Services in China

China Banking System

Introduction to the Banking System	A Fast Growing Market
Restructuring China Banking Sector	Foreign Banks in China

Introduction to the Banking System

Before 1983, People’s Bank of China (PBOC) assumed all the functions of regulation and had control of all banking business. However, in 1983, four specialized banks were established (or re-established) to take over the banking business from PBOC, allowing PBOC to focus on regulation and monetary policy. These four specialized banks are the Industrial & Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BOC) and Agricultural Bank of China (ABC). The big four remained as specialized banks until 1994 when three policy banks were established to take over the policy-directed lending functions.

In 2003, the China Banking Regulatory Commission (CBRC) was established to take over the regulatory functions from PBOC. It aims to separate policy making and implementation from supervision and to leave the PBOC free to concentrate on monetary policy issues.

Although the supervisory functions of financial institutions have been transferred to the CBRC, the PBOC remains a very influential institution with considerable regulatory power. In theory, the PBOC will concentrate on regulations concerning monetary conditions and financial system liquidity with the objective of promoting economic growth and price stability. CBRC, on the other hand, will focus on the strength of financial institutions, capital adequacy issues and the restructuring of the banking sector. In practice, however, there is no clear division between the functions of PBOC and those of CBRC. It is not uncommon for their functions to overlap in some areas.

In the banking business, the four state-owned commercial banks, namely, ICBC, CCB, BOC and ABC are still the biggest players though their dominance is in gradual decline.

As China is playing an increasingly important role in the world’s economy (and world trade in particular), foreign exchange is increasingly important for cross-border business operations. Established in 1979, SAFE supervises, plans and administers control of foreign exchange activities in China.

SAFE has extensive influence over the financial system – its approval is required for foreign exchange receipts and payments, it supervises external debt, and it monitors the forex activities of financial institutions.

In the banking business, the four state-owned commercial banks, namely, ICBC, CCB, BOC and ABC are still the biggest players though their dominance is in gradual decline. At the end of 2007, the Big Four accounted for 50% of China’s total banking assets. Another important type of banking institutions is the 13 joint-stock commercial banks, including Bank of Communications and China Merchant Bank. Currently, joint-stock commercial banks are the most dynamic in China’s banking sector. Their asset expansion is double the pace of the Big Four. By the end of 2007, their market share had increased to 18% from 14% at the end of 2003.

Currently, there are 100 something city commercial banks in China. Local governments have historically exerted a huge influence over city commercial banks and it is not uncommon for them to hold a large bulk of their shares. As the name suggests, city commercial banks were formerly able to operate only within the city from which they originated. However, since 2004, CBRC has allowed city banks to expand outside their home area. Meanwhile, some of the smaller city banks have begun to merge, forming larger regional banks in their stead.

In China, bank loans have been the predominant channel for fund raising. In 2007, in the non-financial sector, loans accounted for 78.9% of fund raising, 6 times more than that through equity offerings.

In China, bank loans have been the predominant channel for fund raising.

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A Fast Growing Market

The booming Chinese economy has been accompanied by a fast-growing banking sector. By the end of 2007, the total assets of China’s banking sector reached RMB 52.6 trillion, indicating a 17.5% average annual growth from 2003 to 2007.

By the end of 2007, outstanding loans reached RMB 27.8 trillion and total deposits reached RMB 40.1 trillion, indicating average growth rates of 13.1% and 16.1%, respectively.

As a result of the fast growing Chinese economy, Chinese banks have profited more. In 2006, major Chinese commercial banks, namely the Big Four and the 13 joint-stock commercial banks, raked in RMB 240.9 billion in pre-tax earnings, 30.2% higher than in 2005, and 6.6 times that of 2002’s pre-tax earnings.

Currently, China’s banking sector remains at its early stage of development. Interest income is the main source of income, though fee-based business has been growing fast. Net income interest accounts for more than 85% of the operating income of commercial banks. In 2006, where major Chinese commercial banks were concerned, the ratio of fee-based income versus net interest income was 0.175 (in other words, net interest income was 5.7 times that of fee-based income).

Currently, China’s banking sector remains at its early stage of development. Interest income is the main source of income, though fee-based business has been growing fast.

Fee and commission income include income from agency services (such as payment disbursement, collection, settlement, clearings), cash management, remittance and settlement, custody services, consulting and advisory services, bank cards, and other services. As competition is heating up, Chinese banks have been trying very hard to increase the share of fee and commission income in order to divest business risks, and to leverage on its extensive networks. Helping Chinese banks develop their fee-based business and evolve into a more sophisticated one will provide them with a lot more business opportunities.

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Restructuring China Banking Sector

China’s banking sector, especially the Big Four, used to be debt-laden. This stems from the fact that in the past, the Big Four were not truly independent commercial banks and were influenced greatly by the central and local government. According to official figures, by the end of 2003, the non-performing loans (NPL) ratio of the Big Four was above 20%.

Understanding the importance of a healthy banking system to China’s growth, China has made considerable achievements in restructuring its banking sector. The first step is to recapitalize and restructure the Big Four into joint-stock banks. After disposing of billions of dollars in bad debts, China further injected a large sum of foreign reserves (mainly through the newly established China Huijin Investment) to boost the capital of state-owned banks. At the end of 2003, CCB and BOC each received a US$22.5 billion capital injection. In April 2005, ICBC received US$15 billion worth of capital injection.

After strengthening its balance sheets, the second step was to invite strategic investors. As the best proxy to China’s growth, many famous foreign banking institutions have invested in the three restructured state-owned banks. Table 3.1.1 below shows the major shareholders of these three listed state-owned banks.

The third step was to become publicly listed. The rationale behind turning state-owned banks into public banks was that besides capital, the Chinese government believed it was better to let the public supervise these banks in order to encourage greater transparency and increase their efficiency.

Ironically, while the Chinese banks’ un-sophisticated business model gives them far less exposure to complex structured products, foreign banks are suffering from huge losses stemming from a variety of structured products. As a result, the shares of many foreign banks have plunged. At the end of January 2008, three of the top five biggest banks (measured by market cap) were from China. By the end of February 2008, ABC was the only bank among the Big Four that was not restructured and listed. After the restructuring, China’s banking sector (in particular, the three publicly listed state-owned banks) became much healthier. As of June 30, 2007, their NPL ratios were all below 4%.

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Foreign Banks in China

To many, December 11, 2006 was the watershed date when China removed all geographic and (most) business restrictions for foreign banks. Foreign banks incorporated in China were now given access to the lucrative bank card business and were able to provide RMB services to Chinese individuals.

Currently, foreign banks have been playing a rather small role in China’s banking sector. By the end of 2007, the market share of foreign banks measured by total assets was only 2%.

Seeing no way to compete with Chinese banks in terms of the number of branches nationwide, foreign banks often choose to be geographically focused. Currently, about 1/3 of foreign bank branches are located in Shanghai, the financial capital of China, and foreign banks’ assets in Shanghai account for about 1?2 of their total assets.

For late-comers into the banking industry, the expansion of foreign banks with a greater presence in China (such as Citibank, Bank of East Asia, HSBC and Standard Chartered Bank) might provide some regarding the locations of the next key markets beyond Beijing and Shanghai.

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