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recently China's banks were described in terms that
made them global pariahs. They were not seen as banks
that mobilised savings for investment, but agencies
for channelling State subsidies (named loans) to sate-owned
enterprises with soft budget constraints. They were
perceived as burdened with huge non-performing assets,
which were a legacy of their position as an instrument
of the State rather than commercial ventures. And they
were considered to be corruption-ridden. Unless they
were restructured and recapitalised with substantial
infusion of funds, their closure was considered a serious
possibility.
Such assessments were particularly disturbing because
the ‘big four' wholly state-owned banks: Agricultural
Bank of China, Bank of China, China Construction Bank,
and Industrial and Commercial Bank of China, dominated
the banking sector, accounting for an overwhelming share
of assets. Failure of any one of them could have devastating
consequences for the financial sector as a whole. But
failure, most observers agreed, was a remote possibility,
given the strength and control exerted by the Chinese
government. What seemed more likely is that foreign
players who were to be provided a greater foothold in
the Chinese banking market as part of China's WTO accession
conditions, which requires a complete opening up of
the banking sector to foreign firms by 2006, were seen
as unlikely to be interested in acquiring a stake in
these banks even if offered a deal.
All that has changed considerably in recent months,
but specially during August which saw the completion
or announcement of three major acquisitions of equity
in Chinese banks. On August 19, the Royal Bank of Scotland
(RBS), leading a consortium that included investment
banker Merrill Lynch and Hong Kong billionaire Li Ka-shing,
acquired a 19.9 per cent stake in Bank of China, the
second largest in the country in terms of assets, with
an investment estimated at $2.5 billion. Soon thereafter,
Temasek Holdings, Singapore's state-owned investment
company that is responsible for state equity investment
in the country, announced that it would acquire around
10 per cent of equity stake in Bank of China. If this
is additional to the acquisition by RBS, foreign ownership
in Bank of China would amount to an unprecedented proportion
of nearly 30 per cent. However, full details are still
awaited.
As if this huge acquisition in China's second largest
bank was not enough, on August 30, a second consortium
consisting of Goldman Sachs, American Express and Allianz
(of Germany), among others, signed a preliminary agreement
for acquisition of a 10 per cent stake in China's largest
bank, the Industrial and Commercial Bank of China for
an estimated sum of more than $3 billion.
Add these to the acquisition by foreigners of two chunks
of equity in China Construction Bank in the second half
of June, and the tendency towards privatisation of the
core of China's banking sector (except, of course, for
the Agricultural Bank of China, which is unlikely to
find willing buyers) is clearly established. On June
16, Bank of America invested a 9 per cent stake in China
Construction Bank for $2.5 billion, with the option
to raise this stake to 19.9 per cent at a later date.
Days later, on July 1, Temasek announced the acquisition
of an estimated 10 per cent stake in China Construction
Bank for $2.4 billion. This, together with the more
recent acquisition of equity in the Bank of China, makes
Temasek the biggest foreign player in China's banking
sector.
Overall, the Wall Street Journal estimates that foreign
investors have pumped in more than $15 billion into
the Chinese banking industry since June. Why has there
been such a sudden rush of interest in a sector that
was not considered a worthwhile investment till recently?
Needless to say, there have been a number of developments
that have been occurring in the background that warrant
a change in mindset. First, partly in preparation for
the full opening up of local currency banking to foreign
players by 2006, the Chinese government has been recapitalising
its banks. The government is estimated to have pumped
as much as $60 billion into the three biggest banks
to write off loans that were unlikely to be repaid.
As a result, official figures show that the proportion
of non-performing loans fell to 13.2 per cent at the
end of 2004, compared with 18 per cent the year before.
The Industrial and Commercial Bank of China, which received
the largest share of recaptalisation funds from the
government, claims to have slashed non-performing loans
to 4.5 per cent of advances as compared with 19 per
cent last year. Though these figures are not accepted
by many, substantial recapitalisation has occurred.
Second, the governance structure of banks has been modified
in keeping with market requirements, with credit-risk
assessment systems, audit committees and boards of directors.
Further, efforts are underway to substantially reduce
''overmanning''. And, third, penal actions against corrupt
senior bankers have been resorted to, in order to convey
the message that such corruption will not be tolerated,
For example, the extreme penalty of a death sentence
(later suspended) was imposed on the head of Bank of
China's Hong Kong unit in August on grounds of embezzlement.
Earlier in March, the chairman of China Construction
Bank was forced to resign because of allegations of
corruption. Bank of China has reportedly has ''tried
and penalised'' at least 50,000 workers for fraud.
These developments are being used to justify why yesterday's
pariahs have become today's favourites. But they still
do not explain why foreign players are interested in
acquiring minority stakes in the big banks rather than
set up operations on their own. As the WTO deadline
of 2006 approaches for providing foreign banks full
national treatment in local banking, what was expected
was that there would be increased interest in increasing
their presence through their own subsidiaries and joint
ventures. Rather it appears that foreign interest in
Chinese banking has gone through a two-step process.
To start with, foreign banks seemed to be interested
in establishing a Chinese presence through subsidiaries
or joint ventures with smaller banks. According to CBRC
statistics, foreign banks had set up 204 operational
entities in China by the end of October 2004, with total
assets amounting to 553.4 billion yuan (US$66.7 billion).
By that time, sometimes ahead of WTO accession requirements,
some 105 foreign banks had won renminbi licenses, 61
of which have been allowed to provide renminbi services
to Chinese enterprises. But their overall presence is
indeed limited. They account for only 1.8 per cent of
all banking assets in China, though they have managed
to secure 18 per cent share of the foreign currency
lending market.
Foreign banks also acquired stakes in smaller commercial
banks. For example, Shenzhen Development Bank announced
in October 2002 that Newbridge Capital Inc. had acquired
a stake of 18.02 percent in the bank through an investment
of new capital and the acquisition of existing holdings
from state shareholders. Citigroup announced on January
2, 2003 that it would purchase a 5 percent stake in
Shanghai Pudong Development Bank. Ing Group acquired
a 19.9 per cent stake in Bank of Beijing in March 2005.
And, Commonwealth Bank of Australia bought a 19.9 per
cent stake in Hangzhou City Commercial Bank in April
2005. Instances of this kind have been proliferating.
However, what the current spate of acquisition suggests
is that foreign banks are graduating out of a complex
process of growth involving building a network based
on making large investments, negotiating the regulatory
framework and competing with the big four banks. The
Chinese government's growing willingness to permit sale
of minority equity blocs in the big four banks as well
as the promise of profit from the large network these
banks control in an economy that continues to boom,
seems to have persuaded the to settle for an initial
minority stake. Competition between foreign banks to
acquire a share in the credit card, consumer credit
and mortgage loan business, which is expected to boom
in the coming years, has obviously changed their mindset.
But that is not all. These investments have a strong
speculative component. There are many who are speculating
on the real possibility that the value of bank shares
would appreciate significantly in the run up to their
being listed on stock markets at different points of
time over the next two years. This clearly explains
the interest of investment bankers like Merrill Lynch
and Goldman Sachs who are unlikely to be interested
in contributing to the management of large banking networks
in a spiralling market. It also possibly explains the
interest of Temasek Holdings in making Chinese bank
equity a significant part of its $54 billion investment
portfolio.
The recent decision of the Chinese government to begin
the process of unpegging the renminbi (RMB) from the
dollar must be aggravating this speculative tendency.
China's massive foreign reserves, unprecedented export
success and attraction of foreign investors suggest
that the RMB would only rise if the government increased
the band within which it can fluctuate. A purchase of
equity today not only promises to offer large profits
when these banks are listed, not only because of appreciation
of the RMB value of such equity, but also due to substantial
gains from currency appreciation.
Thus while foreign investor interest in the Chinese
banking frontier is understandable, what is unclear
is the motivation for the Chinese government's decision
to divest large chunks of equity in the big four banks.
Given China's ambiguous guideline on foreign equity
caps, the extent of such divestment is clearly being
decided on a case-by-case basis. And given the most
recent trends it appears that the aggregate 25 per cent
ceiling and limit of 20 per cent for ownership by a
single investor may be reached. However, having recapitalised
banks with local resources and restructured them, the
government is unlikely to move to a situation where
it loses control.
It could be argued that a foreign presence could ensure
managerial inputs needed for new markets such as the
credit card, automobile finance, consumer credit and
mortgage markets into which these banks are diversifying.
But even if such expertise is seen as not easily developed
or hired, the focus must be on acquiring appropriate
partners. The indications are that speculative motives,
rather than purely long run interest, are involved in
the current spate of acquisitions suggest that this
is not the emphasis. Given that, the reason why the
Chinese government is courting the dangers associated
with the entry of players with international private
concerns that are sharply at variance with national
social concerns, which the banking system must take
account of, remains unclear. One would imagine that
the Communist Party would recognise these dangers and
reverse the tendency, as it has recently done regarding
the inequalising effects of post-reform growth.
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