Foreign Bank Entry in China: An Overview of the Post-Transition Period

1. Foreign Bank Entry in China: An Overview of the Post-Transition Period Liping He Beijing Normal University June 2007

2. Contents • Main Changes in China’s Banking Industry during the Transition Period from 2001-2006 • Foreign Bank Entry in China as of 2007 • Future Prospects of Foreign Banks in China and Challenges for Chinese Banks

3. I. Main Changes in China’s Banking Industry during the Transition Period from 2001-2006 Sino-US and Sino-EU negotiations toward China’s accession to the World Trade Organization in 2001 resulted in an agreement that China have a five-year transition period after then, and the banking industry would become open to foreign players thereafter.

4. I. Main Changes in China’s Banking Industry during the Transition Period from 2001-2006 Realized serious problems existing in domestic banks and great challenges that would be posed by foreign bank entry, the government began to undertake new approaches to help reform and restructure state-owned banking institutions during the transition period.

5. I. Main Changes in China’s Banking Industry during the Transition Period from 2001-2006 Major policy measures undertaken: • Recapitalization: use of FX reserve to recapitalize large state-owned banks; establishment of AMCs to conduct debt-for-equity swaps; special policy allowance for NPL write-offs. • Control the incidence of NPLs: establishment of schemes of punish and discipline on NPLs; management responsibility systems. • Re-regulating: separating banking regulation functions from the Central Bank. • Downsizing and streamlining: retreating from over-stretched businesses; business office closedowns and staff layoffs in unprofitable areas. • Diversifying and developing new banking services: consumer credit; securities investment and service; payments service; clients re-orientation (away from traditional focus of state-owned companies).

6. I. Main Changes in China’s Banking Industry during the Transition Period from 2001-2006 • Market structure diversified multipile institutional players are emerging: traditional national state-owned banks; fast-growing regional banks; new medium and small banks; foreign banks. • Market growth momentum continued the average annual growth ra I. Main Changes in China’s Banking Industry during the Transition Period from 2001-2006 te in deposit-taking, loans outstanding, and total asset maintained above 15%, exceeding GDP growth • Modus Operandi changed traditional business approach (deposit taking from the public and credit supplying to SOEs) transformed into client-oriented, innovative, sophisticated methods

7. II. Foreign Bank Entry in China as of 2007 • A large number of foreign banks have shown great interest in conducting and developing banking business in China during the Transition Period and Post-Transition Period. • Homes of these foreign banks, especially those foreign banks that have more than one branch in mainland China: USA, UK, Germany, France, the Netherlands, Japan, Korea, Singapore, and Hong Kong (technically treated as “foreign”)

8. II. Foreign Bank Entry in China as of 2007 Methods of Foreign Bank Entry in China • Branch network: • Subsidiary (local legal entity) • Joint venture with Chinese partners • Representative office • Stake (equity) holding of Chinese banks

9. II. Foreign Bank Entry in China as of 2007 Main banking businesses of foreign banks in China today: • Banking for foreign companies • Trade finance, including internatinal payments and settlement service • Derivative services for corporate clients • Consumer finance (to a limited number of Chinese custormers, e.g., private banking) • Corporate banking service to a limited number of Chinese companies

10. II. Foreign Bank Entry in China as of 2007 A small number of foreign banks appear to have interest to become a full-fledged, local (“Chinese”) retail banking brand with its own substantial branch network. These foreign banks perhaps include: the Citibank, HSBC, the Standard Chartered, among others. There are probably a few others, large international banks, that are contemplating on the issue “to be or not to be” at the time being.

11. II. Foreign Bank Entry in China as of 2007 Chinese banks that have had foreign bank equity elements: • Largest national banks; • “Second tier”, seminational/regional banks: • “Third tier”, city banks Shares owned by foreign banks (current regulation): • 20% for a single foreign entity • 25% for combined foreign owners • No explicit upper limit if the process is referred to other legal texts.

12. II. Foreign Bank Entry in China as of 2007 Geographic concentration of Foreign Banks in Mainland China: Largest cities: Shanghai, Beijing, Guangzhou, Shenzhen Provincial capital cities/industrial centers:

13. III. Future Prospects of Foreign Banks in China and Challenges for Chinese Banks • Foreign banks have been growing fast in the post-transition period, but their share remains low. • Foreign banks have had multiple ways interacting with domestic banking industry. • Foreign banks help strengthen links between domestic economy and international economy. • Foreign banks play a catalyst role in reform and restructuring of domestic banking system.

15. III. Future Prospects of Foreign Banks in China and Challenges for Chinese Banks Three challenges for China: To domestic banks: new competition emerges especially in some spectra of the domestic market To government regulators: rule of law; fair playing field; transparency and consistence in policy making and enforcement. To macroeconomic policymakers: as domestic financial market become inevitably more open to the outside, effective and more effective use of monetary policy instruments are necessary in the diminishing presence of capital controls.