From Economist.com (registration required):
IT IS a staggering thought: communist China now has a bank more valuable than Barclays, American Express or Deutsche Bank, financial institutions at the heart of Western capitalism. At more than $66 billion following its initial public offering in Hong Kong on October 27th, China Construction Bank (CCB) boasts a larger market capitalisation than any of these three. CCB’s listing, which raised $8 billion from foreign investors for 12% of its shares, is the largest global flotation for four years, China’s biggest and the biggest ever for a bank.
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The real battle for bank reform will be won or lost in the branches. While reforms have changed much at head offices, they are hard to enforce elsewhere. Guo Shuqing, CCB’s new chairman, admitted shortly after he got the job, that “more than 90% of the bank’s risk managers are unqualified””a bold statement from a man wanting to list his company.
These are massive organisations to turn around, after all. CCB alone has 14,250 branches and 304,000 employees. Their historic decentralisation makes them especially hard to control. In a book to be published in November, Wu Jinglian, China’s most respected economist, notes that until a decade ago provincial branches of commercial banks borrowed funds directly from provincial offices of the central bank and lent them to local customers. They enjoyed “legal person status” and did not require authorisation from head office. Even today, big branches of ICBC have their own English-language websites”emphasising their independence. “Branch managers are kings in China,” concurs Frank Newman, an American who took over as chairman of SDB on behalf of Newbridge earlier this year.
At all banks there is a struggle between head office, which wants to centralise processes, and local staff who are in thrall to the demands of local officials and industrialists and who disobey their branch managers on whom they depend for their promotions at their peril. Unhelpfully, the branches are being monitored by a regulator that faces the same problems as its charges”too many unqualified staff spread too thinly. Han Mingzhi, head of the CBRC’s international department freely admits, “we lack people who understand commercial banking and microeconomics. It is a headache for the CBRC.” The result is that it will take China’s banks years to establish proper corporate governance, a genuinely commercial culture and hence decent profitability.
Meanwhile, strategic foreign investors are supposed to bridge the gap”with money, but especially with skills in risk management and advanced financial products. The lure of China’s high growth and huge population has triggered an astonishing stampede, attracting some $18 billion in foreign direct investment in China’s banks in one year. The first big deal was the $1.7 billion HSBC paid for a 19.9% stake in Bank of Communications (BoCom), the fifth-largest lender. Then came CCB. Since then, a consortium led by the Royal Bank of Scotland has put $3.1 billion into BOC, Temasek another $3.1 billion and Switzerland’s UBS $500m, while Goldman Sachs and Germany’s Allianz are investing in ICBC. Only Agricultural Bank, the Big Four bank with the deepest problems, has failed to attract a Western investor.
In return, the international banks get a cut-price entry ticket: Bank of America paid 1.15 times book value for its stake in CCB, which has now floated at almost twice book. They also gain access to a branch network and client list they could never afford to replicate, even after World Trade Organisation rules force China to open its domestic banking market fully from end-2006. Every deal is thus accompanied by a joint-venture in savings and insurance products and, of course, credit cards”the Chinese financial market that has every foreign investor salivating.
Only 12m of the 880m bank cards in China are genuine credit cards. So McKinsey, a management consultancy, predicts exponential growth from this segment, and profits of $1.6 billion by 2013. Yet McKinsey also notes that half of existing accounts are unprofitable. Chinese pay their bills in full each month, show little loyalty to brands and are unimpressed by foreign-backed offers. Ron Logan, head of HSBC’s credit-card venture with BoCom, says acquisition costs are soaring as competition heats up, with everything from DVD players and holidays used to entice customers, further eroding profits. Jean-Jacques Santini of BNP Paribas, which just bought one-fifth of Nanjing City Bank, warns investors: “expect to lose money on credit cards for the first three or four years.” The only way for investors to make decent returns in the short term is by betting on a big rise in post-IPO share prices. Everything else they take on trust.
A very Chinese welcome
Meanwhile, given limited ownership rules, foreign banks can have only a modest influence on strategy or operations at their Chinese partners. Newbridge is an exception since it has won genuine management control of SDB, which is small and has a widely dispersed ownership. HSBC’s vastly greater size compared with BoCom, means it might, in time, have a significant say. The rest are restricted to one or two board members each, while the appointment of senior management remains with the Communist Party. “Can China’s banks be fully reformed while staying under government control? I doubt it,” says Mr Marshall.
To reform its banks properly, China must allow foreign takeovers. And its banks must be allowed to merge and fail. Yet even if Beijing raises cumulative foreign-ownership limits above the current 25% next year, as the CBRC expects, it is unlikely to relinquish control of a major bank. Worryingly, the CBRC seems ambivalent about foreign participation. Mr Han says he doubts the wisdom of raising the ceiling on foreign investment “if we don’t get something in return”. Yet as banks in Poland and the Czech Republic discovered, preventing foreign takeovers simply delays bank reform and means more costly bail-outs. A stockmarket listing cannot really help while the state remains in charge: minority investors can do little to change poor corporate governance or influence strategy.
Instead, China is gambling on going it alone. By rushing poorly reformed banks to market and sucking in a bit of money and know-how (not to mention greater scrutiny) from foreign investors, it hopes to improve them sufficiently and sufficiently rapidly before the economy runs into a headwind. The size of that gamble should not be underestimated.
