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03/28/2011

Banking in China: Market entry remains difficult

Driven by record IPO's, Chinese banks have been in the centre of worldwide media attention lately. These operations, all executed successfully, have been rocking all kind of rankings worldwide (6 Chinese banks are ranked in the top 200 of the current Forbes 2000 list against zero in 2005). Western institutions follow the evolution on the Chinese Banking market with great interest. While developing strongly, conditions to access this market are still very restrictive. Specific strategy and positioning are therefore required.

 

Revisiting the record IPO's

The Industrial and Commercial Bank of China started off in October 2006 raising 21.9 billion dollars. The China Construction Bank followed suit with a more "modest" IPO of 7.7 billion dollars in September 2007, with the share price rising 33% from its first trading day. In July 2010 the Agricultural Bank of China broke the IPO record on the Shanghai and Hong Kong stock exchanges raising over 22 billion dollars after both Shanghai and Hong Kong's over-allotments (the offering bank's option to buy a superior number of securities than initially planned to regulate the stock price) were fully exercised. In overall, 2010 has been characterised by multiple capital raisings in the Chinese banking industry:

These capital raisings are a direct consequence of the tightening of requirements imposed by Chinese banking authorities who wish to prevent any increase in bad debt. Monetary policy is being tightened forcing banks to dispose of more capital to lend.

This has led to a major upheaval in global rankings. Today, in the top 10 of global banks ranked by market capitalisation, China is represented by 4 banks:

An industry strongly backed by the Government

The presence of the Chinese government in the capital of the "Big Four" of China is still overwhelming as shown in the following table:

 

 

The Chinese government has always held close ties with its banks. About 70% of bank loans are accorded to state-owned companies, who are already highly indebted. This particular situation is representative of how the Chinese banking system was created. To understand the stakes at risk we need to come back briefly on its inception.

Before market liberalisation in 1978, the Chinese banking system was focused entirely on financing government projects through the People's Bank of China. Later, four banks were founded under State custody. Each of them was responsible for financing a particular domain while holding a monopoly on its operational perimeter. Bank of China was thus intrusted with trade finance. Agricultural bank of China's objective was financing agricultural project. China Construction Bank was created to finance public infrastructure projects, while Industrial and Commercial bank was in charge of sustaining the development of industries and public commercial services.

In 1995 the Commercial Bank Law put an end to these monopolies. The banks were forced to establish themselves in other market segments, while maintaining a competitive advantage on their basic perimeter. Subsequently, three specialized banks were created again in order to finance public service missions abandoned by "the Big Four" because of their increasing focus on more profitable customers. Commercial and mixed capital banks also emerged in the wake, but in which local authorities still holds large stakes.

A still limited but growing presence of foreign banks

Foreign banks established themselves in China as early as 1978, but their implementation was only fully achieved with the permission to carry out operations in Yuan, following China's membership to the World Trade Organization (WTO) in 2001. KBC established its Shanghai branch in May 1997, the approval from The People's Bank of China to conduct CNY business came through in 2002. Dexia's workforce in China counts 61 people while BNP Paribas Fortis is, in addition to its presence in Hong Kong, also present in China through a branch in Guangzhou and representative offices in Beijing and in Shanghai. Nevertheless it remains important to emphasize that all foreign bank have only been able to control 2% to 3% of China's market.

Indeed, China's regulatory authority, the China Bank Regulator Commission strictly regulates the deployment of foreign banks on its territory. Thus, each activity must be carried out by an own subsidiary and any opening of agencies is subjected to scrutiny by the Authority. The acquisition of a Chinese bank through equity participation is also highly regulated since the country's legislation still limits the participation of a foreign investor in a Chinese bank to 20% of equity - 25% for a group of foreign investors - which hinders any kind of takeover. Regarding any possible establishment of joint-ventures with Chinese banks, again the regulatory framework is very strict since it is only allowed in specific segments such as asset management or private banking.

Nevertheless HSBC has acquired since 2004 shares amounting to nearly 20% in the Bank of Communications, the fifth commercial bank in China. In 2006, Citigroup acquired the Guandong Development Bank following a fierce battle with Société Générale.

A particular positioning

Besides the legal barriers, foreign banks suffer from their near anonymity in this vast country and do not own a single agency. Failing to develop a branch network, they were able to capitalise on their extensive range of financial products, much larger than those of their Chinese counterparties. Foreign banks have been turning notably to high-end customers. This segment, consisting of households owning more than one million dollars, already counts 250 000 people and is growing annually at 15%.

For Corporate and Investment Banks, access to the market seems less difficult. Large foreign banks in China have generally assisted their corporate clients in their establishment on China's territory. Initially they have set up activities to finance these projects and exports. This expertise has allowed them to take part in financing major national projects. BNP Paribas has recently played an important role in financing Shanghai's Metro infrastructure.

All off this suggests that European banks will remain attentive in the coming years to entry opportunities in this market, which by its size offers potentially high growth perspectives.

Sia Partners

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