A4 cover for Banking POV Financial Services China’s...

The opening of China’s banking sector in accordance with WTO requirements presents both domestic and foreign financial institutions challenges and opportunities. Successful financial institutions will draw on inherent strengths to meet customer demand for a dynamic range of products.

As the Intellectual Supporting Partner of the Boao Forum for Asia Annual Conference 2007, Deloitte Touche Tohmatsu presents this special report on service delivery models and the range of product and service offerings for retail and corporate customers.

About Deloitte Touche Tohmatsu Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms, and their respective subsidiaries and affiliates. Deloitte Touche Tohmatsu is an organisation of member firms around the world devoted to excellence in providing professional services and advice, focused on client service through a global strategy executed locally in nearly 140 countries. With access to the deep intellectual capital of approximately 135,000 people worldwide, Deloitte delivers services in four professional areas - audit, tax, consulting and financial advisory services - and serves more than 80 percent of the world's largest companies, as well as large national enterprises, public institutions, locally important clients, and successful, fast-growing global growth companies. Services are not provided by the Deloitte Touche Tohmatsu Verein, and, for regulatory and other reasons, certain member firms do not provide services in all four professional areas.

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We are one of the leading professional services providers in the Chinese Mainland, Hong Kong SAR and Macau SAR. We have over 6,000 people in ten offices including Beijing, Dalian, Guangzhou, Hong Kong, Macau, Nanjing, Shanghai, Shenzhen, Suzhou and Tianjin.

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We have considerable experience in China and have been a significant contributor to the development of China's accounting standards, taxation system and local professional accountants. We also provide services to around one-third of all companies listed on the Stock Exchange of Hong Kong.

For more information, please visit our website at www.deloitte.com/cn.

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Financial Services

China’s banking sector Growing towards diversification

A4 cover for Banking POV

Colour: CMYK processMaterial: Polymax matt white 300gsm

Prepared by Kevin Kwok22 March 2007

Contents

Overview 2

Growingtowardsdiversification 4

Shiftingtowardsproductsandservicequality 6

Buildingonpositionsofstrength 9

Conclusion:Risingtomeetcustomerexpectations 15

References 16

Appendices 17

Ourthoughtleadershipprogramme 18

AbouttheGlobalFinancialServicesIndustryPractice 19

Contacts 19

AboutDeloitte 20

1

China’s banking sectorGrowingtowardsdiversification

Year 2001-05 2005 2006 2007 2008 2009 2010

Australia 3.1 2.2 3.1 3.7 3.4 3.2 3.2

China 8.7 9.9 8.6 8.2 7.9 7.5 7.1

India 6.5 7.3 6.8 6.6 6.4 6.4 6.2

Japan 1.2 2.8 2.6 1.5 1.2 1.3 1.5

Singapore 3.9 6.4 4.9 4.5 4.6 4.8 4.4

South Korea 4.4 4.0 5.1 4.1 4.2 4.0 4.1

EU25 1.8 1.5 2.1 2.2 2.2 2.0 2.0

United States 2.6 3.5 2.7 2.5 3.1 3.1 3.1

World 2.7 3.5 3.3 3.1 3.2 3.2 3.3

Source:EconomistIntelligenceUnit,Bloomberg,Deloitteanalysis

Diagram 1: GDP growth at market exchange rates -Asia Pacific economies

Asia Pacific markets, with China in the lead, will likely provide the greatest opportunities for global financial services companies looking for future growth (diagram 1). For the past five years, economic growth has been driven by strong consumer demographics, political and market reform, and economies of scale in production; the trend will likely continue.

Although these Asian Pacific countries are at different stages of development, they have the potential to become major growth markets for traditional banking, investment banking, investment management, insurance, and securities products. As a result, leading international and regional banks are likely to want to establish a presence there.

There are a few key trends, in addition to GDP growth, that enhance the importance of the region to the banking sector. The region is experiencing an increasing concentration of wealth. In countries such as China, savings rates are significantly higher than in Western countries. A growing middle class with higher disposable income increases the need for more sophisticated financial services, as consumers buy cars and homes, and start planning their finances. Economic growth also has led to an rise in the number of small and mid-sized enterprises (SMEs) needing banking services.

China’s share of Asia Pacific bank deposits could almost double from 15 percent in 2000 to 29 percent in 2010 (diagram 2). The number of bankable households is also projected to rise rapidly, from 260 million in 2000 to 619 million in 2010.1 Bank deposits in Australia, China, India, Japan, Singapore, and South Korea are projected to be over US$11 trillion by 2010 (diagram 3), with over 600 million bankable households.

The savings rate is another distinguishing factor that increases the attractiveness of Chinese retail banking markets. The typical savings rate in China (at 40 percent) is substantially higher than in most North American or European countries, a factor that will lead to continued growth in bank deposits. This explosive growth in bank deposits in China creates vast opportunities for retail banks in everything from mortgage lending to bancassurance.

Overview

1 Taking the Spotlight - Deloitte Touche Tohmatsu, 2006

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0

2

4

6

8

10

12

Australia South Korea India China Japan

Diagram 2: Asia Pacific bank deposits(US$ trillions)

Source: Economist Intelligence Unit Country Reports, Deloitte analysis

United States

Asia, including China and India

Germany Japan

50

40

30

2002 2003 2004 2005 2006 2007 2008-11

20

10

0

Diagram 3: Gross national savings as percentage of GDP

Source: International Monetary Fund, Sept 2006

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China’s banking sectorGrowing towards diversification

Chinese state-owned banks have been reforming their traditional approach of accepting deposits and lending, turning their attention to making commercial business decisions. Three of the largest state-owned banks have received large injections of capital and sold many non-performing loans to state-owned asset management companies. Following the cash injections, these banks took on foreign partners to help speed internal reforms and add commercial risk management and financial product skills. They also listed shares on the Hong Kong Stock Exchange, raising billions of dollars in capital.

China fulfilled its WTO commitments to open its banking sector to foreign banks by issuing rules and regulations in December 2006 The new regulations include eliminating geographic restrictions, expanding the scope of business, and relaxing capital requirements.

Chinese banks have been preparing for the new environment by enhancing their financial and operational health. The next steps they take to improve competitiveness and enhance customer service will be critical. Market analysts have held out universal banking as one logical step in the evolution of Chinese banking. The concept of universal banking appears very inviting; however, a valuable perspective may be gained by observing how other models have performed elsewhere.

Universal banking is a common approach for banks to offer a wide range of services and products to customers. This “one-stop shop” concept requires a bank to hone its services outside traditional banking services (deposits/savings and lending to both personal and corporate customers). To provide a consolidated and convenient experience to its retail banking customers, banks have moved into the following sectors:

Deposits

Residential mortages

Auto loans

Investment management

Wealth management

Credit cards

Commercial banking

Investment banking / brokerages

Custodial services

The result is a blurring of distinctions between banks, insurers and asset managers, as financial services organizations increasingly position themselves in each other’s markets and target customers.

(See panel, “Universal banking: The Experiences of the US and Europe”)

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Growingtowardsdiversification

4


Universal banking: The experiences of the US and Europe

Following the Wall Street crash of 1929, the US government adopted very strict rules to regulate the activities in which the various types of financial institutions could engage. Specifically, the fact that banks could engage in both financial markets and credit-granting activities was regarded as leading to conflicts of interest and as decreasing the prudence that banks normally show in their role as providers of credits. This blurring of roles is considered by some as one of the major causes of the crash of 1929.

Laws were put in place in the US to keep the businesses of commercial banking and investment banking strictly separate: the Glass-Steagall Act of 1933, which prohibited banks from engaging directly or indirectly in the underwriting of or dealing in securities, and the Bank Holding Company Act of 1956, which prohibited banks from affiliating with insurance underwriters and non-financial firms. Thus, for investment banking and insurance services, individuals and corporations had to go to other financial-service providers.

Universal banking's birthplace was Europe, where exuberant equity markets did not cause the reactions seen in the US, which chose to split investment banks from other forms of banking. More recently, the US has relaxed some of the regulations and allowed financial institutions to offer a more complete line of services.

While universal banking practices are nothing new in other parts of the world, the concept is just now taking root in China, where the biggest banks have traditionally catered to the needs of corporate clients at the expense of the needs of individuals. The synergies of universal banking services may not be immediately obvious, but it is clear that increasing the switching costs and the time in which a consumer interacts with a bank raises the likelihood that the bank will be able to sell additional products to the consumer. This focus is especially crucial as higher net worth individuals (HNWIs) are typically convenience- and time-sensitive.

5


Chinese banks have realised significant growth in their businesses since the 1997 Asian financial crisis; now, they find themselves having to revise their business models again.

Global banks, such as Citigroup and HSBC, have gained a significant presence in China, built on decades of experience catering to retail consumers, establishing retail banking infrastructure (branches, technology, services), and leveraging lessons learned about consumer behavior to hone their retail banking capabilities. This experience, combined with the fact that these foreign banks have hands-on insight into Chinese retail consumer patterns, creates a formidable challenge for China’s domestic banks. This challenge comes at a time when China’s banks are looking to focus on the retail consumer to continue to drive profit growth.2

Retail banking will see a rise in demand for products such as mortgages to credit cards. China’s fast-growing middle class will drive retail banking and present opportunities for financial services firms.

To excel in retail banking requires banks to put the customer at the core of their strategy. The customer-centric approach is the most effective way to attract and retain the most lucrative customers, while continuing to ‘cross-sell’ other products and services. Successful retail banks will likely develop their strategy to consider many customer segments, a vast product portfolio, and various channels of distribution, eg, automated teller machines, branches, telephone banking, and e-banking.3

As banks become more sophisticated and their service and product offerings evolve, they should be able to generate a greater percentage of fee-based service revenue as against net interest income. Other demographic factors, such as the growing interest in mortgages in China’s booming property market, will likely fuel growth in retail lending products.

However, being in the right place at the right time does not guarantee success for banks. Investments in the banking sector call for an understanding of the nature of markets; the developed financial services markets of Australia, and Japan are different from the developing ones of China and India. In most cases, existing business models are designed for mature markets with high-wealth, low-growth dynamics; the high-growth, low-wealth emerging markets may need a different model.

We have discussed some of the drivers of both foreign investment and Chinese banking reform; we also need to focus on customer demand. Chinese corporate and retail customers have little choice in banks and financial products. An illustrative example is provided by bank deposits measured as a percentage of GDP (see diagram 4).

A telling sign of how highly Chinese banking customers rank service is the increase in the percentage of deposits held by joint-stock commercial banks (JSCBs). This increased from 12 percent in March 2002 to 14.7 percent in September 2003, the Economist reported. While the reasons for the shift cannot be specifically determined, JSCBs have been actively seeking customers and offering more innovative products at more attractive pricing. The percentage of deposits held by JSCBs is expected to continue to rise until the large state owned banks reforms begin to take hold.

Shiftingtowardsproductsandservicequality

2 The Engine of Growth - Deloitte Touche Tohmatsu, 2006

3 Taking the Spotlight - Deloitte Touche Tohmatsu, 2006

6


0 50 100 150 200

Philippines

India

South Korea

United States

Thailand

Singapore

Malaysia

United Kingdom

Canada

China

Japan

47

56

68

69

99

109

120

130

149

178

193

Diagram 4: Bank deposits as a percentage of GDP

Source:InternationalMonetaryFund2007,Deloitteanalysis

Corporate customers, especially SMEs, also suffer from the lack of choice. While the government bond market is large, the market for corporate bonds is small. About 80 percent to 90 percent of all business funding originated from the banking system. Capital market products in China are only beginning to develop and few domestic institutions have the skill sets or multiple product offerings necessary to serve the demands of corporate customers.4

The ultimate form a financial institution takes may be less important than identifying potential markets, delivering innovative products to customers in a timely manner, and achieving operational results valued by customers.5

In China, insurance companies are attempting to acquire bank licenses, while banks are beginning to offer insurance product through branch networks. Securities companies are not only brokering securities but looking to expand product offerings to meet customer needs. Investment managers are starting to drive demand for securities. Banks underwrite securities offering and have begun to securitize loan and receivables.

An obvious demand for additional services is apparent among Chinese retail and corporate customers. This unmet demand, rather than management’s desire to create China’s first universal bank, will have more influence on how successful a domestic bank is, in the long term. Further, consumer demand will dictate where foreign banks decide to compete and how aggressive they are in serving customer needs.

4 China's Opening to the World: What Does It Means for U.S. Banks? - FDIC, 2005

5 The Economist, 2004

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Buildingonpositionsofstrength

6 Product offerings are subject to the rule of at least one of three regulatory bodies: China Banking Regulatory Commission, China Insurance Regulatory Commission, China Securities Regulatory Commission. While funds are not directly regulated, they are subject to rules from all three regulators depending on how the fund is sold and distributed. As financial institutions increasingly blur the distinction between banks, insurance companies, brokerages and investment managers, regulation limits the diversity of products Chinese consumers appear to desire from a single financial institution. China is early in its financial institution regulatory development and has time to evaluate what has work in other locations and how good regulation resulted in a competitive advantage.

7 Agricultural Bank of China, Bank of China, China Construction Bank, Industrial and Commercial Bank of China


We believe it is more relevant for financial institutions to find where their strengths and their clients’ interests intersect than it is to offer all services to all customers. Domestic and foreign banks have inherent structural and experiential advantages and challenges in developing and delivering products in the China market place.

The rest of this report will cover broad product offerings:6

Deposits

Residential mortages

Auto loans

Investment management

Wealth management

Credit cards

Commercial banking

Investment banking / brokerages

Custodial services

Deposits The Economist in 2005 illustrated the position the “Big Four” Chinese commercial banks7 held over deposits. In its April issue, it indicated that while the Big Four’s market share had fallen, they still held 64.9 percent of all bank deposits collected through about 116,000 branches located throughout China and serviced by 1.4 million employees. About 14.7 percent and 12 percent of the deposit base are held by JSCBs and rural credit cooperatives, respectively. The remaining deposit base, about 8 percent, is held by a mix of deposit-taking institutions, including foreign banks. We can deduce that the Big Four will continue indefinitely to be the primary deposit-taker; changing the hundreds of millions of accounts to other institutions would take years.8

As has been observed, JSCBs have been taking deposit market share from the Big Four banks through offering better rates and, more importantly, better service. It appears likely the JSCBs will be the largest beneficiaries of customer choices, not foreign banks.

Foreign banks have very few branches compared to domestic banks and, so far, they have not shown any ability or desire to quickly attract a depositor base. While it is widely assumed that foreign banks will deliver superior customer service, this assumption has not been tested and is not likely to be tested before domestic banks have time to improve their customer service delivery.

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Residential mortgages Hundreds of millions of Chinese will become home-owners for the first time in the next 10 years. As a point of reference, we estimate that more Chinese will become home owners in the next five years than currently exist in the US. The Economist in 2005 estimated that the number of mortgages grew at an annual compound rate of 115 percent between 1998 and 2004, representing 90 percent of the 242 billion in outstanding consumer loans.

Mortgage lending has been slowed during the same period by the lack of clear title searches, the absence of credit bureau, and incorrectly or falsely completed loan documentation. Some lenders have experienced very fast pre-payment speeds, cutting the expected return on the loans, while Chinese mortgage loans have not experienced significant number of defaults. One possible reason for the pre-payment speed and loan default rate is the popular practice of pre-sales. Pre-sale arrangements allow mortgage borrowers to share the pre-sale risks with the bank. If the borrower is unhappy with the construction, defaulting is effectively a put option to the bank. If the borrower is happy, a pre-payment may become more likely due to the Chinese preference not to hold debt.9

The vast majority of these loans were originated by domestic banks, with only a few foreign bank branches offering mortgage loans. Foreign banks are reported to see an opportunity in providing technology and mortgage underwriting skills to invested bank or joint ventures. While foreign banks clearly have more experience in mortgage lending, much of the gain in processing speed through the use of technology is predicated on the existence of inexpensive and quick credit reporting and a well-established security interest in collateral process; neither of these are advanced in China. Accordingly, both foreign and domestic banks are in the process of developing such capabilities. The first institution to set up such systems will have a clear competitive advantage.

While domestic banks clearly have an advantage in the number of branches available to meet new customers, originate loans and understand deposit histories, foreign banks may be able to gain an advantage by applying well-established processes and marketing programs to attract borrowers. Foreign banks may also be able to use their experience gained in other locations to offer better pricing.

As the mortgage market grows significantly from about 3 percent of all 2004 bank revenues, banks, either domestic or foreign, will determine the best customer service model to offer customers lower prices while mitigating risk.10 Overall, the mortgage market in China is very young and a dominant player has not been established.

9 An Early Assessment of Residential Mortgage Performance in China - By Yongheng Deng, 2004

10 BNA Banking Report, 2004

10


Auto loans Auto lending, like mortgage lending, has experienced tremendous growth over the past five years although growth has slowed in recent reporting periods. As China emerges in the coming years as the world’s largest car manufacturer, hundreds of millions of its population will finance the purchase of new cars. Mobile collateral has traditionally not been good collateral in emerging markets, regardless of the origin of the lender. Chinese auto lenders experienced reported default rates of 55 percent in 2005.11 still looking for recent figures The institution able to solve the issues surrounding obtaining payments on cars or repossession of the collateral will dominate the auto finance market.

In summary, domestic banks appear to have a dominant deposit base and have provided a large number of mortgage and auto loans; however, the growth in the mortgage and auto lending business provides ample opportunity for all market participants. The institutions able to solve, or at least mitigate, the problems of identifying credit-worthy borrowers, establishing clear title and securing collateral will have a competitive advantage. Customers will choose the innovative products with the lowest cost combined with the best services. The best services may be initially defined as having a branch nearby with a person to speak to. But as time passes and technology is implemented, other solutions not requiring bricks and mortar will appear, providing opportunities for institutions.

Investment management In China, the combination of a high savings rate combined with a lack of reasonably safe and managed investment alternatives, tantalizes both foreign and domestic financial institutions. While banks are not permitted to manage funds, they are expanding distribution through the many branches and enhancing custodial services. That total funds under manager represents less than 1 percent of the total financial assets in China is seen as a sign by some that the untapped potential of the wealth management market is vast. The total number of fund sponsors has increased to more than 60, with the total number of funds now at more than 300 and the asset under management exceeding US$100 billion. As of September 2006, the Economist reported, 63 percent of the assets under management are held by the 10 largest funds.

Many investment managers and domestic banks have formed joint ventures with foreign banks to offer traditional fund management services. An example reported by the EIU is ING.12 ING and the International Finance Corp together own 24.9 percent of the Bank of Beijing. ING plans to use the relationship with the bank to offer wealth management and insurance products managed by an ING/Bank of Beijing joint venture through the bank’s branch network. ING and other foreign financial institutions have formed multiple joint ventures to offer wealth management products through distribution channels established by domestic banks. The foreign banks bring management skills and technology, while the domestic banks contribute distribution networks and an established customer base.

Traditionally, retirement in China has been met through a combination of benefits provided by the state employer programs and the children of the retirees or by private savings. The combination of state-owned enterprises being restructured and the aging population provide opportunities for banks able to provide easily understood products that offer returns in excess of deposits, the current mass alternative.

11 China News Weekly, Oct 2006


11


Cards for VIP customers

Minsheng Bank was very successful in introducing its “VIP-Card” for selected customers, fulfilling the desire of many customers for branding and recognition. These cards (later copied although less successfully by other domestic banks with different features) is clearly targeted at specific wealthy clients, or those aspiring to be. These cards are comparable to “bonus-cards” in Europe provided by larger stores as a differentiation and client-binding strategy. The difference is that these bonus cards provide mainly monetary advantages, while the Minsheng cards provide first and foremost an image, and only then are monetary advantages considered.

The success of these VIP cards seems to prove that there is a potential market for such exclusive products in a country where standardised product strategies are implemented only too often to achieve economies of scale. While the need for standardized economies of scale products might be in higher demand inland, where a predominantly larger low-middle income class is found, affluent customers are highly concentrated, with three-quarters of them living in Beijing, Shanghai and Guangzhou. Foreign banks can easily tap into them despite their limited branch networks. These customers are also willing to change their bank for better and more specific services provided, even if at higher costs.13

Wealth management The economic growth achieved in China has produced an increasing number of people exceeding the traditional measures of high net worth. While the types of products and the way services are delivered to Chinese customers may ultimately differ from European and North American markets, the differentiators among services providers will not. High net worth individuals (HNWIs) demand superior customer service and superior returns, however they defined these. Private banks are targeting HNWIs in China, and domestic banks are increasingly offering innovative products that are beginning to look like private banking. An example are the services provided by Minsheng Bank. (See panel: “Cards for VIP Customers”).

13 Study on the Future Opportunities and Challenges of EU-China Trade and Investment Relations - Commission of the European Communities, 2007

14 Opportunity Knocks - Deloitte Touche Tohmatsu, 2006

The successful banks and financial services institutions in the wealth management sector will be those that take the key lessons learned from elsewhere and apply them to the culture of China. Banks and financial institutions will claim their biggest rewards if they can create:

A customer-centric model tailored to their clients

A complete array of best-of-breed products that offer attractive returns, balancing this against the risk tolerance of clients

A seamless infrastructure and communication platform that enables "up-to-the-second" information and transaction efficiencies

A pool of world-class talent with well-rounded technical knowledge as well as with cultural affinities to Chinese clients.14

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Credit cards Many foreign banks have predicated investments into Chinese banks on the opportunities in the cards business. Card use in China by the growing middle class is on the rise. The number of potential cards and card holders is staggering. However, more rigorous analysis reveals the actual number of credit cards in circulation is low, compared with the size of the population. More than 850 million Chinese now hold bank cards, but most are debit cards secured by cash or linked to deposit accounts. The number of credit cards with unsecured limits of credit is estimated to be about 4 percent of the card base.15 At the end of 2004, credit cards accounted for 3 percent of consumer purchases in China. American Express expects that penetration will eventually match Hong Kong's 20 percent rate.16

As with wealth management, foreign banks have partnered with domestic banks, generally through joint ventures, to offer domestic bank branded credit cards as well as foreign bank branded credit cards. The domestic banks provide potential card holders to the joint ventures, while the foreign banks provide access to management practices and clearing networks and technologies.

Inhibiting both domestic and foreign banks is the lack of credit history for most individuals in China, an established clearing network, acceptance of the cards by a large proportion of retail vendors, and consumer penetration. Additionally, foreign banks are slowed by access to potential customer lists while domestic banks have a traditional unwillingness to lend without collateral.

Many foreign banks have successfully developed businesses in other markets despite penetration and acceptance issues. Foreign banks have also developed independent scoring systems to evaluate customers. Extensive customer marketing and solicitation have allowed many foreign banks without domestic affiliation to successfully attract card customers. Domestic banks have not yet developed these skills; they will need to, if they intend to compete in the credit card market.

Commercial banking Commercial lending in China is dominated by the Big Four banks and they will continue to provide credit to most of the SOEs. The cost of credit in China is very low and may actually be negative on a risk-adjusted basis. Foreign banks have been limited to lending to foreign business operating in China. When they have lent, it has largely been to serve their largest and most important global clients.

A closer look at commercial lending shows opportunities for both domestic and foreign institutions. Private companies, or SMEs, are starved for capital. They contribute more than half of China's GDP but only consume 27 percent of all loans.17 SMEs have a particular challenge obtaining financing from state-owned banks; some have turned to "grey market" banks. These banks have reportedly received interest rates of between 8 and 20 percent. Rates in this range would provide a healthier risk-adjusted return for any bank.18

The recent reforms encourage banks seeking risk-based lending opportunities. Should further reforms allow additional pricing flexibility, much of the "grey market" lending would come on the balance sheets of innovative banks.

Domestic and foreign commercial lenders currently struggle to obtain accurate and timely information about borrower financial performance. They do not have enough people with advanced underwriting skills to formulate the volume of sophisticated analysis necessary to meet customer demand. Domestic lenders have relationship advantages and may be able to gain access to more information about borrowers. However, they may not have the risk management skills to continuously evaluate the risks faced. Foreign banks, while facing similar information constrains, are able to use their underwriting experience gained in other markets over a long period of time.

A number of reasons exist for the regulatory prohibition to true risk-based pricing of loans. However, a broad commercial lending market is not likely to be developed until some mechanism is implemented. Until competitive pricing is allowed, foreign banks will continue to help their "investee" banks improve their underwriting and risk management skills.


16 Forbes.com, 2004

17 EIU, 2006


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Investment banking / brokerage The growth rate of the Chinese economy demands that corporations continuously seek additional capital. The numbers and value of new issuance each year in Shanghai, Hong Kong and other places around the globe is staggering. Foreign investment banks have dominated the offering process. While few Chinese banks had led the share offering process, it is now not uncommon for these institutions to play significant roles.

As Chinese corporations merge with and acquire companies in China and abroad, they will seek advice about the transactions. The foreign investment banks will continue to be very competitive, but China will quickly produce institutions that will compete with the traditional investment banking powers. Chinese corporations will likely feel more comfortable hiring a Chinese advisor in addition to the foreign investor until enough cross-border transactions are completed to allow corporations to gain confidence in their ability to manage the global investment banks.

While the Chinese stock market has performed well recently, most brokerages are only beginning to recover from past downturns. Most are unlikely in the near term to provide serious competition to foreign brokerage houses. China's WTO commitments regarding securities operations were fewer than its commercial banking commitments. Accordingly, substantial barriers to investment in the securities industry exist for foreign institutions. Domestic banks also have prohibitions against operating or owning a securities enterprise.19

Financial institutions in China have a short history of trading derivatives with Chinese businesses. Credit, fixed income and foreign exchange derivative trading came into existence in China in 2004 and have quickly expanded into significant revenue-generators for both domestic and foreign banks. Traditional wisdom holds that the foreign institutions will dominate the market due to better risk management, faster product innovation and more sophisticated trading systems. While foreign institutions do appear to have advantages, the domestic institutions have gained by being able to hedge exposure to risk.

Custodial services Custodial services have not been discussed significantly in relation to Chinese financial institutions nor have many foreign institutions attempted to enter the market. Top-flight custodian services will be a competitive differentiator of financial institutions as product offerings broaden, the securities market becomes more complex, wealth management products expand, and share ownership changes hands more often. Fees generated by these services can be substantial, while costs can be reduced through the use of technology and process enhancements. Institutions that seek to develop superior custodial service in core competencies - custody, clearing and settlement, transfer agency, fund accounting, financial reporting, legal and compliance, and tax - will add a fee annuity business and a competitive advantage.


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Conclusion:Risingtomeetcustomerexpectations

Domestic banks will not be challenged for size for a very long time, if ever. But the new product-market share and profitability will be hotly contested, with the winners determined by who delivers what the customer wants at the best price with the best service. As Chinese customers, both retail and corporate, have in the past really only had limited investment choices, namely deposits, most financial products are not well-understood or trusted.

Currently, Chinese banks and insurance companies, with their large branch network and millions of customer accounts, appear to have product-distribution advantage over foreign banks. The latter will, as they have in other markets, provide innovative and intense competition for retail and institutional customers.

Successful banks and financial institutions in China should not have universal banking as their destination. Rather, they will grow to be a universal bank by capably meeting diverse customer expectations with timely and innovative products and services. The best news is the consumer will have more and better choices due to the competition between and among domestic and foreign banks.

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ReferencesAssociation for Sustainable & Responsible Investment in Asia, Taking Stock, Adding Sustainability Variables to Asian Sectoral Analysis, 2006

Deloitte Touche Tohmatsu, Taking the Spotlight - Asia Pacific Financial Services in 2010, 2006

Deloitte Touche Tohmatsu, Opportunity Knocks - Unlocking the Wealth Management Potential in Asia Pacific, 2006

Deloitte Touche Tohmatsu, Embracing Challenges, A Roadmap for Domestic Banks in China to Improve Competitiveness, 2006

Deloitte Touche Tohmatsu, Is a Crisis Imminent, or are Things Better Than We Thought?, 2007

Deloitte Touche Tohmatsu, Applying Past Lessons to Strengthen Future Performance, 2005

Deloitte Touche Tohmatsu, Retail Banking Customers Drive the Future of Financial Services in Asia, 2005

Deloitte Touche Tohmatsu, The Changing Banking Landscape in Asia Pacific, 2004

EIU, 2007

FDIC Review, China's Opening to the World: What Does it Mean for U.S. Banks? 2005

Forbes.com, Chinese Banks to Offer U.S. Credit, 2004

FT Mandate, Financial Reform in China: What Next?,2006

International Monetary Fund, 2006,

Kevin McGeehan, China’s Banking System and How Citibank Can Capitalize on Its Liberalization, 2005

Lardy, Nicholas R., Integrating China into the Global Economy, 2002

Study on the Future Opportunities and Challenges of EU-China Trade and Investment Relations - Commission of the European Communities, 2007

Yongheng Deng, Della Zheng and Chanfeng Ling, An Early Assessment of Residential Mortgage Performance in China, 2004

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Appendices

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Deloitte Touche Tohmatsu provides senior executives with thought-provoking information relating to the global economy and industry-specific issues critical to improving performance and competitiveness in their business. One of GFSI’s goals is to provide clients with useful independent research that is timely in addressing the challenges and seizing opportunities within their industry. Below are some of our publications. To obtain a copy, please contact our offices.

Ourthoughtleadershipprogramme

Opening the door - New regulations to enforce a fully open Chinese banking market In December 2006, new rules and regulations came into effect governing foreign bank ownership in the People’s Republic of China. In accordance with its year five WTO commitments, China has now issued the regulations required to fully open its banking sector to foreign banks. The regulations will have a significant impact on China’s banking sector.

The engine of growth - Retail banking customers drive the future of financial services in Asia This report explores China and five other major retail banking markets in Asia Pacific. While the more developed markets such as Australia and Japan differ greatly from rapidly developing markets such as China and India, there are common themes that banks can address in order to excel in retail banking

Seven disciplines for venturing in China The report identifies seven disciplines vital to successful investment in China and outlines the key features of China's venture capital and equity marketplace and illustrates the application of these principles - from sourcing, to managing and, finally, to exiting a deal. It was based on detailed interviews with pioneering venture capital and private equity investors

Opportunity knocks - Unlocking the wealth management potential in Asia Pacific The vast wealth in Asia Pacific, including China, presents significant growth opportunities for financial services institutions in the wealth management sector, where the majority of the Asian wealthy class is believed to be under-served. This report provides insights into how wealth managers can succeed in the marketplace.

Taking the spotlight: Asia Pacific financial services in 2010 This report highlights the common trends that should help financial institutions better prepare for the rapidly changing and dynamic nature of Asia Pacific in 2010. Markets will likely provide the greatest opportunities for financial services companies looking for future growth.

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Deloitte’s Global Financial Services Industry (GFSI) practice has dedicated financial services practices in more than 40 countries, with over 1,500 partners and 17,000 financial services professionals. GFSI is organised to transcend geographic and functional approaches to provide our clients with enterprise-wide solutions. Through our member firms, we audit some of the world’s largest banks, and insurance and asset management companies; our clients include four of the top investment banks and securities firms in the world.

With consulting as one of our core service offerings alongside audit, tax and financial advisory, Deloitte serves clients taking a multidisciplinary approach that considers clients' business needs across the entire spectrum of their enterprise. Our services include:

Accounting and reporting

Actuarial

Asset securitisation

Enterprise application and technology advisory services

Financial management transformation

Governance and regulatory compliance

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M&A global transaction

Strategic risk and capital management

Strategy and operations

Tax and legal

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AbouttheGlobalFinancialServicesIndustryPractice

WadeDeffenbaugh China Financial Services Industry Leader Tel: + 852 2852 6629 Email: [email protected]

CharlesLip China Audit Leader Tel: + 86 10 8520 7100 Email: [email protected]

JosephTse China Tax Leader Tel: + 86 21 6141 1006 Email: [email protected]

ContactsNormanSze China Consulting Leader Tel: + 86 21 6141 2388/2233 Email: [email protected]

LawrenceChia China Financial Advisory Leader Tel: +852 2852 1094 Email: [email protected]

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AboutDeloitteToucheTohmatsu Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms, and their respective subsidiaries and affiliates. Deloitte Touche Tohmatsu is an organisation of member firms around the world devoted to excellence in providing professional services and advice, focused on client service through a global strategy executed locally in nearly 140 countries. With access to the deep intellectual capital of approximately 135,000 people worldwide, Deloitte delivers services in four professional areas - audit, tax, consulting and financial advisory services - and serves more than 80 percent of the world's largest companies, as well as large national enterprises, public institutions, locally important clients, and successful, fast-growing global growth companies. Services are not provided by the Deloitte Touche Tohmatsu Verein, and, for regulatory and other reasons, certain member firms do not provide services in all four professional areas.


AboutDeloitte'sChinapractice

Deloitte's China practice provides services through a number of legal entities and those entities are members of Deloitte Touche Tohmatsu (Swiss Verein).





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The opening of China’s banking sector in accordance with WTO requirements presents both domestic and foreign financial institutions challenges and opportunities. Successful financial institutions will draw on inherent strengths to meet customer demand for a dynamic range of products.

As the Intellectual Supporting Partner of the Boao Forum for Asia Annual Conference 2007, Deloitte Touche Tohmatsu presents this special report on service delivery models and the range of product and service offerings for retail and corporate customers.

About Deloitte Touche Tohmatsu Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms, and their respective subsidiaries and affiliates. Deloitte Touche Tohmatsu is an organisation of member firms around the world devoted to excellence in providing professional services and advice, focused on client service through a global strategy executed locally in nearly 140 countries. With access to the deep intellectual capital of approximately 135,000 people worldwide, Deloitte delivers services in four professional areas - audit, tax, consulting and financial advisory services - and serves more than 80 percent of the world's largest companies, as well as large national enterprises, public institutions, locally important clients, and successful, fast-growing global growth companies. Services are not provided by the Deloitte Touche Tohmatsu Verein, and, for regulatory and other reasons, certain member firms do not provide services in all four professional areas.


About Deloitte's China practice Deloitte's China practice provides services through a number of legal entities and those entities are members of Deloitte Touche Tohmatsu (Swiss Verein).





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Financial Services

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