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foreign banking in China
Man-kwong Leung Assistant Professor of Financial Services Hong Kong Polytechnic University Hong Kong, PRC
o sustain the growth momentum resulting from the ambitious economic reform program undertaken in late 1978, the government of the People's Republic of China (PRC) has been trying, among other things, to reform the banking sector, which has failed to raise and supply capital efficiently. Scarce capital has been allocated to relatively inefficient and loss-making state-owned enterprises (SOEs), while small and medium-sized firms have often been denied the funds. At this juncture, foreign capital from or through international banks has bridged the gap between savings and investment. Foreign banks, entering China mainly to follow and serve their clients from home countries, have been restricted to foreign currency business--until recently. Now that China is soon to accede to the World Trade Organization (WTO), foreign banks will be presented with new and growing opportunities to exploit the vast local currency (Rmb) markets.*
T
Growth of Foreign Banks To facilitate the growth of foreign trade and direct investment, China first allowed foreign banks to set up representative offices to engage in liaison service in Beijing soon after the reform program started. Since 1985, foreign banks have been allowed to engage in foreign currency business as branches in special economic zones and selected cities. Foreign banks in general have competitive edges in the areas of financial soundness, risk management, and financial innovations. Several advantages are specific to both ownership and location. *7he Chinese unit ( f currenc~, is called R e n m i n b i D~a,e, or Rml).
Executive Briefing / Foreign Banking in China
In the Chinese context, ownershipspecific advantages mainly take the form of specialized knowledge and relationships with the government and customers in the PRC. Location-specific advantages include the extent of business opportunities and the degree of political stability of the Chinese economy. Moreover, a foreign bank is in a better position to evaluate investment projects and protect the confidentiality
With China joining the WTO, the prospects for foreign banks there keep brightening. of information about its clients' projects from its competitors. And it incurs lower costs of monitoring borrowers' behavior. Thus, a physical branch in China has emerged as the best "institution" for internalizing the country's various advantages. To protect domestic banks and control money supply and foreign debt, China's government has carefully controlled and monitored the entry and scope of foreign banks' operations. Despite these barriers, however, foreign banks have grown in response to more total trade and the improving political stability of the Chinese economy. By the end of 1999, China had a total of 74 foreign banks from 18 countries, with 161 branches in 22 cities.
Restricted Role Asian banks, mostly from Japan, Hong Kong, Korea, and Singapore, accounted for more than half the total number of foreign banks in China as of December
1999, reflecting the high level of trade and direct investment between China and Southeast Asia. Other non-Asian banks that have established a large network of operations in Hong Kong, such as HSBC, Standard Chartered, Citibank, Chase, and Bank of America, have adopted a multibranch strategy in China and maintain a competitive edge. Their success may reflect the importance of cultural and geographic advantages, which help generate savings in information and negotiation costs when undertaking business in China. Although the growth of foreign banks has been rapid, their penetration in the PRC market is still very limited due to restrictions on branching and Rmb business. At present, the total assets of foreign banks in the Chinese banking system comprise only about 2.5 percent of the country's total, and the number of foreign bank branches represents about 1.5 percent.
~1~ Large, Untapped Market Nearly all foreign banks in China have provided loans to joint ventures and engaged in trade finance. Loans to PRC enterprises and project financing are other important lines of business. The key motive in entering the Chinese market is to follow customers in trade and investment. A fairly typical example is the Chase Manhattan Bank, which set up its first branch in Tianiin in 1993 to service its major corporate client, Motorola. which had moved into this market. In March 1997, the New Pudong area of Shanghai was designated as the first location to allow foreign banks to engage in Rmb business, though on a very restricted basis. Those banks can undertake local currency business only with joint ventures in Shanghai, how3
ever; consumer banking with Chinese citizens is prohibited. Selected foreign banks in Shenzhen have also been allowed to engage in Rmb business since August 1998. China's central bank, the People's Bank of China (PBOC), has allowed foreign banks to increase their Rmb deposits in proportion to their foreign exchange deposits from 35 to 50 percent since July 1999. They are also granted access to interbank markets for Rmb funds. At the same time, the PBOC loosened geographical restrictions on foreign banks' operations. Those originally located in Pudong can now also do local currency business with joint ventures in the adjacent provinces of Jiangsu and Zhejing. The Shenzhenbased foreign banks can do business in Hunan, Guangzi, and Guangdong. According to an agreement between China and the United States in November 1999 and one between China and the EU in May 2000 over China's accession to the WTO, the market segmentation between domestic and foreign banks is to be gradually eliminated. Foreign banks will be able to conduct Rmb business with Mainland firms and citizens in phases after China's WTO entry. Geographical restrictions will also be lifted. With a much wider participation in the once highly protected banking sector, foreign banks are going to find new and growing business in the evolving PRC economy.
Developments in the B a n k i n g Infrastructure
have subsequently been formed to meet the flourishing, diversified economy. In 1994, three policy banks were created to help reduce the state-directed lending of state commercial banks. The legal framework aimed at facilitating banking operations on a market principle was also formalized with the enactment of the Central Bank Law and the Commercial Bank Law in 1995. Asia's recent financial crisis underpinned the need for expediency in Chinese banking reforms. Emphasis has been placed on the risk management system in banks by introducing an international loan classification system and complying with asset and liability ratio requirements. To address the problem of highlevel, nonperforming loans of domestic commercial banks, the Chinese government has pressed ahead with shareholding reform on SOEs. Many SOEs have adopted corporate governance and management structures in a bid to increase their production efficiency. In addition, four asset management companies were set up in 1999 to purchase the nonperforming loans of SOEs from the major state commercial banks. The asset management companies will swap the debt for the equities of the SOEs. Finally, to forestall the influence of local governments over its supervisory role, in January 1999 the PBOC replaced its 31 main branches in provinces, autonomous regions, and municipalities with nine regional offices, along the lines of the U.S. Federal Reserve System.
Promising Prospects, But... To form a more stable, competitive, and well-regulated banking market for foreign banks, China has initiated a series of policy actions. Its banking reforms began with the reinstatement of various previously established banks and the formal establishment of the PBOC as the nation's central bank in 1983. New national and regional commercial banks
4
With China's accession to the WTO, the prospects for foreign banks are promising. First, with current operations accounting for only a tiny segment of the PRC banking market, there is still much room for foreign banks to grow. Second, both trade and direct investment in China are expected to increase, pro-
viding more and more foreign currency business. Third, given continued economic growth, the rising number of enterprises with modern corporate governance, and China's huge population, opportunities for local currency business will virtually explode. Large Chinese enterprises are likely to be the main customer group for both state commercial banks and foreign banks in terms of local currency business. Retail markets in Rmb loans for mortgage, credit cards, cars, and education are still in their infant stage and certainly offer a large and untapped future market for foreign banks. In view of the increasingly liberalized environment, foreign banks might be able to exploit their comparative advantages to a much greater extent. However, they should carefully examine the risk implications for credit, liquidity, interest rate, and foreign exchange when operating in the domestic currency markets. To capitalize on the burgeoning business opportunities in China, foreign banks should be prepared to invest in information and delivery technology to compensate for their lack of adequate branches. More important, to further offset the protection and inherent advantages enjoyed by Chinese banks, they should adopt a localization policy by employing people who have previously worked in Chinese banks, as well as graduates from prestigious Chinese universities (presumably with a postgraduate education in Europe or the United States). Such actions can help foreign banks establish proprietary relationships and networks with clients, enterprises, and various government officials more effectively. ~3
The author wishes to acknowledge the financial support from a grant provided by the Hong Kong Polytechnic University.
Business Horizons / November-December2000
o sustain the growth momentum resulting from the ambitious economic reform program undertaken in late 1978, the government of the People's Republic of China (PRC) has been trying, among other things, to reform the banking sector, which has failed to raise and supply capital efficiently. Scarce capital has been allocated to relatively inefficient and loss-making state-owned enterprises (SOEs), while small and medium-sized firms have often been denied the funds. At this juncture, foreign capital from or through international banks has bridged the gap between savings and investment. Foreign banks, entering China mainly to follow and serve their clients from home countries, have been restricted to foreign currency business--until recently. Now that China is soon to accede to the World Trade Organization (WTO), foreign banks will be presented with new and growing opportunities to exploit the vast local currency (Rmb) markets.*
T
Growth of Foreign Banks To facilitate the growth of foreign trade and direct investment, China first allowed foreign banks to set up representative offices to engage in liaison service in Beijing soon after the reform program started. Since 1985, foreign banks have been allowed to engage in foreign currency business as branches in special economic zones and selected cities. Foreign banks in general have competitive edges in the areas of financial soundness, risk management, and financial innovations. Several advantages are specific to both ownership and location. *7he Chinese unit ( f currenc~, is called R e n m i n b i D~a,e, or Rml).
Executive Briefing / Foreign Banking in China
In the Chinese context, ownershipspecific advantages mainly take the form of specialized knowledge and relationships with the government and customers in the PRC. Location-specific advantages include the extent of business opportunities and the degree of political stability of the Chinese economy. Moreover, a foreign bank is in a better position to evaluate investment projects and protect the confidentiality
With China joining the WTO, the prospects for foreign banks there keep brightening. of information about its clients' projects from its competitors. And it incurs lower costs of monitoring borrowers' behavior. Thus, a physical branch in China has emerged as the best "institution" for internalizing the country's various advantages. To protect domestic banks and control money supply and foreign debt, China's government has carefully controlled and monitored the entry and scope of foreign banks' operations. Despite these barriers, however, foreign banks have grown in response to more total trade and the improving political stability of the Chinese economy. By the end of 1999, China had a total of 74 foreign banks from 18 countries, with 161 branches in 22 cities.
Restricted Role Asian banks, mostly from Japan, Hong Kong, Korea, and Singapore, accounted for more than half the total number of foreign banks in China as of December
1999, reflecting the high level of trade and direct investment between China and Southeast Asia. Other non-Asian banks that have established a large network of operations in Hong Kong, such as HSBC, Standard Chartered, Citibank, Chase, and Bank of America, have adopted a multibranch strategy in China and maintain a competitive edge. Their success may reflect the importance of cultural and geographic advantages, which help generate savings in information and negotiation costs when undertaking business in China. Although the growth of foreign banks has been rapid, their penetration in the PRC market is still very limited due to restrictions on branching and Rmb business. At present, the total assets of foreign banks in the Chinese banking system comprise only about 2.5 percent of the country's total, and the number of foreign bank branches represents about 1.5 percent.
~1~ Large, Untapped Market Nearly all foreign banks in China have provided loans to joint ventures and engaged in trade finance. Loans to PRC enterprises and project financing are other important lines of business. The key motive in entering the Chinese market is to follow customers in trade and investment. A fairly typical example is the Chase Manhattan Bank, which set up its first branch in Tianiin in 1993 to service its major corporate client, Motorola. which had moved into this market. In March 1997, the New Pudong area of Shanghai was designated as the first location to allow foreign banks to engage in Rmb business, though on a very restricted basis. Those banks can undertake local currency business only with joint ventures in Shanghai, how3
ever; consumer banking with Chinese citizens is prohibited. Selected foreign banks in Shenzhen have also been allowed to engage in Rmb business since August 1998. China's central bank, the People's Bank of China (PBOC), has allowed foreign banks to increase their Rmb deposits in proportion to their foreign exchange deposits from 35 to 50 percent since July 1999. They are also granted access to interbank markets for Rmb funds. At the same time, the PBOC loosened geographical restrictions on foreign banks' operations. Those originally located in Pudong can now also do local currency business with joint ventures in the adjacent provinces of Jiangsu and Zhejing. The Shenzhenbased foreign banks can do business in Hunan, Guangzi, and Guangdong. According to an agreement between China and the United States in November 1999 and one between China and the EU in May 2000 over China's accession to the WTO, the market segmentation between domestic and foreign banks is to be gradually eliminated. Foreign banks will be able to conduct Rmb business with Mainland firms and citizens in phases after China's WTO entry. Geographical restrictions will also be lifted. With a much wider participation in the once highly protected banking sector, foreign banks are going to find new and growing business in the evolving PRC economy.
Developments in the B a n k i n g Infrastructure
have subsequently been formed to meet the flourishing, diversified economy. In 1994, three policy banks were created to help reduce the state-directed lending of state commercial banks. The legal framework aimed at facilitating banking operations on a market principle was also formalized with the enactment of the Central Bank Law and the Commercial Bank Law in 1995. Asia's recent financial crisis underpinned the need for expediency in Chinese banking reforms. Emphasis has been placed on the risk management system in banks by introducing an international loan classification system and complying with asset and liability ratio requirements. To address the problem of highlevel, nonperforming loans of domestic commercial banks, the Chinese government has pressed ahead with shareholding reform on SOEs. Many SOEs have adopted corporate governance and management structures in a bid to increase their production efficiency. In addition, four asset management companies were set up in 1999 to purchase the nonperforming loans of SOEs from the major state commercial banks. The asset management companies will swap the debt for the equities of the SOEs. Finally, to forestall the influence of local governments over its supervisory role, in January 1999 the PBOC replaced its 31 main branches in provinces, autonomous regions, and municipalities with nine regional offices, along the lines of the U.S. Federal Reserve System.
Promising Prospects, But... To form a more stable, competitive, and well-regulated banking market for foreign banks, China has initiated a series of policy actions. Its banking reforms began with the reinstatement of various previously established banks and the formal establishment of the PBOC as the nation's central bank in 1983. New national and regional commercial banks
4
With China's accession to the WTO, the prospects for foreign banks are promising. First, with current operations accounting for only a tiny segment of the PRC banking market, there is still much room for foreign banks to grow. Second, both trade and direct investment in China are expected to increase, pro-
viding more and more foreign currency business. Third, given continued economic growth, the rising number of enterprises with modern corporate governance, and China's huge population, opportunities for local currency business will virtually explode. Large Chinese enterprises are likely to be the main customer group for both state commercial banks and foreign banks in terms of local currency business. Retail markets in Rmb loans for mortgage, credit cards, cars, and education are still in their infant stage and certainly offer a large and untapped future market for foreign banks. In view of the increasingly liberalized environment, foreign banks might be able to exploit their comparative advantages to a much greater extent. However, they should carefully examine the risk implications for credit, liquidity, interest rate, and foreign exchange when operating in the domestic currency markets. To capitalize on the burgeoning business opportunities in China, foreign banks should be prepared to invest in information and delivery technology to compensate for their lack of adequate branches. More important, to further offset the protection and inherent advantages enjoyed by Chinese banks, they should adopt a localization policy by employing people who have previously worked in Chinese banks, as well as graduates from prestigious Chinese universities (presumably with a postgraduate education in Europe or the United States). Such actions can help foreign banks establish proprietary relationships and networks with clients, enterprises, and various government officials more effectively. ~3
The author wishes to acknowledge the financial support from a grant provided by the Hong Kong Polytechnic University.
Business Horizons / November-December2000