The Decline of Foreign Banks in China

Market, page 17, issue 465, April 26, 2010
Translated by Tang Xiangyang
Original article: [Chinese]

According to the International Financial Market Report released by the People's Bank of China in April, the market share of foreign banks in China fell from 2.16 percent in late 2008 to 1.71 percent by the end of 2009, and their currency and bond market share decreased by 8.21 percent on the level of last year.

These statistics contradict the widely held fear among Chinese banks when their foreign counterparts poured into China in 2007 and their employees were lured away by foreign banks. Now, those talented individuals are returning and individual Chinese clients appear to place less trust in foreign banks.

While the amount of new yuan-denominated bank loans almost hit ten trillion yuan last year, those issued by foreign banks only accounted for 1.8 billion yuan of the total.

Now many foreign banks are beginning to pay more attention to their strengths, such as investment banking services, financial consulting and acting as business intermediaries.

Reputation at Risk

In 2005, the State Street Bank, the biggest trustee bank in America, founded a Beijing representative office. Lu Xiaoma, leading representative of the State Street Bank's China division, said to his boss before leaving America for China, "China has entered an era of fast development and there is going to be a financial party. We have to book a seat at the table."

By the end of 2009, banks from 13 countries and regions had founded 33 foreign-owned banks in China, two jointly-owned banks, and two foreign-owned financial companies; 24 countries and regions set up 71 bank branches in China and 194 banks from 46 foreign countries and regions had established 229 representative offices.

Abiding by the terms of its entry into the WTO, China also opened up the domestic RMB retail banking market to foreign banks.

Foreign banks underestimated the speed at which Chinese banks could catch up and learn from their foreign counterparts, especially in regard to the battle for retail banking.

Because foreign banks lack a competitive edge in long or medium-term loans, their desire to acquire medium to long term deposits was also not as strong.

A source from a foreign investment bank said, foreign banks generally help their clients diversify their deposits into financial products. This reduces interest expenses and lowers banking risks, in turn adjusting their business structure so that they shift away from a reliance on profits gained from the discrepancy between the interest charged on deposits and credit towards a profit model based on the intermediary services they provide.

When they first entered the market, foreign banks attracted China's elite. Over time, various structural financial products designed by foreign banks were introduced in to the Chinese market, when a Dutch bank offered a series of lectures on financial management they were very popular.

Mr Li is a financial management fanatic. He believes in "never putting all your eggs in one basket" and bought a structured financial product at a price of one million yuan from a foreign bank and was very pleased with the bank's service. But in 2008, as the world financial crisis broke out, the value of his product shrunk to only 360,000 yuan. The bank told Mr Li that when they recommended the structured financial product to him they thought he was a "aggressive investor". The damages from this purchase to his financial assets were disastrous.

From that point on, Mr Li began regarding all financial management products with contempt; he is not the only one who feels this way. Many people became increasingly alarmed by the various "services" offered by foreign banks.

With the financial crisis and the huge losses on various wealth management products that came with it, the reputation of foreign banks in China suffered as never before. Elite clients are, one-by-one, returning to Chinese banks.

Talented banking employees are returning to Chinese banks as well.

Some high-level executives who felt confined when working within the comparatively small business scope of foreign banks are gradually heading to work for Chinese banks. Recently, Zhang Hongli, former president of Deutsche Bank's global banking business (Asian and Atlantic division) and chairman of its China division, joined the Industrial and Commercial Bank of China (ICBC) as vice president.

Mid-level executives returning to Chinese banks can be found everywhere. One who formerly switched from the Industrial and Commercial Bank of China (ICBC) to a foreign bank has recently joined Bohai Bank; an HSBC department head has left and gone to China Minsheng Bank; and a senior vice president of Standard Chartered Bank is now a chief investment officer at the private China Minsheng Bank.

"Foreign banks are less human and they have a limited business scope. As the salaries provided by Chinese banks increase and the banks become more competitive, the lure of foreign banks is fading," a staff member of the French bank, Société Générale, stated.

Difficulties Entering the Mainstream Credit Business

Chinese banks still derive most of their profits from the spread between interest rates on deposits and loans.

The net income from interest contributed to 79.4 percent, 79.3 percent, 68.4 percent and 82.3 percent of the total revenue of ICBC, Construction Bank of China, Bank of China and Communications Bank of China respectively in 2009.

"When conducting loan business, banks are fighting over quality clients instead of competing over market share. Foreign banks do not have access to those big clients," a source from ICBC said.

Foreign banks are unable to contend with Chinese state-owned banks who service many of these wealthy individuals. Up until the end of 2009, foreign banks had issued 720.4 billion yuan in loans, accounting for 1.7 percent of the total loans of all financial institutions in China. The deposit balance of foreign banks was 701.8 billion yuan.

The EO has obtained data about the amount of new loans granted by foreign banks at the end of each quarter of 2009. In March 2009, the amount of renminbi-denominated loans issued by foreign banks declined by 26.4 billion yuan which was the first time the amount of new loans had decreased since 2005. The amount of new renminbi-denominated loans continued to decline by 32.7 billion yuan in June and a further 6.5 billion yuan in September, before increasing by 1.8 billion yuan in December 2009.

Wen Chunling, banking analyst with Fitch Ratings, does not believe the current loan business model of foreign banks will fundamentally change in the near future.

Henry, an analyst with BNP Paribas, said foreign banks have to expand the number of branches they have and also their deposit base which requires large-scale investment.

Currently, foreign banks mainly depend on China's inter-bank market to meet demand for liquidity.

Though foreign banks, including HSBC, Standard Chartered Bank and Citibank, have opened branches in China's main cities and some wealthy rural areas, their business network and client base remains weak.

A high-level executive of a foreign bank said its branches in western China were merely ornamental.

Wu Jingzhu, leading representative of NORD/LB's Beijing representative office, attributed the failure of foreign banks to expand in China to, "serious errors in allocation of funds, restrictions on the scale of loans, comparatively small registered capital, having a parent-bank trapped in the financial crisis, conservativeness, and having a risk management system stricter than that of Chinese banks".

Lin Tianfu is the managing director of the Standard Chartered Bank's Chinese financial management department for small and medium-sized enterprises. He admitted that, "Standard Chartered has not accepted any third party guaranteed loans." His major fear lies in the quality and lack of supervision of the numerous bond companies; this fear has led to foreign banks losing a large proportion of potential Chinese credit customers.

Compared with Chinese state-owned banks, foreign banks also lack competitiveness and can only compete for comparatively small loan projects with higher risks. They can not gain support from their parent banks who are suffering from a shortage of adequate capital.

According to Guo Tianyong, director of the Central University of Finance and Economics banking research center, foreign banks are restrained.

"The cost of developing a new client is very high. Foreign banks must first conduct a thorough investigation of their potential client. Furthermore, they may not be familiar enough with the conditions of doing business in China and thus can not communicate as effectively with Chinese enterprises and government departments as their Chinese counterparts do, which inevitably leads to their marginalization in the credit market."

"In China, the traditional business for commercial banks calls for big investment and takes a long time to regain costs. There are no short cuts; banks have to first gain clients and projects."

Attaching Importance to Investment and Intermediary Services

Though the reputation of structured financial products has been tarnished by the global financial crisis, foreign banks are still fond of them and plan to promote them as the world economy recovers. "[Foreign banks] at least have an advantage in terms of diversifying investment channels," an analyst with the Minsheng Securities said.

In China, foreign banks are in a more dominant position in the non-loan business field than they are in the loan business sector. "Non-loan business is more profitable and less risky. Intermediary business is the focus of competition for foreign banks, specifically over market share," Guo Tianyong said.

The services offered by investment banks has been imitated by Chinese banks for the past few years. Foreign banks hope to expand their overseas resource network in order to develop their investment banking operations.

Currently there is a gradually rising wave of  overseas merger and acquisitions being pursued by Chinese enterprises. The total value of such M&A activity has reached 11.6 billion US dollars in the first quarter of this year, rising by 863 percent on the level of the same period last year and creating a new record single quarter growth rate.

A source with Sinopec said, the more international a company is, the more they will be willing to cooperate with foreign banks because they need their help when doing business abroad. While Chinese banks like ICBC might need a long time to build an international network, Citibank, HSBC and other foreign banks have branches in over one hundred countries. They have built this up over the past two hundred years, it's impossible for Chinese banks to catch up with them in just one or two years.

Chinese enterprises produced an investment bank revenue of 731 million US dollars through the capital market and M&A activity in the first quarter of 2010, a six fold increase on that amount produced in the same period last year- creating a new record.

According to a high-level executive with Royal Bank of Scotland (RBS), RBS will completely give up its Asian retail business and switch its focus to investment banking.

Foreign banks are also trying to increase their strength in the field of financial consulting.

Now more and more foreign commercial banks are beginning to pay more attention to offering investment banking  and financial consulting services.

Based on incomplete data, 70 percent of the income of foreign banks in China comes from domestic business clients.

“We are producing complicated and innovative products to survive. Local enterprises, especially those who want to develop an international business and have high financial demands, are very important to us. This is our strategy and these are the clients we will be targeting in the coming five years," a high-level executive with Citibank told an EO reporter in March.

The EO learned from the National Association of Financial Market Institutional Investors that foreign banks, including Citibank and JP Morgan, are working hard to get authorization to sell short-term financing notes and medium-term bills.

Guo Tian Yong said, "It's still difficult for foreign banks to adapt to the local environment, obtain Chinese clients and fully compete with Chinese banks. Only when the large amount of bad loans Chinese banks have granted are exposed, will foreign banks be able to prosper in China."

This article was edited by Rose Scobie

Image:Wall Street Journal