China’s unique opportunity with foreign banks; must liberalise quickly to become top global financial hub

China Foreign BanksEconomic growth in China for this year is projected to be 7.7% and while this figure is one most countries around the world are highly envious of, it’s low by Chinese standards. But that does not mean that every sector is doing worse than usual, when it comes to banking (both high-street and investments) the Chinese market is doing quite well; but they’re hamstrung by international rules and need more freedom to expand.

As wage costs rise and the scarcity of resources increasingly becomes an issue in mainland China, the manufacturing industry on which the basis of China’s rise relied can no longer be counted on to provide astronomic growth. China is rapidly realising it must shift direction and increase service provision, of which banking will form a central pillar.

Shen Wei, an analyst from Everbright Securities, told the WSJ that “We expect banks’ profit growth to continue to decline in the fourth quarter and into next year as banks may need to set aside more money as a buffer against potential risks from bad loans in times of a slowing economy”.

But according to PWC calculations, growth rates for the top ten banks in China during the first half of 2012 were (combined) 17%. While this is an astonishing figure in itself, it’s only half of the growth figure posted for the same period last year of 34%. Part of this fall in growth stems from crucial liberalizations made to Chinese interest rate regulations, cutting base deposit and lending rates, but also allowing the floating of deposit rates. This form of gradual liberalisation is precisely the methodology that has led to the success of the Chinese economy to date.

While domestic banking offers substantial growth potential for Chinese firms, regulators and bankers alike have understood the importance of integrating their banking with other financial hubs, and increasing their overseas portfolio to provide stability. Wang Zhaoxing (China Banking Regulatory Commission Vice-Chairman) has encouraged banks to look overseas and compete internationally, effectively giving a further green-light to Chinese companies seeking to partake in international capitalism. ICBC (China’s largest bank) increased its foreign assets by an impressive 34% between the end of 2011 and September 2012. The China Construction Bank is also looking to spend up to $15bn in Europe in order to acquire assets and build a reputation in established markets (the City in London).

But investment banking is increasingly showing promise to boosting China’s income. Recent figures from the China Futures Association show that futures’ trading in the first 11 months of 2012 was up just short of 20%, totalling about $24.2tn.

While Chinese banks still lag behind those in London and New York in terms of global portfolios, they are cash-rich, and therefore well placed to exploit the current weakness in the Western banking system.

But the future success of Chinese financial firms does not rest in London, New York, or any other major financial centre. It rests in China itself. Instead of Chinese firms increasingly looking abroad for opportunities to expand, they should be seeking to bring firms in to China and create a new financial hub. I wrote last week about the efforts of Chengdu to invite London (UK) financial firms to invest and open offices within the city, and how this would provide a jump-start to growth in Western China.

Leaving aside the fact that most Western markets are now in a period of prolonged relative decline, the on-going witch hunt against bankers in the UK and USA provides a unique window of opportunity for foreign banks to relocate to China. Given that in the UK financial services account for between 6% and 12% of the total national tax-take, despite providing only 3.6% of the jobs, financial services are clearly a profitable sector. Yet non-Chinese based banks hold only a 2% market share in China, limited by regulations on investment size.

In an interview in June, Liu Yuhui (Director of Financial Research at the Chinese Academy of Social Sciences) said “Being huge [China] means that you [foreign banks] have to plough in billions and billions to build the franchise and customer base from scratch, not to mention that China’s banking market is highly regulated and well-entrenched by big state-owned players”.

The interview continues: “Foreign banks have pretty much sat out a once-in-a-lifetime expansion opportunity in China”.

With this statement however, I disagree completely. Chinese growth potential is colossal, and companies around the world recognise this. While retail banking may be a virtual impossibility in the short-term, investment banks have an unparalleled opportunity for growth, conditional on reform of the banking sector which is still extremely hostile to foreign banks.

Even a recent Citigroup joint venture has only been allowed with 33% ownership limitations and $126m in capital.

The key to success for China’s financial markets lies not only in boosting the portfolios of existing Chinese banks abroad, but more importantly in liberalising markets and encouraging foreign firms to relocate. The big financial firms in the USA and UK are getting tired of constant political wrangling regarding their operations, and burdensome regulation. If China were to throw open the doors to global financial institutions it would benefit from job creation, substantial taxation increases, and all the other benefits that come from hosting a major centre of finance.

China cannot afford to let this window of opportunity pass by, it must change from its historical strategy of incremental change and liberalise radically.

Categories: Finance & Economy

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1 reply

  1. I’d be surprised if this happens at either a fast enough pace or in a transparent enough manner.


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