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| Which way next? A Bank of China poster in Beijing. Royal Bank of Scotland this year sold its stake for $2.4bn |
When Bank of America was negotiating to take a stake in China Construction Bank four years ago, advisers who worked on the investment gave it the code name “Project Solidgold”.
Yet the landmark “strategic” relationship between the US and Chinese lenders has conspicuously failed to glister. BofA was among a wave of overseas financial institutions that in recent weeks sold down their holdings in their Chinese counterparts as soon as lock-in periods expired.
The stake sales, driven largely by the foreign banks’ urgent need for capital, have angered China – prompting fears that the fallout will hamper the scope granted to overseas banks in the mainland financial services market for years to come.
“The institutions that bought stakes in Chinese banks with promises of helping them to improve their risk management, but later crashed out, will not be seen positively in China,” says Andrew Crockett, president of JPMorgan Chase International and former head of the Bank for International Settlements, the central bankers’ bank.
Some are going further than simply reducing their holdings. The UK’s Royal Bank of Scotland, which in January sold its entire $2.4bn (€1.7bn, £1.45bn) stake in Bank of China to raise capital, is in the process of selling its mainland retail and commercial operations.
Bankers and bureaucrats in Beijing and Shanghai warn that, as a result of the U-turn, groups such as RBS will struggle to regain their positions in the country if in the future they wish to return to what is set to become one of the world’s most important banking markets over the next decade. Indeed, building a significant presence in China is likely to be crucial in determining who will be in the vanguard of the next group of truly global financial institutions.
BofA and RBS were among a number, also including UBS and Citigroup, which in 2005 and 2006 together spent tens of billions of dollars accumulating stakes in China’s largest banks. The state-owned banking system was technically insolvent and its institutions riddled with bad debts and outmoded lending practices.
Chinese authorities thought allowing in overseas investors would help to recapitalise its banks, modernise risk management and bolster sentiment ahead of planned initial public offerings by the top lenders.
At the time, foreign retail banks – even those with deep roots in the region, such as HSBC – were not permitted to incorporate their mainland operations locally, which severely restricted their ability to offer local currency products to business and individual customers. They saw the investments in domestic banking groups as a bridgehead to joint ventures, in areas such as credit cards, which would help them reach tens of millions of new customers.
But then came the west’s financial crisis and the starkest of turnrounds in fortunes. Today the three largest banks in the world by market capitalisation are all Chinese and there is little appetite in Beijing for whatever the humbled giants of Wall Street, London and Zurich are trying to offer.
“The strategic aspect of these deals was always overstated,” says Lonnie Dounn, formerly of HSBC in Asia but who in 2005 was named chief credit officer of Bank of China, becoming the first foreigner to hold a senior executive position at a top mainland lender. “The Chinese banks did not want to give the foreign banks access to their best customers and the foreign banks did not, going in, have clear strategies for the Chinese market,” says Mr Dounn, who is no longer with BoC.
Yet while the strategic element proved largely illusory, the deals did benefit both sides. The foreign investors have made handsome paper gains of up to three times their outlay, while the Chinese lenders each had successful stock market listings. Industrial and Commercial Bank of China, now the world’s biggest bank by deposits, raised $22bn in a dual listing in Hong Kong and Shanghai in October 2006 – which remains a world record for an IPO.
ICBC’s cornerstone investors were Goldman Sachs, American Express and Allianz, the German insurer. Goldman last month sold one-fifth of its 5 per cent holding for $1.9bn, five weeks after Amex and Allianz together raised the same amount by offloading half of their stakes. BofA sold 10 per cent of CCB for $10bn. It retains another 10 per cent, most of which BofA must hold until 2011.
So will Beijing’s annoyance, or indeed public disenchantment with western-style banking, negatively affect the wider landscape for overseas institutions that remain keen to grow on the mainland? In December 2006, foreign banks were finally allowed to incorporate locally. This change in status, taken up by 26 banks to date, has allowed them to offer retail banking services through local subsidiaries. Foreign banks at present account for just 2.2 per cent of total nationwide banking assets, although the figure is higher in the bigger cities and is rising slowly.
The likes of HSBC and Citigroup have built branch networks, of around 40 outlets each, concentrated in the largest urban centres. Groups such as RBS opted instead to boost business through joint venture agreements spanning credit cards and wealth management. Such ventures have had mixed results, however, with insiders describing each side as suspicious of the other’s motives.
“The two traditional weapons that foreign banks have used to penetrate Asian retail banking markets – wealth management and credit cards – are harder to use in China,” says Emmanuel Pitsilis, Hong Kong-based senior partner of McKinsey, the consultancy. Entrusting family wealth to a foreign money manager remains a leap too far for many Chinese, while the crisis has greatly reduced not only the attraction but also the availability of products engineered by western banks to try and part the wealthy from their assets.
China lacks a welfare safety net and savings rates are high to pay for unforeseen healthcare and education costs. Relatively few fail to pay off their monthly credit card balance, lest they pay high interest charges. The Chinese overwhelmingly prefer debit cards, a position that suits domestic lenders with huge branch networks because they can charge an annual fee for their use. Predictions by bankers at RBS and elsewhere that the take-up of credit cards could reach hundreds of millions within a decade now appear way off the mark.
Foreign investment banks, too, have struggled to make an impact. Until recently only Goldman Sachs and UBS were permitted to operate securities joint ventures able to undertake lucrative stock trading and IPO work.
While progress for foreign banks has been slow, the Chinese market remains a huge growth opportunity for foreign banks – assuming regulations and conditions allow. According to McKinsey, one-third of the increase in global financial services revenue in 2007-12 will come from China, or close to $200bn of the $600bn in estimated growth. “Foreign banks are likely to be more successful in focusing in niche product areas or geographies and not trying to compete on scale with domestic lenders,” says McKinsey’s Mr Pitsilis.
Analysts say products relating to corporate and investment banking remain a profitable niche for overseas banks. These include activities that serve the everyday needs of China’s army of multinational companies – such as cash management and foreign exchange, areas where domestic expertise remains relatively weak.
Those foreign groups crushed by the financial crisis and rescued by their governments, including RBS, Citi and BofA, are not expected to commit significant resources to expand their China business any time soon. This could open opportunities for rivals such as HSBC and Standard Chartered, which are seen to have built their mainland businesses methodically and in a more disciplined manner. HSBC’s tie-up with Bank of Communications is widely hailed as a model partnership, with the western lender helping to improve the mainland bank’s risk management, marketing and technology.
The shake-up in the pecking order of global banks has left Canadian, Australian, Spanish and Italian lenders relatively well placed to enlarge their global footprint – and each of those countries’ leading banks are woefully under-represented in China. From the US, JPMorgan Chase is also perceived to have had a “good” financial crisis, though it too has a limited presence in mainland’s retail and investment banking. “We are bullish on China over the long term but we are not rushing into things at the moment,” says JPMorgan’s Mr Crockett. “However, there will be major initiatives in the longer term.”
But how much the likes of JPMorgan or Spain’s Banco Santander will be allowed to expand in China ultimately depends on the political mood in Beijing. Policymakers have been left unimpressed by the near-death experience of the western banking system, which Liu Mingkang, the country’s top banking regulator, this week in the Financial Times attributed to overleverage, financial engineering and a short-term focus on compensation.
“Just four or five years ago, the Chinese banks were all being shouted at and told they were useless. Now they are asking what they are supposed to learn from western banks,” says David Eldon, former chairman of HSBC in Asia, who oversaw the bank’s re-entry to the mainland market after a near 50-year absence.
As a result of the crisis, western bankers expect the Chinese authorities to be ultra-cautious about allowing more foreign banks access to the market or to expand their branch networks or product ranges. The only thing that may prompt regulators to go easy is the danger that the efforts of China’s own banks to expand overseas might be frustrated by reciprocal constraints. Chinese lenders are keen to expand their global presence to service cross-border trade and are eyeing acquisitions of small banks in Asia and beyond.
Shanghai is also keen to project itself as a global financial hub, a position it cannot credibly attain without a large presence of overseas financial institutions. “Foreign banks in China hold the view that their limited market share would have to be expanded significantly if Shanghai is to achieve its goal of becoming an international financial centre,” says Mervyn Jacob, PwC’s top financial services consultant for China.
Domestic banks have been on a lending splurge in recent months, amid government-directed efforts to stimulate the economy, further eroding the market share of overseas rivals in areas such as corporate loans. Despite slower economic growth and strains in important sectors such as steel, property and exports, top mainland banks boast improving asset quality and profits.
Many believe this rosy scenario cannot be maintained for much longer. Some bankers contend, however cheekily, that while Beijing can barely contain its gloating over the failures of the Anglo-Saxon banking model, it might not be too long before it again calls on the west to provide capital and expertise.
While investment banks such as Goldman Sachs and UBS made financial investments in Industrial and Commercial Bank of China and Bank of China respectively, two overseas retail banks went one step further – with mixed experiences.
At the end of last year, Bank of America held a 20 per cent stake in China Construction Bank, while the UK’s Royal Bank of Scotland held 5 per cent of Bank of China. Both foreign banks were rescued by their governments at the height of the financial crisis – and BofA this year offloaded half its stake and raised $10bn, while RBS pocketed $2.4bn by selling its BoC holding.
They had hoped the investments would help in their aim to become significant lenders to Chinese clients. But what was supposed to be the start of a beautiful relationship never went to plan.
At BoC, selected RBS staff turned up in early 2006 and set about helping it establish risk management procedures, a credit card business, insurance products, marketing operations and various other trappings of modern retail banks. The foreign bankers had drivers and fancy apartments but complained that the pace of life and work was too slow, that the Chinese listened politely and then ignored every bit of advice they had to offer and that they had no idea what was really going on at BoC.
The Chinese complained they had not been sent the brightest star talent they expected RBS to provide. To the Chinese, the foreigners were vastly overpaid and few if any understood the Chinese language or the nation’s culture. After a little over a year, most of the RBS people were holding their farewell parties and heading back to London.
While RBS has exited its financial investment, BofA cannot sell most of its remaining 10 per cent stake in CCB for another 18 months. But there is constant speculation surrounding its long-term commitment to CCB.
CCB executives insist they have been repeatedly assured by BofA that the US bank intends to remain the second largest shareholder after the Chinese state. “They earn a lot of money because we give them a big dividend,” Guo Shuqing, CCB chairman (above), told the Financial Times in a recent interview. “This is a typical example of a Sino-US joint venture company.” However, according to one CCB board member, “CCB is constantly anxious about how long their cornerstone investor [BofA] will stay in there.”
Mr Guo insists that China has benefited from allowing foreign lenders to buy stakes. “The experience has been different from bank to bank but in general it was a correct choice we made in banking reform by introducing investors and leading international banks – at least they were leading banks at that time – to be involved in our restructuring and reform,” according to Mr Guo.
He adds: “They had very professional management and market operations ... They still have a lot of expertise we should learn from them and get that.”
