July 18,2014

Tell You the Truth: the Big 5 Chinese Banks Still Need West Investment. Here is Why

By CT Johnson

Contrary to current practice and prevailing expectations, in June the Chinese government began signaling a willingness to open its domestic banking giants to more foreign investment.  In three separate meetings with Australian Treasurer Joe Hockey, Zhou Xioachuan (governor of the Central Bank of

China), Xu Shaoshi (chairman of the National Development and Reform Commission) and Lou Jiwei (China's Finance Minister) all raised the possibility of Australian lenders investing in China's five largest banks.  Hockey and Treasury Secretary Martin Parkinson both came away impressed.  "Reading between the lines, what they are saying is that they are going to allow larger institutional stakes," Parkinson said.  The relevant question for investors is whether the sex appeal of buying into the financial institutions that drive the world's largest economy outweighs the risk of getting involved in one of the murkiest, most politically driven sectors in the Middle Kingdom.  The very fact that the Chinese government is taking this step tells us three things:


1.  China is serious, if slow, about making further economic reforms.

China's large state owned banks have been the primary tools used by the government in choosing winners and losers in the post-Deng era.  Easy credit has fueled the growth of mammoth state owned enterprises like Sinopec, China Telecom and State Grid.  Conversely, many of China's most successful private corporations have had to turn to the West for financing; Huawei, a large private telecoms company, gets three quarters of its debt from overseas lenders.  Despite handwringing in the West about the slow pace of new reforms, giving outsiders more ownership in these banks exposes the current nepotistic system to more scrutiny and reflects serious intent on the part of the Chinese government to shake up the financial sector.


2.  China recognizes that markets are more powerful than governments in fighting corruption.

One of the hallmarks of Xi Jinping's presidency has been a sustained anti-corruption campaign, featuring mass advertising and episodic purges of Party members at all levels of government.  However, the thin line between legitimate business relationships and corrupt influence has proved hard to police, especially in the area of granting credit and calling in nonperforming loans.  Possibly showing themselves as the worst communists in history, the Chinese government is admitting that the job is beyond the state's power and only market forces have sufficient oomph to suppress corruption at a grass roots level.  


3.  Investors will have less visibility and control than they imagine.

Given the centrality of large banks to enforcement of China's economic policy, and considering the myriad sweetheart deals that still clog up the works, it stretches credibility to imagine that the government will suddenly allow all things hidden to be made known, nor all secrets to be made manifest.  Rather, the history of Chinese companies suggests that investors will be wooed with promises of transparency that and control the go only half-filled.  The very fact that the government is opening the banks to more scrutiny guarantees that that scrutiny will be less than advertised.


Whether these factors add up to investor fascination or suspicion remains to be seen.  In either event, the fact that the Chinese government is using cross border investment as a means of improving the performance of the country's five largest banks speaks volumes about the direction of future economic reforms.



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