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Banking on China
By: Jim Trippon
Only six years ago, China expert Gordon Chang declared that China's banks were doomed to imminent collapse, an event that would bring the entire Chinese economy to its knees. Chang's book on the subject was widely read and entirely wrong. I have been on record for years predicting the very opposite: that China will experience an unprecedented economic boom, ultimately creating the largest economy in the world. In the process its banks will become worldwide financial giants.
All
of this is coming to pass, and it is happening much sooner
than one might think. China's nascent banking and financial
system has already begun to reach around the planet, exerting
global influence that will inevitably rival America's greatest
investment and retail banks. Citigroup and Goldman Sachs will
be obliged to take their place alongside the likes of the
Bank of China, the Industrial and Commercial Bank and China
Construction Bank.
How
did China's banks come back from the brink? Only part of the
credit goes to the Chinese economy which has raced ahead of
all expectations, growing by double digits every single year
since Gordon Chang and a number of other "experts" predicted
doom. China is now home to some of the largest financial and
corporate entities in the world.
Rescuing
China's banks hasn't been easy or cheap. The Chinese government
has been pouring hundreds of billions of dollars into the
nation's four biggest banks, preparing them for their debut
on the world stage. Hard statistics are tough to come by in
the secretive Chinese system, but it's estimated that in excess
of $400 billion has been used to rebuild the reserves of the
country's major banks, and the job isn't over yet.
Back
in 1998 the number of non-performing loans on the books of
Chinese banks were estimated to make up 50% or more of their
assets. China's banks were an empty shell, and it's small
wonder that foreign observers were alarmed. So-called "policy
banks" were nothing more than a funding arm of the Communist
regime. They were routinely forced to shovel money into technically
bankrupt state-owned enterprises (SOEs) with no hope of repayment.
That had to change. Ever since China's accession to the World Trade Organization back in 2001, Chinese bankers and bureaucrats have been preparing for 2007 when foreign players would be allowed relatively free access to the country's banking industry. That meant shutting the doors on thousands of failing state-run companies. Next, the government had to decide what to do about the teetering mountain of bad loans to SOEs on the books of every bank in the country. There had to be a cleanup. Approximately $400 billion dollars worth of bad debt were shifted to so-called ARCs, asset recovery companies, which were stuck with the job of finding anything worth saving in the financial mess.
The
job of preparing China's banks for their debut on the world
stage dwarfs America's savings and loan industry bailout.
More than thirty million Chinese workers lost what they thought
were secure government jobs in the country's economic restructuring.
The total cost of the bank bailout has been estimated at more
than a quarter of China's annual GDP.
Long
before the restructuring of the banking system was in full
swing, foreign retail and investment banks were welcomed into
partnerships with China's ailing giants. To the surprise of
some, major players like Bank of America rushed in. In June
of 2005, Bank of America agreed to pay $2.5 billion for a
9% holding in China Construction Bank and to buy $500 million
of stock when the Chinese bank went ahead with a planned IPO.
It turned out to be the biggest IPO on the planet that year.
For
Bank of America it was a spectacularly good deal. China Construction
Bank raised $8 billion in its initial public offering in Hong
Kong. The offering was fifty times oversubscribed and share
values tripled in a matter of weeks. Bank of America now says
it made a profit of $30 billion on the deal, more than enough
to cover $3 billion in losses from subprime mortgages.
Even
more important to Bank of America's strategic aims, the U.S.
banking giant gained access to the vast and still underdeveloped
Chinese financial arena through its partnership with the mainland's
third largest lender.
Despite
nagging reports of widespread corruption and cronyism in the
Chinese banking system, not to mention the overhang of nonperforming
loans, China's policy banks have proved to be irresistible
partners to the banking giants of America.
Citigroup
describes China as its number one investment destination.
Back in 2003 when the Chinese banking system was still in
serious trouble, Citigroup bought a five percent stake in
Shanghai Pudong Development Bank and began to introduce credit
cards to Chinese consumers. The Chinese people are traditionally
known as habitual savers and credit cards are still relatively
new to them. Now, 18% of China's retail sales are paid for
by credit card. Citigroup's Chief executive for China, Richard
Stanley was right when he described his company's move into
China as "one of the greatest opportunities we will ever have."
Getting
in early has proved to be a big advantage. In 2004, HSBC paid
$1.75 billion for a 19.9% stake in Bank of Communications,
the maximum permitted shareholding in a Chinese bank for a
single foreign investor. (Total foreign holdings in Chinese
banks may not exceed 25%.) HSBC and Goldman Sachs helped organize
the highly successful Hong Kong IPO of Bank of Communications,
China's fifth largest lender.
Global
alliances have proven to be a huge plus for Chinese banks
and their foreign partners. China's central bank estimates
that Citigroup, HSBC and other foreign lenders have more than
doubled their profits from Chinese banking operations, raking
in a combined total of more than half a billion dollars a
year. Foreign investors have invested more than $20 billion
in Chinese banks and brokerages. Among the contingent of foreign
investors taking a stake in China are Merrill Lynch, Goldman
Sachs, the Royal Bank of Scotland, and the Commonwealth Bank
of Australia.
But
Chinese banks and regulators haven't allowed foreign firms
onto their turf merely to help outsiders profit from China.
Even China's biggest banks and brokerages are still inexperienced
and unsophisticated by today's standards. In addition to capital,
foreign investors have been expected to provide management
skills, experience with modern lending practices and internationally
recognized standards of governance.
Global
partnerships have delivered as promised. China's major banks
are now reporting record profits almost every quarter. The
ratio of nonperforming loans has been cut sharply. As the
government tries to drain liquidity from China's burgeoning
economy, it is strengthening the banks even further by raising
their required reserve ratios.
China's
three biggest banks now rank among the top twenty in the world.
Last year Industrial & Commercial Bank of China (ICBC) beat
Citigroup and Bank of America, becoming the largest bank in
the world by market value.
China's
banks have now turned the tables. Flush with cash after huge
IPOs in Hong Kong and Shanghai, Chinese banks and financial
firms are snapping up bargains overseas. With the plummeting
dollar and continuing weakness in American banking stocks
in the wake of the subprime mess, U.S. banking giants and
financial institutions suddenly look cheap to their Chinese
counterparts. China Construction Bank, which once welcomed
capital from Bank of America, bought out Bank of America's
investments in Hong Kong and Macao.
China's
largest private lender, Minsheng Bank purchased a 9.9% stake
in San Francisco-based UCBH Holdings in 2007, the first move
of its kind by a Chinese bank on American soil. UCBH, which
serves the Chinese-American community, received a capital
injection of more than $200 million, and Minsheng Bank gained
access to the United States, and a partner with considerable
expertise in risk management and private banking.
In
another milestone move, China's CITIC Securities invested
a billion dollars in Bear Stearns, the U.S. investment bank,
which was struggling with the slumping mortgage market. ICBC
and China Merchants Bank are waiting impatiently for permission
to open branches in the United States. The Chinese government
has hinted that ceilings on foreign ownership of Chinese banks
will not be lifted until the U.S. relents on the opening of
Chinese bank branches in America.
The
big picture for China's banks is very big indeed. China's
Banking Regulatory Commission is pushing banks to seek out
mergers and acquisitions around the world. That's exactly
what's happening. ICBC purchased a 20% stake in South Africa's
Standard Bank for $5.56 billion. In support of China's push
to develop a presence in Africa, China Development Bank has
forged a partnership with United Bank for Africa, one of Nigeria's
biggest lenders.
Today
it is China which is offering capital and banking services
to the world. As an official of the China Banking Regulatory
Commission said last October, "We will encourage Chinese banks
to go abroad to participate in international competition and
overseas acquisitions to improve global competitiveness."
There are still critics who say that China's banking system
is still a house of cards. But the smart money is betting
that Chinese banks are a colossal source of capital. And those
who are listening closely realize that yesterday's banking
derelicts are likely to become tomorrow's fiercest competitors.
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