November 28,2007

Moving out Meets Challenges

By Ma Wenluo

Not long ago, China’s Big Four state-owned banks were all facing at least technical bankruptcy. Nowadays, not only does China boast some of the world’s richest banks, but those banks are also accelerating their "moving out" strategy of overseas acquisitions and branch operations after restructuring and IPOs on the stock market.  In the upcoming strategic economic talks, China will urge the US to further open its banking market to Chinese banks tit for tat while dealing with a request for China to open its own financial market to US banks.

On Nov. 8th, China Merchants Bank (CMB) gained the US Federal Reserve’s approval of its application to establish a New York branch, becoming the third Chinese bank to open a branch in the US, following the Bank of Communications (BOC) and the Bank of China, and the first Chinese bank expand its business in USA after the Foreign Bank Supervision Enhancement Act in 1991. China Banking Regulatory Commission ( CBRC ) said the approval means the opening of a new era for China’s banking industry and that China’s banking industry is realizing an important transition on its way to gaining a foothold in the world’s largest financial market. USA banking insiders called it a watershed for the market.

In the not too distant past reports of this little spark in the great "moving out" strategy would not have been credible.  As recently as November, 2003, the Wall Street Journal reported that Standard & Poor’s (a ratings firm) had confirmed its rating for China mainland banks as junk.  In Nov. 2002, the WSJ reported that China’s banking industry’s bad debt was continuing to deteriorate at the same speed as that of Indonesia’s and Thailand’s in the financial crisis of 1997.  The report quoted the Brookings Institution’s prediction that a "financial crisis is on the verge of breaking out." But in merely the last 4 or 5 years, China’s banking industry has gone a long ways towards sorting itself out, and is now indeed moving out.

A fine example would be the Industrial and Commercial Bank of China (ICBC), China’s largest commercial bank. In August, 2007, it bought a 79.9% stake in Macao Chengxing Bank at the cost of Macao Pataca 4.683 billion (about USD 585 million). It has also finished its acquisition of a 90% stake in PT Bank Halim Indonesia . In October, it signed an agreement to buy 20% of the Standard Bank of South Africa for USD 5.46 billion. In November, Wu Yi, China’s vice-premier, and his Russia counterpart attended the unveiling ceremony for ICBC Moscow branch, which is registered with Rubles 1 billion (approximately USD 40 million). In addition, ICBC has submitted its applications to establish branches in New York, Dubai, Doha and Sydney, and is negotiating with the National Bank of Pakistan, Pakistan’s largest, for their cooperation in plans to expand its business in that country.

As new participators in the international market, China’s banks mostly prefer acquisitions to accelerate their expansion in those markets rather than establishing branch offices.  By acquiring a 100% stake in the Bank of America Asia branch, China Construction Bank (CCB) doubled its business in Hong Kong in a short time, and its loan book has moved to 9th from 16th.  ICBC has gained its banking license in Indonesia by acquiring PT Bank Halim Indonesia .

In recent years, as China’s major commercial banks have stepped into the capital markets with IPOs and investments in other financial fields, the upsurge of the stock market and RMB appreciation have strengthened their capacity and their confidence.  Their restructure included invitations to overseas banks to become strategic investors. The regulatory structure for the industry has improved, and the information disclosure is gradually closing in on international rules. Risk management has been improved, and new international talent has been recruited.  All this is laying the foundation for the further overseas expansion.

That expansion is seen as a requirement and natural consequence of the industry’s own development.  CBRC chairman Liu Mingkang has said the regulator will encourage these acquisitions as long as they are helpful for the development of China’s banking industry.  And they would seem to be.  According to the CBRC, by the end of June, 2007, overseas assets of China’s banks had reached RMB 1.8 trillion (USD 240 billion), and were growing 22% year-on-year.

The strategy is also driven by other motivations.  One is the same thing that drove the US and Japan banking industries during their overseas expansions, the international growth of industry and commerce.  As the world’s economy globalizes, stakes are being rearranged and following the industrial expansion is strategically important for financial institutions.  Others, according to Dr. Liu Yong, a strategist for CMB, is that China’s domestic banks need to access the international market directly, improve international competitiveness, and get ready for the acceleration of foreign investment in China’s banking industry.

Yet another motivation is that a Chinese banking presence overseas will further the national industrial policy.  Foreign-based Chinese banks cannot help but be important tools in the implementation of national strategy by aiding in the vital procurement of energy sources and raw materials held by foreign countries.  Indeed, one, China Development Bank (CDB), has as its main purpose to serve the multinational acquisition by China’s large companies of enterprises, especially those in energy, mining, national strategic petroleum reserve, and so on.  ICBC’s 20% stake in Standard Bank of South Africa was acquired because the latter has branches in 18 countries across Africa, a convenience for Chinese companies anticipating economic activities in Africa. China’s government is also encouraging banks to expand into countries with developed banking industries, e.g. the US and in Europe.

The entry of Chinese banks into the US market has not been smooth.  Some think that the approval for China Merchants Bank’s New York branch was the result of CBRC’s pressure on US banking regulators, but in truth the bank’s move had been in the works for 16 years.  Ma Weihua, the president of CMB, said the bank has not enjoyed any policy privilege, and the whole process has followed the relevant US regulations strictly. He expressed his appreciation for PBOC and CBRC’s negotiation with US regulators.

In early 2007, ICBC submitted its application to establish a New York branch to the New York Federal Reserve.   The bank, one of the world’s richest, has not yet received any clear answer. Lou Wenlong, an officer of CBRC, says the application is expected to advance after the Sino-American strategic economy talks, to be held in December, 2007.

Meanwhile, CCB chairman Guo Shuqing has complained that though CCB long ago established offices in London and New York, its applications for establishing branches there have still not been approved. US regulators cite the foreign banks?weaker management capacity and the risk management ability. At the same time, there are worries that these Chinese banks could "endanger the nation’s financial security."  In 2005, China National Offshore Oil Corporation’s (CNOOC) plan to acquire Unocal Corp, a US oil concern, led to vehement objection from the US Congress over worries that an important US asset could be controlled by China.  Similarly, any Chinese bank’s action in the American banking market will always spark political objection.  But it is thought that if western countries ask China to open its banking market to a degree that is above the requirements in the WTO rules, China will require compensation, which would include allowing China to enter their banking industries.

But there are other challenges facing China’s banks as they expand into foreign markets, the biggest being the controlling of the risk of acquisition.  China’s banking industry was for long state-own and is weak in risk recognition and management and the absorption of overseas acquisitions. There will be the risk of regime change in target countries and lack of proper laws and regulations protecting foreign investors, and so on. Sun Xiaoyu, vice director of Development Research Centre of the State Council, has said that political risk is an important factor for Chinese enterprises?going out, beyond their own commercial risks. Currently, China has no authoritative risk evaluation institution at the national level.

China’s banking industry is also short of the talent, techniques and market resources for proper due diligence of acquisition targets. The western media have reported that CCB has consulted with Bear Stearns, the fifth largest investment bank in USA, and hoped to buy a stake.  Nowadays, the later to its neck in the sub-prime mortgage crisis, and financially strapped. CCB has denied the news, but perhaps the potential is there.  The CBRC needs to urge the banks to be careful, and train and organize a team which is familiar with the operation of the overseas banks? says Liu Mingkang.





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