It is perhaps apt that this year is the Chinese Year of the Horse. Following China’s accession to the World Trade Organisation (WTO), foreign banks are champing at the bit to extend their treasury services to Chinese investors. And with the rest of Asia still under the cloud of a US-led downturn, most international players are fine-tuning detailed strategies to hit the soon-to-be liberalised Chinese market at a gallop.
But while the Chinese government will open up its financial markets to foreign institutions over the next few years, it’s going to be a drawn-out affair. Foreign banks will be unable to compete on a totally level playing field until 2006; while China’s banks, fully aware of the competition they will eventually face, are tackling fundamental problems, and in particular, the huge non- performing loan (NPL) problem. In the most recent round of profit releases, the big four mainland banks – Bank of China, Industrial and Commercial Bank of China, Agricultural Bank of China and China Construction Bank – announced that they have exceeded targets for reducing NPLs this year, recording decreases of around three percentage points.
Although there are more than 180 foreign bank branches in the Chinese market, only a handful of banks have renminbi (RMB) licences, and those that do are restricted to dealing with foreign-invested enterprises (FIEs) and joint ventures. In addition, those banks with RMB licences, such as HSBC, Standard Chartered and most recently JP Morgan Chase, are restricted in the cities they can conduct local currency transactions in – currently Shenzhen, Shanghai and, since the WTO agreement, Tianjin and Dalian.
The products these banks have been able to offer up to this point have also been limited, says Stanley Wong, chief executive for China at Standard Chartered in Shanghai. “We can offer foreign exchange transactions involving RMB on spot, but we cannot offer forwards,” he says. Those banks holding the coveted RMB licences can also take part in the Chinese interbank market, known as the national interbank funding centre (NIFC), for short-term RMB funding.
However, with only 24 foreign banks in Shanghai and eight banks in Shenzhen holding RMB licences, activity has been sparse, says James Wu, head of treasury in Shanghai at ING Barings. “Foreign banks trading volume in the NIFC is now less than 2% of the total market turnover,” he says. Moreover, the amounts foreign banks are allowed to borrow on the NIFC are strictly regulated. Consequently, foreign banks have had to borrow from local banks as a last resort, continues Wu. “Since a foreign bank can only take 1.5 times its RMB working capital in NIFC, they have to go to Chinese banks directly for RMB funding to meet their lending requirements,” he says. As a result, many foreign players enter into bilateral loan agreements with local banks at a rate higher than interbank market rates.
Those banks without RMB licences, meanwhile, are only able to offer treasury products in foreign currencies. These include foreign currency loans and deposits, and foreign currency-denominated interest rate derivatives. A limited cash management service has also been permitted but, again, product offerings are restricted to multinationals and foreign invested joint ventures.
However, immediately after China officially joined the WTO on December 11, 2001, China’s central bank, the People’s Bank of China (PBC), announced its commitment to a gradual liberalisation of the banking industry. Foreign banks with a foreign business licence are now able to offer foreign currency services to Chinese institutional, corporate and individual customers, providing the bank’s operating funds and capital increase accordingly. A timetable has also been set to gradually extend the number of cities that banks are permitted to transact in, with an end to all regional restrictions in 2006. Furthermore, a staggered programme has been announced to allow foreign banks with RMB licences to conduct RMB business with Chinese institutional clients in 2003, and Chinese individuals at the end of 2006.
The ability to transact RMB business with Chinese individuals is particularly significant. By allowing foreign banks to accept local RMB deposits, these banks will have the funds to offer loans, and develop comprehensive treasury products from 2006, as opposed to relying on the regulated NIFC market, or high-cost loans from local banks.
The treasury market itself is at an early phase of development. For instance, the development of a local forwards market is still at a very nascent stage. Currently, only the Bank of China (BoC) has been allowed to do RMB forwards with a tenor of up to six-months, and this is on a trial basis. ING’s Wu explains that because the RMB does not have a standard interbank interest rate structure such as Libor, achieving swap points are difficult, and therefore a final forward exchange rate is virtually impossible. If customers wish to hedge their exposure in RMB, he continues, they must tap the non-deliverable forwards market (see Treasury supplement, page S10).
Many bankers believe that further development of treasury products will be very gradual, with the Chinese authorities likely to be cautious. “My feeling at this point in time is that the Chinese government’s top agenda is to maintain stability – this overrides anything else,” says Standard Chartered’s Wong. He points out that stability plays a central role in Chinese economic policy – for example, the renminbi is pegged in a narrow range to the US dollar, while the PBC has maintained a fixed interest rate without change for over five years.
In fact, some bankers believe that stability is a bigger government priority than providing local banks time to increase their risk management and treasury expertise. “Stability takes priority over creating a more friendly environment for local banks,” says Anita Fung, director and head of trading for Asia-Pacific treasury and capital markets at HSBC in Hong Kong. However, she adds that the imminent arrival of foreign banks in 2006 means that this level of caution can only go so far. “Without local banks having a chance to survive, there will be no stability.”
But corporate pressure is helping to speed up development, says Kenneth Poon, head of trading and sales, global financial markets, China, at ABN Amro. “Corporate and institutional investors are not only interested in treasury products by choice, but by need,” he says. “With entrance into the WTO, international trade volumes and exposure to foreign currency will increase, so such customers will have to hedge their exposures,” adds Wong of Standard Chartered. “The process of allocation, recognition and management of risk for RMB, foreign exchange and interest rate products are required, and these inherent risks are being recognised by companies.”
As the large Chinese companies are becoming increasingly sophisticated, they are looking for more complex tools to hedge their underlying risks. “Traditionally, they only considered using the plain vanilla products available, simple interest rate swaps for example,” Fung says. “But now we see they are buying insurance against interest rate volatility using options.” Fung predicts that more companies will look at options, as they become more familiar with international practice, and become more adept at identifying underlying risk. This improvement, though, is likely to occur on a step-by-step basis, with companies unlikely to venture into products with which they have no experience.
It is not only Chinese companies that are looking to hedge in China. With increased opportunities for foreign firms within the Chinese market, there will be a greater demand from these institutions as well, says Gerald Chan, regional head of business development at UBS Warburg in Singapore. “We should be careful not to focus solely on Chinese companies,” he says. “Over the next five years or so, non-Chinese multinationals will increase their presence in China.” This will provide the opportunity for foreign banks to capture more business in China and could prove to be a significant aspect of foreign banks’ business, he adds.
Certainly, the strategy of foreign banks in China varies greatly. While foreign banks that are traditionally strong on the commercial banking side are looking to offer full services to companies and state-owned entities, as well as expanding their branch networks; a number of other investment banks are focusing on providing services to the local banks themselves. “In China, the end game for us is not to compete with Chinese banks, but to provide them with liquidity and services to allow them to better service their own clients,” says Seth Cohen, head of foreign exchange distribution at UBS Warburg in Singapore. As Chinese banks increase the level of business conducted with their domestic customers, foreign banks should be able to attract more business by wholesaling treasury products to them. “As the overall level of sophistication within the Chinese market increases, banks must continue to satisfy their clients’ needs as well as keep in touch with the most global and up-to-date best practices,” says Cohen.
Meanwhile, as foreign banks gear up for the opening of the Chinese markets, China’s banks are improving their systems and gearing up in expertise in order to compete with international banks and comply with international standards. But there are other more pressing issues, such as the enormous NPL ratios. Although banks are required to decrease NPL rates by two percentage points each year, they are still at very high levels. Wei Yen, vice-president and senior credit officer at Moody’s Investor Services in Hong Kong, estimates the average NPL ratio for Chinese banks at around 26%, but thinks this figure could be too low, because of the way NPLs are classified and measured in China. “The operating efficiency of Chinese banks is horrendous,” says Yen. “In the past, banks were self-contained entities in different regions with their own integrated suite of services and staff. As a result, the data centres of these banks are not compatible with each other.” Centralised loan classification systems are now being implemented, but it is a slow process to bring the whole network up to speed, he adds.
However, many of the banks – and certainly the big four – are improving their risk management, credit and treasury systems. According to ABN Amro’s Poon, the four banks have implemented and tested sophisticated treasury systems in Hong Kong, and are now applying the systems to their China operations. Bank of China, for instance, uses Reuters Kondor+, a trading and risk management system to measure credit and market risk, in its Hong Kong and Beijing offices. Meanwhile, CITIC Industrial Bank (China International Trust and Investment Corporation) implemented risk management software company SunGard’s Panorama program to integrate its forex, money market, fixed-income, and derivatives businesses in late-October last year.
Certainly, the big banks are now keenly aware of international best practice, says HSBC’s Fung. “The four major local banks in China have an extensive branch network. They are now prioritising the development of their treasury operations,” she says. “Essentially, they are trying to conform as much as possible to international standards, and they are looking at themselves as international banks.”
The banks are also beginning to expand their product range, and are keen to offer as many financial instruments as the regulators will allow, adds Poon. “The Chinese banks are very interested in offering many products and if the banks are allowed by the regulators they will provide all the products they can,” he says.
Consolidation of the Chinese banking sector would improve the services and products offered by Chinese banks, says Fung. “Economies of scale in technology, customer service and product development cannot be achieved unless there is reasonable consolidation in the banking industry,” she says. International banks, on the other hand, are also looking to take stakes in China’s smaller banks, and the PBC governor, Dai Xianglong, recently stated that China would welcome foreign investment of up to 25% in the country’s smaller financial institutions. Moody’s Yen cites the Bank of Shanghai as one institution being courted by every potential suitor. In fact, HSBC announced an agreement to acquire an 8% equity stake in the Bank of Shanghai in late December (see box below).
A domestic acquisition would appear to be crucial for foreign banks, because Chinese banks are expected to retain the vast majority of customer relationships in China, certainly in the early years. “Foreign banks might put some competitive pressure on the banks, but it will result in Chinese banks improving their product capabilities and their efficiency,” argues UBS Warburg’s Cohen. He believes that foreign banks may never compete with the local banks for small- to medium-sized corporate clients, as a host of concerns including credit, legal and compliance issues must first be addressed.
However, there should still be room for all in the Chinese market, as international banks can focus on providing their expertise and access to international networks to large companies, both private and state-owned, as well as to the local banks. Says Standard Chartered’s Wong: “I believe it will be a win-win situation for both foreign and Chinese banks. With leeway for the Chinese banks to catch up, the pace of improvements has, so far, been impressive. The market can only grow bigger, so there should be enough business to sustain both Chinese and international banks.”
HSBC’s recently-acquired 8% stake in China’s Bank of Shanghai makes it the first foreign-owned commercial bank to own an equity stake in a Chinese bank. The deal, announced in late December, cost the bank RMB517.92 million ($62.6 million), but gives HSBC a further foothold in the Chinese market through the Bank of Shanghai’s 196 branches in the city.
HSBC already has its own presence in the Chinese market, but is currently restricted to offering renminbi (RMB) products to multinationals and foreign joint ventures. But with regulations set to relax gradually following China’s accession to the World Trade Organisation (WTO) late last year, HSBC will be able to gain further exposure to the Chinese market through the Bank of Shanghai’s customer base. “We have to build up direct dealings with corporates,” says Anita Fung, director and head of trading, Asia-Pacific, treasury and capital markets in Hong Kong. “To do this we must strengthen our distribution network capabilities locally as well as strengthen links between the local distribution networks and our Asian networks.”
HSBC is currently one of only a handful of foreign banks to offer RMB services in both Shenzhen and Shanghai. While RMB-denominated derivatives are restricted, the bank can engage in RMB spot trading, the interbank market, Chinese government bond trading, and repo activities – amongst others – but only to the eligible, foreign-invested enterprises in Shenzhen and Shanghai. Banks with renminbi licences will be allowed to conduct RMB business with Chinese institutional clients in 2003, and Chinese individuals at the end of 2006, but the timetable for the opening of the derivatives market is still not known, says an HSBC official.
The bank also offers a foreign currency business including forwards and options, as well as foreign currency-denominated interest rate swaps, which up until China’s entry into the WTO had been restricted to the foreign-invested enterprises. Now, however, foreign banks can offer foreign currency products to Chinese corporates and individuals. And the stake in the Bank of Shanghai will allow HSBC to extend these non-local currency services to a larger pool of Chinese corporates.
HSBC says it is co-operating with Bank of Shanghai on training, technical and product expertise. Until regulations ease, it is regarding its investment as a “friendly co-operative relationship,” an official says. But the acquisition could also be construed as an insurance policy against delays in the opening of the Chinese market. “It is premature to comment on whether the opening of the financial service market in 2006 is really going to create a level playing field,” adds Fung. “The WTO accession agreement does not include full details of the opening up of financial services.”
Meanwhile, the bank has not stated whether it will acquire stakes in more Chinese banks. “We do not have a shopping list in China,” states the official. However, as other foreign, as well as large mainland banks, are likely to buy into the mid-size Chinese banks, further acquisition could well occur. “We will look at opportunities as they arise and regulations permit,” he adds.
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
You are currently unable to print this content. Please contact firstname.lastname@example.org to find out more.
You are currently unable to copy this content. Please contact email@example.com to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email firstname.lastname@example.org
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email email@example.com
Lawmakers expected to seek stronger customer protection; industry wants flexibility for DeFiReceive this by email