennington LehmanBrown, Shanghai.
