Banking on China: Successful Strategies for Foreign Entrants · John Garabedian BCG Chicago +1 312...
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Banking on China Successful Strategies for Foreign Entrants BCG REPORT
Transcript of Banking on China: Successful Strategies for Foreign Entrants · John Garabedian BCG Chicago +1 312...
Banking on China
Success fu l S t ra teg ies fo r Fore ign Ent rants
BCG REPORT
Since its founding in 1963, The Boston Consulting Group has focusedon helping clients achieve competitive advantage. Our firm believes thatbest practices or benchmarks are rarely enough to create lasting valueand that positive change requires new insight into economics, markets,and organizational dynamics. We consider every assignment a unique setof opportunities and constraints for which no standard solution will beadequate. BCG has 61 offices in 36 countries and serves companies inall industries and markets. For further information, please visit our Website at www.bcg.com.
Banking on China
Success fu l S t ra teg ies fo r Fore ign Ent rants
THOMAS ACHHORNER
JOHNSON CHNG
HOLGER MICHAELIS
TJUN TANG
M A Y 2 0 0 6
www.bcg.com
© The Boston Consulting Group, Inc. 2006. All rights reserved.
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3
Table of Contents
Note to the Reader 4
Acknowledgments 6
Preface 7
Summary of Key Findings 8
Responding to the Lure of an Opening, Expanding Market 10
Foreign Activity Is Intensifying 10
New Entrants Must Size Up an Irresistible Opportunity 12
Making the Opening Move 15
Foreign Banks Must Weigh the Pros and Cons of Two Entry Approaches 15
A Variety of Options Exist Within the Two Approaches 16
Moving Ahead, with Caution 19
Understanding That Uncertainty and Change Abound 19
Learning from Other Industries 21
Drawing Insight from Winners 21
Playing to Win 23
Defining a Clear Strategy 23
Positioning Your Institution for Success 28
Managing for China 28
Taking the Next Critical Step 30
Banking on China
4 BCG REPORT
Note to the Reader
BCG established its Greater China practice in 1990 in Hong Kong, the second office that the firm openedin Asia-Pacific. The practice now includes three other offices—Beijing, Shanghai, and Taipei—and morethan 150 employees. For more information about the practice, please visit www.bcggreaterchina.com.
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5Banking on China
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Acknowledgments
6 BCG REPORT
We extend heartfelt thanks to the many people who contributed their time and knowledge to this report. Weare particularly grateful to the senior executives of leading foreign banks, both at headquarters and inChina. By graciously sharing their firsthand experience and perspectives, these leaders have deepened ourunderstanding of successful entry into the Chinese banking market and greatly enriched this report.
We also thank our BCG colleagues for their valuable insights, notably Douglas Beal, Giles Brennand, ThomasKlotz, Alain LeCouédic, Frankie Leung, and Jay Sala. We are grateful also to the project team of Linhai He,Lai Jiang, Victoria Le, Denise Wong, and Yvonne Zhou for providing invaluable research and analysis, andto Bonnie Fong, Christine Lee, Caltina Ng, Anna Zhang, and Yiting Zhang for aiding us in developing thisreport.
Finally, we thank the members of the editorial and production teams—Katherine Andrews, Gary Callahan,Dan Coyne, Mary DeVience, Kim Friedman, and Sharon Slodki—for their support in publishing ourfindings.
Thomas AchhornerVice President and Director
Johnson ChngVice President and Director
Holger MichaelisManager
Tjun TangVice President and Director
Preface
7
China has sustained explosive economic expansionfor so long that the extraordinary nature of itsgrowth is sometimes overlooked or forgotten. Butthe facts are self-evident: over the 25-year periodfrom 1979 to 2004, China’s economy grew at anaverage annual rate of 9.6 percent.1
China’s unrelenting growth will continue to createpersonal wealth, fuel economic development, andattract multinational corporations, which in turnwill lead to greater demand for financial services.In fact, for the period between 2004 and 2010,China is expected to generate approximately $130 billion—or more than one-quarter of theincrease in annual global banking revenues.
Foreign institutions have long recognized thisopportunity, but their participation has been heav-ily restricted. When China joined the World TradeOrganization at the end of 2001, however, the gov-ernment began encouraging foreign banks to in-vest in local financial institutions while graduallyexpanding the range of products and services thatforeign-owned branches could offer. Foreign com-panies have embraced this liberalization. Between2001 and 2005, they invested or committed toinvest about $20.9 billion in Chinese financial insti-tutions, with $17.6 billion invested in 2005 alone.2
Faced with seductive circumstances—continuinggrowth in the market, fading restrictions, and surg-ing foreign investment—potential entrants mightbe tempted to proceed immediately. But many chal-lenges and uncertainties lie behind China’s allure.
Although banks face an uphill battle when theyestablish operations in any foreign market, the ter-rain in China is even more daunting. For example,it is not entirely certain how the government regu-lations that shape the entry approaches and in-country operations of foreign institutions willevolve—or how they will be applied in the comingyears. In addition, the relative immaturity of theChinese market makes disruptive change a majorpossibility.
Banking on China
As a result, many foreign entrants feel forced toessentially gamble on the options that market con-ditions and regulations will ultimately favor. Intruth, however, strategy, not luck, will determinethe winners in China. Although many factors inChina are beyond the control of entrants, just asmany skills and capabilities can be leveraged to cre-ate advantage.
In such an environment, explicit plans for estab-lishing a winning position are critical to achievingcompetitive advantage. To this end, we havedefined the actions that can help foreign institu-tions set a course for long-term success. We alsoexplore the rationale for participating in this mar-ket, the approaches foreign institutions have usedto enter China, and the challenges they have faced.In identifying the emerging best practices thatunderpin our recommendations, we have drawn onthe experiences of foreign banks in China and onour own critical perspective of this unique sector.
Ultimately, we have been struck by the close resem-blance that entering the financial sector in Chinabears to playing the ancient Chinese game of Weiqi(pronounced “WAY-chee”)—a game of skill andstrategy, not of chance. The layout of the Weiqiboard game is a simple grid, and the object isstraightforward: to capture more territory thanone’s opponent. Therefore, in illustrating theoptions for foreign banks seeking to capture valu-able territory and unleash significant value in China,we’ve used the Weiqi grid in many of our exhibits.
In China, as in Weiqi, a strategic outlook is essen-tial. Players in both realms must know their desiredposition and must plan a sequence of moves lead-ing to it while maintaining sufficient flexibility torespond to moves by adversaries and changes in theenvironment. Finally, the opening move in Weiqi iscritical: players must secure a small parcel of terri-tory as a platform for growth. Likewise, entrantsinto China’s financial-services sector will find it use-ful to secure a manageable position before estab-lishing a broader presence.
1. This rate reflects real growth in gross domestic product (GDP) as updated in December 2005 by the National Bureau of Statistics of China.
2. These figures reflect bank-related investments only; they exclude $2.8 billion that foreign nonbank financial institutions have invested in Chinese non-bank financial institutions.
Summary of Key Findings
8 BCG REPORT
• To address alliances, the Chinese governmentlimits a foreign institution to holding a maximum20 percent stake in a local bank (as of thisreport’s publication date). While local banks canhave more than one foreign investor, the totallevel of foreign investment cannot exceed 25percent.
• To address organic growth, the Chinese govern-ment has set high capital and asset thresholds for foreign-owned banking operations and hasallowed foreign-owned branches to offer prod-ucts and services in the Chinese currency,renminbi (RMB), only after the branches havemet minimum operating and performancerequirements.
Although the opportunities are enticing, unknownsin the market make success in China uncertain.
• Even after December 2006, substantial regulatorybarriers are likely to remain. Some industryobservers believe that the pace of deregulationwill be linked to the competitiveness of localinstitutions.
• Because it is a unique and relatively immaturemarket, China will require foreign banks to investtime and money to learn about Chinese cus-tomers and the products and services that willappeal to them.
• The relative immaturity of this market also pavesthe way for sweeping change. The landscapecould be radically altered as emerging mega-trends—for example, a shift from product silos tocustomer-based competition—redefine thesources of value and the challenges associatedwith competing for them.
To win in the long term, foreign entrants must firstdefine a clear strategy that spells out how they willuse their existing capabilities and what type ofplayer they will become in China.
• To help mitigate the risk and uncertainty inher-ent in this market, a sound strategy shouldinclude more than one pathway toward achievingthe desired position.
Since the end of 2001, when the Chinese govern-ment began encouraging foreign companies toinvest in local banks, more than 30 foreign playershave invested in the country’s financial institutions.
• Foreign institutions invested or committed toinvest approximately $20.9 billion in Chinesefinancial institutions from 2001 to 2005, with thelion’s share of that amount—$17.6 billion—invested in 2005 alone.
• The top five investors account for about 70 per-cent of the total foreign investment in the indus-try. The largest single investments hover near $3 billion, but many companies have invested lessthan $100 million.
In this liberalizing environment, foreign institu-tions are drawn to China for its spectacular growth,its concentrated areas of value, and the opportunityit presents to deploy competitive advantages.
• For the period between 2004 and 2010, China isexpected to generate approximately $130 bil-lion—or more than one-quarter of the increase inannual global banking revenues.
• Although China is a vast and populous country,banking opportunities and revenues are—andare expected to remain—highly concentrated.For example, the wealthiest 0.4 percent of house-holds in China own more than 60 percent of thecountry’s total personal wealth. Furthermore,over the next five years, more than half of thebanking revenue in China is expected to be gen-erated in 6 of the country’s 31 provinces, andmore than 80 percent will be generated by fourlines of business that will open to full foreign par-ticipation in December 2006.
• Chinese banks currently offer a limited range ofundifferentiated products and services. Foreignplayers will be able to leverage new and bestpractices, especially in winning attractivecustomers.
Foreign banks face government restrictions thataffect their entry through both alliances andorganic growth.
• Entrants should look to other industries—such asautomotive—for insight into the types of strate-gies that have succeeded and failed in China.
• Among other operational challenges, most entrystrategies must grapple with the scarcity of well-trained banking employees who are literate inChinese and familiar with the culture. As soon asthey define a strategy, therefore, entrants mustfocus on recruiting, training, and retaining valu-able employees in China.
Next, players must position their institution for successby carefully managing stakeholders both within andbeyond their organizations.
• A company’s senior leaders must understand howand why an investment in China will differ frominvestments in more developed markets—andmust commit to a long-term strategy.
• Companies must dedicate significant resources toestablishing lines of communication with all rele-vant government and regulatory bodies in China.
Finally, entrants must manage for China by excellingat building alliances and growing organically. Theformer includes both joint ventures and equityinvestments in existing institutions.
• In forging alliances, entrants must choose part-ners that will embrace change, taking care tobuild trust on the basis of common motivationsand concerns, and to use quantitative measuresto track performance.
• Those seeking to enter China by building a busi-ness from the ground up must position outstand-ing leaders and managers on the ground—peoplewho excel at building not only enterprises butalso relationships.
9Banking on China
Chinese banks, with two of those institutions—Industrial and Commercial Bank of China andBank of China—together capturing more than halfof the investments. (See Exhibit 2 and the sidebar“The Local Landscape.”)
In China’s financial-services sector, foreign invest-ment not only focuses on a handful of targets butalso is generated by a handful of investors.Although more than 30 foreign institutions haveinvested in Chinese financial institutions, a mere
Responding to the Lure of an Opening,Expanding Market
10 BCG REPORT
China’s financial-services industry is undergoingsubstantial liberalization on two fronts. Since theend of 2001, the Chinese government has encour-aged foreign institutions to invest in local banks.During the same period, restrictions on foreign-owned branches have gradually eased. Five yearsago, foreign-owned branches could offer only alimited range of products—and only to foreigncustomers in selected cities. Beginning inDecember 2006, they will be permitted to deliverproducts in the local currency, renminbi (RMB),to all retail and corporate customers across thenation. In conjunction with China’s relentless eco-nomic growth, these reforms represent anunprecedented opportunity for banks around the world.
Foreign Activity Is Intensifying
In October 2005, Liu Mingkang, chairman of theChina Banking Regulatory Commission (CBRC),endorsed foreign banks as “an indispensable com-ponent” of China’s banking industry. Indeed, regu-lators have even gone so far as to mandate foreignparticipation as a prerequisite for new banking ven-tures, with Liu saying in late 2004, “With respect tonew entrants in the banking sector, such as BohaiBank in Tianjin, the presence of a qualified foreignstrategic investor is considered an essential crite-rion for approval. In addition, we at the CBRC alsowelcome foreign participation in the existing andnewly licensed finance companies, the restructur-ing of trust and investment companies, and theestablishment of securities investment funds spon-sored by banks in China.”
Consequently, the foreign presence in the Chinesefinancial-services sector is significant and growing.Between 2001 and 2005, foreign investments inChinese financial institutions soared. (See Exhibit1.) Securities and insurance companies haveattracted some interest, but foreign investors havehomed in primarily on local banks. In fact, foreigninvestors have channeled more than three-quartersof their total investment into four of the largest
Annual foreign investment in Chinese financial institutions($billions)
Securities Insurance
= Total annual investment
0
5
10
15
20
2001 2002 2003 2004 2005
17.6
0.20.7 0.4
2.0
Banks
E X H I B I T 1
FOREIGN INVESTMENT IN CHINESE FINANCIAL INSTITUTIONS SURGED IN 2005
SOURCES: Literature research; BCG analysis.
NOTE: These figures reflect bank-related investments only; they exclude
$2.8 billion that foreign nonbank financial institutions invested in Chinese non-
bank financial institutions.
5—including one consortium—account for about70 percent of the total foreign investment. (SeeExhibit 3, page 12.) While individual investmentsby these five major investors are approximate- ly $3 billion, many more institutions have investedless than $100 million. Furthermore, most in-vestors have sought a stake in only one or two localplayers.
Some foreign institutions are also establishingtheir own branches and representative offices inChina. After Nanyang Commercial Bank, based inHong Kong, opened the first foreign-ownedbranch in the Shenzhen Special Economic Zonein 1982, 69 banks from 20 countries established232 operational entities in China throughSeptember 2005.
11Banking on China
26.8Percentageof total 24.8 18.7 8.4 7.8 2.2 1.6 1.4 1.3 1.2 5.8 100
Approximately 79 percent of investment wasdirected to four of China’s largest banks
Foreign investments in Chinese financial institutions, 2001–2005 ($millions)1
20,881
Industrial and Commercial
Bank of China
Bank of China
China Construction
Bank
Bank of Commu-nications
Ping AnInsurance
Huaxia Bank ChinaPacific
Insurance
Industrial Bank
Company
Bank of Beijing
Shenzhen Development
Bank
Others Total
3,100
5755,175
3,600
2,000
5,600 1,500
2,500
1,750
1,640 125454
329
327 303 267 2501,215
1,4003,900
Goldman Sachs, Allianz, and American Express3
JPMorgan consortium2
RBS consortium5
Bank of America
Temasek HoldingsHSBC HSBC
PangaeaCapital
Deutsche Bank and Sal. Oppenheim7
Hang Seng Bank, GIC, and IFC8
ING andIFC9
NewbridgeCapital andGE Capital10
GoldmanSachs
Temasek Holdings6
ADBandUBS4
E X H I B I T 2
FOUR OF CHINA’S LARGEST BANKS GARNERED ABOUT 79 PERCENT OF FOREIGN INVESTMENT
SOURCES: Literature research; BCG analysis.
NOTE: Figures are based on December 2005 data and exchange rates.
1These figures reflect bank-related investments only; they exclude $2.8 billion that foreign nonbank financial institutions invested in Chinese nonbank financial institutions.
2The deal has not yet closed. JPMorgan is investing $1 billion, and Abu Dhabi Investment Authority and Kuwait Investment Authority together are investing $1 billion.
3Goldman Sachs is investing $2.1 billion, Allianz is investing $1.2 billion, and American Express is investing $0.3 billion.
4UBS is investing $500 million, and Asian Development Bank is investing $75 million.
5The consortium consists of The Royal Bank of Scotland, investing $1.6 billion; Li Ka Shing Foundation, investing $0.75 billion; and Merrill Lynch, investing $0.75 billion.
6Central Huijin Investment Company has not yet approved the deal.
7Deutsche Bank is investing $232.65 million, and Sal. Oppenheim is investing $96.35 million.
8Hang Seng Bank is investing $209 million, the Government of Singapore Investment Corporation (GIC) $52 million, and the International Finance Corporation $42 million.
9ING is investing $215 million, and the International Finance Corporation is investing $52 million.
10Newbridge Capital is investing $150 million, and GE Capital is investing $100 million.
There are five types of domestic banks in China,the largest being the so-called Big Four state-owned institutions: Agricultural Bank of China,Bank of China, China Construction Bank, and In-dustrial and Commercial Bank of China. There arealso 12 national shareholding banks. Bank of Com-munications, the largest of these, is the only share-holding bank with a truly national branch network.
In addition, there are more than 100 city commer-cial banks, tens of thousands of urban and ruralcredit unions, and three so-called policy banks:China Development Bank, the Export-Import Bankof China, and Agricultural Development Bank of China.
T H E L O C A L L A N D S C A P E
New Entrants Must Size Up an Irresistible Opportunity
Clearly, deregulation has been the greatest impetusfor foreign activity in China’s financial-servicesmarket. But foreign institutions are also drawn bythe market’s much-touted growth, the promise ofunleashing significant value while focusing on justa few areas, and the potential to outperform localcompetitors with superior products and services.Growth is the most obvious of these draws—bothbecause the banking industry in China today is soprofoundly undersized when compared with othermajor markets and because multinational banksseek a new avenue to boost their bottom lines.
To understand China’s potential, consider thatwhile the United States and the combination of thetop five European countries (France, Germany,Italy, Spain, and the United Kingdom) accountedfor 32 percent and 22 percent, respectively, ofglobal banking revenues in 2004, China repre-sented a meager 6 percent. (See Exhibit 4.) By theend of this decade, however, China is expected tosee its share of global banking revenues rise to 10percent while the United States, the top five
European countries, and Japan will see their sharefall. For the period between 2004 and 2010, Chinais expected to generate 28 percent of the increasein annual global banking revenues, the equivalentof approximately $130 billion—and more thaneither the United States or the combined top fiveEuropean countries.
Fortunately for many global financial institutions,the market in China is opening just as their cost-reduction initiatives are winding down. Althoughsuch initiatives have brought measurable benefitsover the past decade, further cost cutting may startto weaken sales capabilities at many institutions andthus jeopardize market share. Looking ahead, onlythose financial institutions that can generate highand sustainable growth will be poised to lead theglobal market. Yet growth will be difficult to achievein most mature markets, where the consolidation ofthe financial services industry, together withincreasing competition and commoditization, offerlimited local opportunities for expansion.3
12 BCG REPORT
16.6Percentageof total 14.8 14.4 12.0 11.8 9.6 5.8 3.4 1.6 1.4 8.6 100
The top five investors accounted forabout 70 percent of investment
Foreign investments in Chinese financial institutions, 2001–2005($millions)1
3,472
3,100
3,010
2,500
2,460
2,000
1,204 710 329 300 1,796
20,881
HSBC RBS consortium2
TemasekHoldings3
Bank of America
Goldman Sachs
JPMorgan consortium4
Allianz UBS Deutsche Bank
consortium
American Express
Others Total
E X H I B I T 3
FIVE INVESTORS GENERATED MORE THAN TWO-THIRDS OF THE TOTAL FOREIGN INVESTMENT IN CHINA’S FINANCIAL-SERVICES SECTOR
SOURCES: Literature research; BCG analysis.
NOTE: Figures are based on December 2005 data and exchange rates.
1These figures reflect bank-related investments only; they exclude $2.8 billion that foreign nonbank financial institutions invested in Chinese nonbank financial institutions.
2The consortium consists of The Royal Bank of Scotland, investing $1.6 billion; Li Ka Shing Foundation, investing $0.75 billion; and Merrill Lynch, investing $0.75 billion.
3The figure includes the not-yet-approved deal to purchase a stake of Bank of Communications at $1.5 billion.
4The deal has not yet closed. JPMorgan is investing $1 billion, and Abu Dhabi Investment Authority and Kuwait Investment Authority together are investing $1 billion.
3. This topic is explored further in the BCG report Striving for OrganicGrowth in Retail Banking, December 2005.
Furthermore, global players are drawn not just to the pace but also to the pattern of growth in China. In a country of 1.3 billion people andmore than 9 million square kilometers, the great-est potential value in financial services is highlyconcentrated in particular regions, customer segments, and lines of business. Institutions seek-ing to establish a presence in China can reason-ably pursue their goals by focusing on a few keytargets:
• In combination, 6 of China’s 31 provinces areexpected to generate more than half of the coun-
try’s banking revenues over the next five years.4
Individually, each one of those provinces boastsbanking assets equivalent in volume to the assetsheld in entire countries—such as Australia,Brazil, and Sweden. (See Exhibit 5, page 14.)
• The wealthiest 0.4 percent of Chinese householdsown more than 60 percent of the country’s totalpersonal wealth. Despite the concentration of
13Banking on China
China The Americas (excluding the United States) Asia-Pacific (excluding China) Europe (excluding the top five countries), the Middle East, and Africa
Japan Europe’s top five countries1 United States
2004$1,880 billion
Annual global banking revenues ($billions)
Growth 2010$2,350 billion
Total growth =$470 billion
Share of growth in annual global banking revenues, 2004–2010($billions)
Share ofannualglobal bankingrevenues (%)
110
145
155
210
240
410
610
6
8
8
11
13
22
32
240 Share of annualglobal bankingrevenues (%)180
210
260
270
470
720
10
8
9
11
11
20
31
Share of growth in annual global banking revenues, 2004–2010 (%)28
7
11
12
6
13
23
130
55
35
30
60
110
50
E X H I B I T 4
CHINA’S SHARE OF ANNUAL GLOBAL BANKING REVENUES IS PROJECTED TO RISE—AND THAT GROWTH WILL DRIVE THE LARGEST INCREASE IN ANNUAL REVENUES THROUGH 2010
SOURCE: BCG analysis and estimates.
NOTE: Percentages are based on rounded revenue figures.
1France, Germany, Italy, Spain, and the United Kingdom are the top five markets for banking revenues in Europe.
4. The six provinces are Beijing, Guangdong, Jiangsu, Shandong,Shanghai, and Zhejiang. (This report does not cover Taiwan or the twospecial administrative regions, Hong Kong and Macao.)
wealth in such a tiny percentage of households,China’s vast population makes it the second-largest market for wealth management in Asia,excluding Japan, with about 1.6 million house-holds in the country today owning approximately$820 billion in assets.
• Value is also concentrated in retail and corporateloans and deposits in renminbi—an area that weestimate will generate 80 percent of banking rev-enues by 2008.
Finally, financial institutions have been attracted toChina because they believe they can easily bestChinese banking products and sales channels,which remain largely undifferentiated, particularlyin retail banking. Once the December 2006 reformexpands the competitive scope for foreign banks,they will have a clear opportunity to build competi-tive advantage by offering a more sophisticatedrange of products and services, either in partner-ship with local banks or through their ownbranches.
14 BCG REPORT
Total banking deposits, 2004 ($billions) Total banking loans, 2004 ($billions)
Nominal gross domestic product, 2004
0
100
200
300
400
500
200 400 600 800
South Korea
India
Australia
Brazil Mexico
RussiaIndonesia
Sweden
Ireland
Guangdong
JiangsuShanghai
Beijing
Shandong
South Korea
India
BrazilMexico
Russia
Indonesia
Ireland
CzechRepublic
Guangdong
JiangsuShandong
ZhejiangBeijing
ShanghaiZhejiang
CzechRepublic
China’s top six provinces by gross domestic product
0
100
200
300
400
500
200 400 600 800
Sweden
Nominal gross domestic product, 2004
E X H I B I T 5
CHINA’S LARGEST PROVINCES BOAST BANKING ACTIVITY ON A PAR WITH THAT OF SOME NATIONS
SOURCES: Almanac of China’s Finance and Banking, 2005; The Economist Intelligence Unit; China Statistical Yearbook 2005.
15
Making the Opening Move
Foreign companies seeking to compete in China’sfinancial-services sector must navigate a reform pol-icy that sometimes promotes conflicting interests.On the one hand, China recognizes that foreignplayers can help strengthen local institutions byintroducing best practices, providing valuablerecapitalization, raising the level of competition,and improving governance. On the other, a rapidincrease in competition could catch some localinstitutions off-guard.
Foreign Banks Must Weigh the Pros and Cons of Two Entry Approaches
To balance these competing interests, the govern-ment has imposed restrictions on the two broadtypes of entry available to foreign players: buyinginto an existing business through an alliance with aChinese bank and building an organic presencefrom the ground up. These restrictions, which willremain in place after product offerings are liberal-ized in December 2006, are intended to enable for-eign banks to participate in, but not dominate, themarket.
Minority Stakes in Alliances. Foreign participationis welcome in China, but foreign control over bank-ing operations is still viewed with skepticism.Therefore, even though established banks in Chinaare encouraged to take on strategic investors fromabroad, current regulations limit a foreign institu-tion to holding a 20 percent stake in a local bank.While local banks may have more than one foreigninvestor, the total level of foreign investment maynot exceed 25 percent.
Thresholds for Organic Growth. The governmenthas set high thresholds for entry that effectivelyrequire foreign banks to invest for five years ormore before they can establish a branch that offersa competitive range of products and services. Onlybanks with total assets of at least $20 billion mayestablish a branch that can conduct business inrenminbi and serve local nonretail customers. Thebank must also hold at least RMB 300 million(about $37 million) in working capital, must haveoperated a representative office in China for atleast two years before establishing an operational
branch, and must have run the operational branchfor at least three years and earned profits for twoconsecutive years. Playing in the local retail sectoris not possible until December 2006—and then theante will be higher than in the corporate sector. Inaddition to meeting all the above requirements,foreign banks will need to hold RMB 400 million(roughly $50 million) in working capital to offerretail lines.
In seeking to establish the strongest presence inChina as quickly as possible, foreign institutionsmust weigh the advantages and disadvantages ofthese two approaches and strike a balance that bestexploits their capabilities. Given all the possibleenvironmental changes and competitors’ potentialmoves, the game of Weiqi serves as a valuable lensfor assessing strategies in China. In applying theWeiqi framework, we view the two approachesexplored above—alliances and organic growth—aspossible opening moves for entry into the market.Furthermore, we view the ultimate goal for foreigninvestors as commanding a position that providesregional or national coverage in China. (SeeExhibit 6, page 16.)
By embracing the first approach—forging analliance with a Chinese bank—a foreign investorcan tap into local knowledge as well as an existingnetwork of branches, an established customerbase, and a recognized brand. When entrants buyinto the market this way, the geographic coveragethey gain can range from local to national, buttheir degree of control can range only from minor to no more than moderate—depending onwhich company they invest in and how much theyinvest.
Along with the benefits they acquire through analliance, however, entrants also sacrifice controland assume risks—specifically, the risks embeddedin the existing bank’s loan and customer portfolio,operational processes, culture, and organization.The lack of operational control may make it diffi-cult for companies to drive the changes necessaryto improve performance, manage the loan portfo-lio, and develop differentiated offerings. Certainly,local management could opt to ignore the practices
Banking on China
suggested by a foreign partner, leaving the poten-tial for competitive advantage unrealized.
Even when foreign investors can assume manage-ment control while holding a minority share, they may find effecting change tremendouslydifficult. That’s because other factors unique tothe Chinese environment affect control as well.For example, because the Communist Party ofChina maintains an active presence within compa-nies, it has an impact on management decisions.As a result, achieving change in China’s financialinstitutions will require a much more gradual and careful approach than many investors wouldprefer.
The second approach, building a presence organi-cally, presents opposing advantages and disadvan-tages. Foreign financial institutions that “grow theirown” forgo an existing base of customers andbranches, as well as local know-how. As a result,they risk being stymied by the complexities of gov-ernment regulations and cultural differences.However, they gain control of their destiny—at leastto the extent that Chinese regulations will enableforeign entrants to expand branch networks andbusinesses.
Although foreign players have been permitted toestablish branches in China for more than 20 years,none of those efforts have yet evolved into a sub-stantial presence. Major restrictions limiting for-eign-led organic growth are set to expire inDecember 2006, but some regulations and adminis-trative processes will remain. These will continue toaffect the speed and depth of entry of foreign play-ers. For example, while a foreign bank will be ableto obtain licenses to conduct business everywherein China and across all permitted renminbi-denom-inated products, the opening of each new branchand the launch of each new product will stillrequire government approval.
A Variety of Options Exist Within the Two Approaches
In practice, many foreign players pursue bothalliances and organic growth, resulting in a broadrange of activity in the market. (See Exhibit 7.)The most common organic-growth strategies—embraced by more than 60 players—have been based on small branch networks, which com-prise fewer than five branches and provide onlylocal coverage. Only a handful of entrants have pursued more aggressive organic growth by
16 BCG REPORT
Geographiccoverage
Low High
Control
National
Regional
Multicity
Local
Smallstake1
Largestake2
Jointventure
Negotiated control
Controlstake Ownership
Long-term goal:command a position
with regional ornational coverage
2
Groworganically
Use an alliance to buy into a local player1
E X H I B I T 6
IN MAKING THEIR OPENING MOVE IN CHINA , FOREIGN ENTRANTS HAVE TWO BROAD APPROACHES
SOURCE: BCG analysis.
1A small stake is less than 10 percent.
2A large stake is between 10 and 20 percent.
building a larger branch network covering multi-ple cities.
Many foreign players dissatisfied with the progressof organic growth added alliances to the mix afterthe government began allowing them. Each type ofpotential partner brings distinct advantages andchallenges to an alliance.
• “Big Four” Bank. These state-owned targets offerforeign investors an opportunity to access anationwide sales network and broad customerbase, but they leave investors with little controlover local management. These banks havealready attracted significant investment, andthree of the four—China Construction Bank,
Bank of China, and Industrial and CommercialBank of China—already have investors.
• Joint-Stock Bank. This option provides investorswith a national banking license and a betterchance to exert influence on local management.Since 1986, 12 joint-stock banks have been estab-lished. Because they were established morerecently than the Big Four banks, they tend tocarry less historical baggage and could be moreagile and responsive to the market. The coverageof joint-stock banks is typically regional. Like theBig Four, most joint-stock banks have alreadyaccepted a foreign investor. The most prominentexample is Bank of Communications, which solda 19.9 percent stake to HSBC.
17Banking on China
Geographiccoverage
Low High
Control
National
Regional
Multicity
Local
Smallstake1
Largestake2
Jointventure
Negotiatedcontrol
Controlstake Ownership
Hot = option used by 20 or more players Cool = option used by 1 to 4 players
Warm = option used by 5 to 19 players Cold = option used by no players
Big Fourbank
Joint-stockbank,
insurance
Jointventure (cards,
funds man-agement)
Joint-stockbank6
Hong Kong bank
Joint-stock bank7
Large branchnetwork8
Small branchnetwork
Joint-stockbank
Joint-stockbank
Jointventure (cards,
securities)
Multiplecity
commercialbanks3
Jointventure
(wealth man-agement)4
Single citycommercial
bank
Single citycommercial
bank
Jointventure(bank)5
E X H I B I T 7
ACROSS BOTH APPROACHES, ENTRANTS ARE UNDERTAKING A FULL SPECTRUM OF STRATEGIC OPTIONS
SOURCES: BCG research, BCG analysis.
NOTE: The geographic coverage of each example is determined by the current extent of its sales network; the number of examples is based on the number of investors, not
the number of targets.
1A small stake is less than 10 percent.
2A large stake is between 10 and 20 percent.
3Each entrant invests in more than one city commercial bank.
4This example is currently under negotiation.
5There is only one example.
6There is only one example of an entrant that negotiated management control despite its minority stake.
7One example is pending approval: a foreign bank acquiring a stake of more than 40 percent.
8A large network has branches in more than five cities.
• City Commercial Bank. By partnering with one ofthese banks, an investor would have a greaterchance of influencing management and wouldalso gain access to a citywide sales network and cus-tomer base. Geographic scope, however, would belimited to the municipality, and many of the topten targets are already spoken for. Prominentexamples include ING’s acquisition of 19.9 per-cent of Bank of Beijing, BNP Paribas’s acquisitionof 19.2 percent of Nanjing City Commercial Bank,and Australia and New Zealand Banking Group’sacquisition of 19.9 percent of Tianjin CityCommercial Bank. With more than 100 city com-mercial banks in existence, however, many second-tier targets remain available. Their attractivenessmay get a boost if regulations ease, allowing expan-sion beyond home territories.
• Hong Kong–Based Bank. By partnering with or gain-ing control of one of these banks, an entrant couldleverage the preferential terms of the CloserEconomic Partnership Agreement (CEPA), whichlowers the capital requirements and waives therequirement that foreign investors establish a rep-resentative office prior to opening a branch. CEPAalso makes it easier for banks to demonstratebranch profitability. In addition to these benefits,a bank based in Hong Kong would provide accessto a large pool of employees who are literate inChinese and experienced in this market.
• Securities Firm. These firms could offer a foreignentrant not only an existing customer base andsales network but also access to a comprehensivenational license that covers brokerage, underwrit-ing, proprietary trading, and asset management—but not banking. Securities firms therefore serveas an attractive platform for entering segment-focused businesses such as wealth management.Unfortunately, with stock market reforms stillpending in China, few securities firms are per-forming well. Yet underperforming players areoften eager to strike alliances—thus affordingentrants a strong negotiating position. Recently,UBS acquired 20 percent of Beijing Securities, andGoldman Sachs took a 33 percent share in a jointventure with Gao Hua Securities—the maximumshare that foreign companies can hold in a jointventure with a securities firm.
• Fund Manager. Through an alliance with this typeof partner, an entrant could tap into China’s grow-
ing fund-management industry while leveragingexisting distribution channels and an establishedcustomer base. In addition, a foreign player coulddevelop its own investment products to comple-ment existing offerings. Institutions that have cho-sen this path include ING InvestmentManagement, Deutsche Asset Management, andFortis Investment Management. Again, pendingstock-market reforms in China limit the currentattractiveness of this option.
• Joint-Venture Bank. By establishing a joint-venturebank with a local partner, an entrant could buildfrom scratch the organization, operations, andprocesses necessary to win in this market while stilldrawing on the strengths of its partner. Joint-ven-ture banks in China, however, are subject to thesame restrictions as any foreign bank or bankbranch. Bohai Bank is the only example of a joint-venture bank that is treated as a local bank, butmany industry observers expect that the Chinesegovernment will not allow another deal of thiskind in the near future. Therefore, the true bene-fit of this kind of play is the strength of the localpartner and its offering. An example of thisapproach is HSBC’s investment in Ping An Bank, ajoint venture with Ping An Insurance.
• Product Joint Venture. Under this approach, anentrant cherry picks profitable product seg-ments. For example, some investors have alreadytaken strategic stakes in a Big Four or a joint-stock bank and have deployed them as a base forlaunching a product joint venture while securinga broad sales network. The approach is a goodstarting point, but most commercial banks willwant to go beyond a single-product strategy tocapitalize further on customer relationships.
• Insurer. The insurance business in China is attrac-tive in its own right, but it can also provide com-plementary products for an integrated financial-services player. Some banks are already active inthis sector. The most notable example is HSBC,with its 19.9 percent stake in Ping An Insurance.
Whereas most entrants assess these options with aneye toward establishing a sustainable presence inthe Chinese market, some also seek attractive capi-tal gains. But the prospect of realizing a capital gainshould not be the only reason for making a largeinvestment in a Chinese bank.
18 BCG REPORT
19
Moving Ahead, with Caution
Many foreign banks recognize the unparalleledopportunity that has been created by the openingof China’s financial-services sector, but they areuncertain about how or when their investments inthe market will grow to become sustainable, suc-cessful operations. If they proceed with caution,however, they can move ahead in China, armedwith lessons from foreign investors that havealready made moves in other portions of China’sopening economy.
Understanding That Uncertainty and Change Abound
Perhaps the clearest evidence of the uncertaintypervading China’s financial-services market can befound in the entry strategies of the foreign institu-tions themselves. Many have placed more than onebet—in fact, some have made as many as seven dif-ferent investments—largely because it is so hard topredict how the opportunities in this market willunfold.
Their caution owes, in part, to lingering questionsabout future competitiveness in the Chinese bank-ing industry. It is difficult to forecast how local play-ers will evolve or what will happen if their improve-ments do not proceed far enough, fast enough.Some industry observers believe that the pace ofderegulation will be linked to the competitivenessof the local industry.
Furthermore, while December 2006 will signal animportant new phase of reform, it will by nomeans end government involvement in this sector.In interviews we conducted for this report, severalCEOs expressed concern about just how muchregulation will remain and how predictably it willbe applied. “The key unknown is the speed ofderegulation of the market,” remarked one partic-ipant. Others noted the lack of transparency inthe regulators’ decision-making processes or werestaggered by the number of official bodiesinvolved. “There is always another layer of deci-sion makers,” one interviewee contended.Although the government is working diligently toimprove the regulatory environment, most ofthese complexities are likely to persist for some time.
Additional uncertainty surrounds the developmentof China’s financial-services sector as a whole. Insuch a relatively immature market, foreign institu-tions—despite their wealth of experience—willneed to invest time and money to fully understandtheir potential customers and the products andservices that will appeal to them.
For example, Chinese consumers have a culturallyunique outlook on credit. “The typical credit-cardcustomer segment in today’s China is still difficult topenetrate, as they [consumers] do not spend morethan they have,” remarked one executive. Because ofthese differences, strategies that have proved suc-cessful in mature markets may be of little value inChina. Banks will need to discover new ways to win.
The relative immaturity of this market also providesa basis for sweeping change. The experience ofmore developed markets suggests that China’sfinancial-services sector could evolve in any of sev-eral ways—for example, by shifting from productsilos to customer-focused competition. Coupledwith the catalysts of government reform and for-eign investment, the dual opportunity and threat ofa nascent market makes for a dynamic environ-ment. Although many expect the Chinese market tochange for the better—by gaining an improvedinfrastructure and realizing an increase in fee-based income as a proportion of revenue—theyalso grapple with the uncertainty that arises when-ever competitive evolution is compressed into ashort time frame.
In assessing the situation in China, we haveobserved ten megatrends that, over the next fiveyears, will redefine the sources of value in this mar-ket and the challenges associated with competingfor them. (See the sidebar “Ten Megatrends WillTransform Banking in China,” page 20.) Ultimately,foreign institutions will benefit from most of thesechanges, but they will also have to work hard toremain competitive in a rapidly changing environ-ment. Many institutions will need to revisit theirprocesses, operations, and strategies to ensure com-patibility with the evolving marketplace. The poten-tial for radical change adds another dimension ofcomplexity to an already complicated market.
Banking on China
20 BCG REPORT
1. Banks will shift from product silos to customer-based competition.
• Foreign banks will lead the trend
• Chinese banks are already planning customer-centric systems
2. Fee-based income will increase as a proportion oftotal banking revenues.
• Current fee levels are low compared with inter-national standards
• Chinese banks have already begun to intro-duce fees
3. The walls dividing banking, securities, and insur-ance will collapse.
• Local financial holding companies (FHCs) areemerging
• New regulations for FHCs are expected
4. Joint-stock banks will challenge the market posi-tion of the Big Four banks.
• Joint-stock banks are growing faster and havehigher-quality assets than their Big Four coun-terparts
• Typically, these banks also boast better productinnovation and service, as well as more modernsystems
5. Foreign banks will cherry pick the most at-tractive customer, product, and geographicsegments.
• New entrants can focus on the most profitableproducts
• Proven expertise and an established brand willgive new entrants a strong position
T E N M E G A T R E N D S W I L L T R A N S F O R M B A N K I N G I N C H I N A
6. The gap will widen between China’s developedEast and its underdeveloped West.
• The government is providing incentives toencourage investment in the West
• The business environment in the West, how-ever, remains more challenging
7. Sophisticated players will spur growth infinancing in small-to-medium-sized enter-prises (SMEs).
• The SME segment is underserved, in part be-cause serving it requires sophistication
• Some foreign institutions are already operatingprofitable SME-financing businesses in China
8. The infrastructure supporting credit, informa-tion, and payments will improve dramatically.
• Substantial investment is already flowing intoIT systems
• Payment and credit information platforms arebeing established
9. The market will shift from primarily bank-creditfinancing to financing from the capital markets.
• The regulatory environment will improve
• In an enhanced environment, a broader rangeof companies will be able to access debt andequity through capital-market finance
10. Overcoming the scarcity of talent will becomean increasingly important, and challenging,factor for success.
• The demand for qualified staff is projected tooutpace the supply
• Employee poaching has already been observed
One of the most significant trends, and perhaps oneof the greatest challenges, is the growing scarcity oftalent. With an increasing number of foreign banksconverging on this market, the demand for localprofessionals—people who are familiar with the cul-ture, the language, and the overall landscape andwho can communicate with senior managers fromforeign banks—is quickly outpacing the supply.Some players are already poaching talent fromcompetitors. Most foreign banks are also having dif-ficulty finding enough of their own managers whoare willing to work in China and can flourish in this environment. As competition in China in-creases, human resources are only going to becomemore scarce.
Learning from Other Industries
Foreign investors in the financial services marketaren’t the first to race one another into China’sopening economy. Competitors in other industrieshave entered China with much the same hopes oftapping into the country’s spectacular growth andexploiting their own competitive advantages in aburgeoning marketplace. And the challenges thatthe other new entrants have faced provide a sober-ing reminder that winning is not a foregoneconclusion—even when a market is growing atbreathtaking speed and on a grand scale. In fact,the high growth rate in China may be confoundingsuccess.
The automotive industry provides an illustrativeexample. Foreign manufacturers began investing inthis rapidly growing market in 1985, and as theirinvestment surged, capacity quickly outstrippedsales. (See Exhibit 8.) As prices plummeted, mar-gins eroded. Of the roughly 20 foreign manufac-turers that entered this market, only 4 have man-aged to gain market share above 5 percent, andonly 3 are growing at above-average rates.
With the pace of foreign investment not likely towane, China’s banking industry could become justas overcrowded as the car industry. Moreover, theconcentrations of value in the financial services sec-tor—by region, customer segment, and line of busi-ness—mean that competition could intensify par-ticularly quickly in specific areas.
“Expect tough competition from local banks, espe-cially the better ones,” one executive predicted.
Another said, “Once the floor on interest rates isremoved, Chinese banks will compete heavily onprice without even knowing when they get them-selves into trouble, because they do not have thenecessary interest-rate risk-management capabili-ties yet.
Drawing Insight from Winners
Fortunately, not every lesson from other liberalizedindustries in China is grim. A handful of foreign
21Banking on China
0
1
2
3
Annual sales Total capacity
4
1999
0.3
2002 2004 2006 (estimate)
0.7
1.2
2.4
0.5
1.2
1.6
3.6
Number of passenger cars produced in China, 1999–2006(millions of units)
The industry averaged a utilization rate of 65 percent between 1999 and 2006.
E X H I B I T 8
SURGING FOREIGN INVESTMENT FUELED OVERCAPACITY IN CHINA’S AUTO INDUSTRY
SOURCES: Credit Suisse First Boston; China Automotive Technology & Research
Center (CATARC); literature research; BCG analysis.
entrants in the automotive industry, as notedabove, were able to gain market share above 5 per-cent, and several achieved growth rates in excess ofthe market average—in some cases, far above it.Their successes highlight the value of clearlydefined strategies that take a long-term view, as wellas the importance of focusing on the elements ofin-country operations that are critical to success,such as the performance of alliances.
One exemplary tale to consider is the story of aNorth American automaker that entered theChinese market in the late 1990s. Together with itsjoint-venture partner, the company developed long-term strategies for its product portfolios and brandpositioning, and it built an effective sales and distri-bution network. In the end, the close collaborationand long-term vision paid off, and the automakerwas able to avoid a problem common among part-ners in joint ventures: “sleeping in the same bed buthaving different dreams.” The automaker quicklyemerged as a leader in China’s passenger-car mar-ket, and China in turn has become a bright spot inthis player’s global portfolio.
Another positive lesson can be drawn from aJapanese automaker that designed its joint venturefor balanced power-sharing with its local partner.The venture clearly delineated responsibilities,with the Japanese automaker focused on produc-
tion and marketing and the local partner focusedon financials and government relationships. In sixyears, the joint venture became the most prof-itable manufacturer of automotive equipment inChina, in part because the foreign player recog-nized that its success hinged entirely on the suc-cess of its partner.
Three broad lessons can be derived from the expe-riences of foreign companies in China’s automotiveindustry. First, foreign entrants can succeed inChina—but only if they learn how to serve localmarkets and local tastes, how to cope with regula-tory restrictions, and how to manage theiralliances. Second, not all players that are successfulin Europe and the United States will enjoy the samesuccess in China. Conversely, some players that lagin other markets have won leadership positions inChina by leveraging the unique capabilities that areessential in this market. And third, the only cer-tainty in China is change.
With these lessons in mind, financial institutionsshould be careful not to underestimate the chal-lenges of this rapidly developing economy. Butthese realities shouldn’t deter them from enteringand moving ahead in this space. Financial servicesinvestors should emulate their peers in other indus-tries that have found ways to thrive amid uncer-tainty, change, and restrictive regulations.
22 BCG REPORT
23
Playing to Win
The Chinese market presents a seductive set of cir-cumstances: continuing impressive growth, fadingrestrictions, and surging foreign investment. Soseductive, in fact, that entrants might be temptedto proceed with immediate speculation.
In an environment as challenging and uncertainas China, however, competitive advantage cannotbe achieved unless an entrant makes explicit plansfor establishing a winning position from the out-set. To this end, we propose three sets of actionsthat can help foreign institutions set a course forlong-term success. (See Exhibit 9.)
First, to mitigate some of the risk associated withuncertainty, a financial institution should define aclear strategy that is explicitly linked to relevantcapabilities, focused on a specific target aspira-tion, and diversified—that is, charts more thanone pathway to the desired goal. Second, theentrant should position its institution for success byfostering relationships with key stakeholders atcorporate headquarters and in the government.Third, it should manage for China by recognizing
the challenges and factors for success specific tothe two broad types of entry approach: alliancesand organic growth.
Defining a Clear Strategy
Fending off increasingly fierce competition andcapturing a growing share of China’s financial-services sector will require leading-edge skills.Through interviews and research, we have identi-fied seven sources of competitive advantage in thismarket. (See Exhibit 10, page 24.) In defining asuccessful strategy, a company should begin byassessing its strategic advantages in these areas. Ifit has none, it must think hard about how to com-pete in China in the long run.
The next step is to identify a target aspiration. Wehave defined six possible target aspirations inChina’s financial-services market. (See Exhibit 11,page 24.) An entrant should identify the aspira-tions that are within its grasp, understanding thatdifferent capabilities and combinations of capabil-
Banking on China
2. Positioning your institution for success
Manage internal andgovernment stakeholders
Manage alliances andorganic growth
3. Managing for China
1. Defining a clear strategy
Identify advantages
Leverage a mix of competitiveadvantages
Define target aspiration
Ensure that strengths are relevant to specific target positions in China
Select pathways
Plot severaldifferent pathways to each target position
E X H I B I T 9
ESTABLISHING A WINNING POSITION IN CHINA REQUIRES THREE KEY STEPS
SOURCE: BCG analysis.
24 BCG REPORT
Example of playerCompetitive advantage
Proximity to China
Customer segment expertise
Product expertise
Processing expertise
A banking titan with ample financial and human resources
An institution with a home market close to China or the ability to draw on management’s understanding of China and employees who speak Chinese
An institution with a winning customer-service model for specific customer segments
An institution with leading capabilities in designing and managing specific product lines
An institution with best-in-class, highly efficient product-processing capabilities
Emerging-market expertise
Existing corporate-customer base
An institution with ample experience in building successful banking operations in a similar environment
An institution that can leverage the customer base to generate revenue early in the entry process
1
2
3
4
5
6
7
Leading global position
E X H I B I T 1 0
SUCCESS IN CHINA DEMANDS COMPETITIVE ADVANTAGES
SOURCE: BCG analysis.
Role
Corporate bank
Regionally focusedretail bank
Wealth managementspecialist
Product specialist
Industryutility provider
Leadingnational bank
Target aspiration
Serving all customer segments across all
banking products with a national branch network
that ranks among the top banks in China
Capturing profitable corporate-customer
relationships with a focus in high-growth regions
Offering full commercial-banking services to
personal and commercial retail customers in
attractive geographic areas
Providing superior service to affluent and
high-net-worth customers with a focused
network and full product and service portfolio
Offering single product lines
with attractive economics
Leveraging strong processing and technical
capabilities to provide national outsourcing
services to Chinese banking players
E X H I B I T 1 1
INSTITUTIONS SEEKING TO WIN IN CHINA CAN PURSUE MANY TARGET ASPIRATIONS
SOURCE: BCG analysis.
ities are suited to different target aspirations. (See Exhibit 12.) The most ambitious aspirationsrequire the most—and most sophisticated—capa-bilities.
The third step is to identify a pathway to achievingthe target aspiration. The Weiqi board can be usedto illustrate the range of potential pathwaysassociated with the six target aspirations. (SeeExhibit 13.)
• Playing the role of a leading national bank, whichtargets integrated banking operations on anational basis, requires an attack on all fronts.Some examples are investing in a joint-stock bankto secure a national banking license, buildingprofitable product franchises through joint ven-tures, and growing a foreign-owned branch net-work organically.
• To establish a corporate bank with a regionalpresence, an entrant must capitalize on existingcorporate-banking relationships with multina-tional clients while building a local wholesalebusiness. Control is crucial when playing thisrole because the high levels of nonperformingloans in China will pose inherent risks as the riskmanagement infrastructure remains under
25Banking on China
Target aspirations
Leading national bank
Corporate bank
Regionally focused retail bank
Wealth management specialist
Product specialist
Industry utility provider
• • • • • • •
• •• •
• •
• • •• •
Leading global position
Proximity to China
Customer segment expertise
Productexpertise
Processingexpertise
Emerging-market expertise
Existing corporate- customer base
1 2 3 4 5 6 7
Competitive advantages
E X H I B I T 1 2
IMPERATIVES FOR INSTITUTIONS VARY BY TARGET ASPIRATION
SOURCE: BCG analysis.
Leading national bank
Corporate bank
Regionallyfocused
retail bank
Wealthmanagement
specialist
Productspecialist
Industry utility provider
National
Regional
Regional
Multicity
National
National
• Big Four bank• Joint-stock bank• Product joint ventures
• Hong Kong bank• City commercial bank
• City commercial bank• Product joint ventures
• City commercial bank• Securities firm• Product joint ventures
• Product joint ventures
• Big Four bank• Joint-stock bank• Joint-venture bank
✓
✓
Not applicable
✓
Not applicable
Not applicable
Geographic focus Alliance options Organic growth options
Geog
raph
icco
vera
ge
Control
Geog
raph
icco
vera
ge
Control
Geog
raph
icco
vera
ge
Control
Geog
raph
icco
vera
ge
Control
Geog
raph
icco
vera
ge
Control
Geog
raph
icco
vera
ge
Control
E X H I B I T 1 3
GIVEN THEIR TARGET ASPIRATIONS, ENTRANTS CAN CHART POTENTIAL PATHWAYS
SOURCE: BCG analysis.
NOTE: In each target position, an entrant will aim to achieve full control of banking operations in a specific geography or market.
development. As a result, the organic branchnetwork can play a vital role. At the same time,acquiring a Hong Kong–based bank can addknowledgeable staff, a customer base, the advan-tages of CEPA, and perhaps an existing branchnetwork in mainland China. City commercialbanks in attractive cities could further comple-ment these pathways.
• An entrant looking to build a regionally focusedretail bank needs to leverage local partnersrather than rely on organic growth. A citycommercial bank can provide a strong platform for building this business, offering afocused network and the potential for launchingattractive product joint ventures, such as mort-gages or credit cards. This approach suits for-eign banks that have limited corporate businessbut strong retail expertise and close proximityto China.
• A wealth management specialist will focus onmunicipalities that have high concentrations ofwealth. In order to win in this segment, anentrant must focus on the quality of sales chan-nels and customer service, as well as the attrac-tiveness of products. In these respects, both citycommercial banks and securities firms can serveas platforms for establishing a strong position. Aforeign-owned branch network is also a feasibleoption, but it may be difficult to secure a goodreturn on equity in the absence of a strong cor-porate loan book. Product joint ventures forfund management or mortgages could also com-plement the service offering. Finally, although ajoint venture with a large bank would allow theentrant to tap into an existing client base, nosuch arrangement has yet been negotiated suc-cessfully.
• As a product specialist, an entrant seeks nationalcoverage for specific products. The pathways tothis target aspiration can involve narrowlydefined joint ventures, in which the foreigninvestor could leverage the valuable assets of aChinese partner without having to assume therisks embedded in the local organization. Theforeign investor will contribute product exper-tise, while the Chinese partner will provideimportant industry and government relation-ships, sales channels, and access to an existingcustomer base.
• An industry utility provider will strive for nationalcoverage, providing outsourcing opportunitiesacross China for activities such as payments orretail loan processing. While a foreign entrantneeds to bring outstanding processing expertiseto the table, a Chinese partner will be requiredfor its national presence and business portfolio.Joint ventures would be a possible pathway, sup-ported by a stake in a joint-stock bank or a BigFour bank.
A portfolio approach, which relies on more thanone pathway, can help mitigate some of the riskassociated with this market. In charting their path-ways, entrants should also recognize that China isfar too large to capture at once. Even if a bankwants to establish a broad national presence inChina, it must begin with a more manageablefocus. Initially, banks should concentrate onspecific customer segments, regions, and lines ofbusiness.
Banks that are planning to form an alliance mustrecognize that the number of potential partners is dwindling, owing to the surge of foreign invest-ment. But they should also keep in perspective the size and number of options that remain. Manyof the top city commercial banks had not yet formed an alliance as of December 2005. (See Exhibit 14.) Some of the available optionsare located in cities that boast GDP levels compa-rable to the national economies of Vietnam orSlovakia.
In addition to the three steps described above, for-eign banks that are planning to enter the Chinesemarket must observe some guiding principles asthey develop their target aspirations and pathways:a balance between long- and short-term goals, a bal-ance between analysis and action, and a focus onhuman resources.
The first guiding principle is critical becausealthough a sound China strategy requires a long-term horizon for success, banks must also enter thismarket with a plan to score wins in the short term.Even if corporate headquarters is willing to wait forprofitability, an alliance partner may not be asaccommodating. In addition, while investing inChina is seemingly obligatory for many financialinstitutions today, popular sentiment among bothshareholders and leadership could change, espe-
26 BCG REPORT
cially if returns on investment fail to materialize. Bydemonstrating success early, entrants will stand agreater chance of maintaining the momentum nec-essary to drive these investments toward long-termgoals. An entrant should therefore plan to leverageits advantages—for example, international bestpractices in risk management, IT, product design,and customer service—as soon as possible.
The second principle implies that a “fast follower”approach can make more sense than rushing into this market simply to secure banking realestate, particularly if a bank spends its time delib-erating on the best target aspiration and pathways,and developing essential capabilities to reactquickly when the right opportunity arises. Forexample, a company would be well served by tak-ing time to understand the dynamics of theChinese banking market, build relationships with
regulators, and gather a team of people who areready to hit the ground running. But a bankshould not postpone its plans for China indefi-nitely in the hopes that the uncertainty will beresolved, regulations will be streamlined, or a rap-idly changing environment will suddenly becomestable and predictable. China’s banking marketwill remain dynamic and challenging for the fore-seeable future.
Although China boasts the largest population inthe world, the third principle—focusing on humanresources—is critical because well-trained bankingemployees who speak Chinese and know the cul-ture are scarce. Foreign entrants are already scram-bling for the few eligible employees in the market.As soon as they define a strategy, therefore,entrants must plan for recruitment, training, andretention.
27Banking on China
GDP of the Chinesecity in which the bank operates ($billions)1
Profitability of top city commercial banks in China
as measured by return on assets, 2004 (%)2
Comparable GDP levels1
0
10
0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6
20
30
40
50
60
100
City commercial bank with foreign investor City commercial bank without foreign investor (as of December 2005) Asset = $10 billion
Hungary, $100 billionNew Zealand, $97 billionPhilippines, $86 billion
Vietnam, $46 billionSlovakia, $41 billion
Chengdu
Wuxi
Shenzhen Tianjin
Qingdao
Fuzhou
Changsha
LanzhouBaotou
DongguanJiaxing Zhengzhou
Shanghai
Beijing
YantaiWenzhou
Kunming
Hangzhou
Weihai
JilinGuiyang
Qiqihaer Yinchuan Yingkou Panzhihua
Rizhao HuangshiMa’anshan
Hefei Huzhou
Xi’an
Ningbo
Chongqing
Taizhou Nantong
HarbinNanjing
Luoyang
Ganzhou
XiamenAnshan
Yichang
WuhuXining
Zhenjiang Jinan
E X H I B I T 1 4
SIZABLE INVESTMENT OPPORTUNITIES REMAIN
SOURCES: BCG’s proprietary database on city commercial banks; city commercial bank annual reports; China Statistical Yearbook 2005; city-level statistical yearbooks, 2005.
NOTE: Jinan City Commercial Bank and Hangzhou City Commercial Bank have both received foreign investments, but the return on assets for them is unknown.
1The GDP is nominal, reflecting current prices.
2Return on assets is calculated by dividing profit before tax by year-end assets.
Positioning Your Institution for Success
As they prepare to launch operations in China,either with a partner or on their own, foreign insti-tutions will need to manage relationships with cor-porate headquarters and with government offi-cials—two imperatives commonly associated withbuilding enterprises in developing markets.
Managing the Relationship with Corporate Head-quarters. To manage this relationship carefully,entrants should focus on three important elements:engaged leadership, defined performance meas-ures, and communication.
In the report Organizing for Global Advantage inChina, India, and Other Rapidly Developing Economies(March 2006), BCG determined that success in rap-idly developing economies (RDEs) such as China ischaracterized by high levels of engagement fromsenior leaders. Successful companies rely on theseexecutives to set bold top-down goals for growth;provide clear indications of sustained commitment(for example, through public announcements ofincreased investments); orchestrate the global allo-cation of resources to support operations in theRDE; and overcome barriers, including any inter-nal bias toward directing resources to mature mar-kets, in which short-term results are generallylarger and more certain.
As a next step, a bank should define clear perfor-mance measures for its in-country operations, tak-ing care to reflect the top-down goals articulated bysenior leaders. In doing so, it should be careful notto impose measures used in mature markets,because they could place unreasonable demandson managers to focus purely on short-term, bottom-line results.
And finally, regular, comprehensive communica-tion should update senior leaders frequently onbasic facts, figures, and issues. Local leadershipshould also make an effort to manage expecta-tions at corporate headquarters so that seniorleaders understand how and why an investment inChina will unfold differently from investments inmature markets. In parallel, entrants shoulddevelop a communication plan for reaching otherkey audiences, with a special focus on investors,including the board of directors, analysts, andshareholders.
Managing the Relationship with Government. InChina, government is not a monolith but a multi-layered collection of interests—municipal, provin-cial, and national—that sometimes pursue con-flicting agendas. To ensure that they reach allrelevant parties, entrants should map the govern-ment approval process for the pathways they havechosen, identifying all decision-making parties. Ifappropriate, they should share this map with thepotential partner. An articulated and shared planwill clarify the network of contacts that must bebuilt and maintained. Furthermore, the planshould be reviewed regularly, with contacts priori-tized and a budget specified. Dedicating resourcesin this manner will ensure a smooth communica-tion process. Separately, entrants should pursuegoodwill programs that demonstrate a strongcommitment to China. Being a good citizen can bejust as valued as complying with licensing re-quirements.
The consequences of neglecting these relationshipscan be severe. Without government ties, plans forpartnering with local institutions, opening newbranches, or even launching new products mightbe stifled. “Some products, while waiting to beapproved, might get copied and then launched bycompetitors,” cautioned one leader.
Managing for China
The imperatives for managing internal and govern-ment relationships apply to both organic growthand alliances, but each entry approach demands itsown unique set of management priorities.
Management Priorities in Organic Growth. Asfinancial institutions pursue plans for organicgrowth in China, they should recognize threeimperatives: employing talent on the ground,adapting operating models to local conditions, andtapping global resources.
When it comes to employing talent, sending out-standing leaders and managers to China not onlyimproves the competitiveness of local operationsbut also sends a strong signal about the company’scommitment to its investment. These people mustthrive in a dynamic environment and should be asskilled in building relationships as they are in build-ing enterprises. They also must spend a significant
28 BCG REPORT
amount of time in the country. (See the sidebar“Dedicated Expatriates.”) In addition, financialinstitutions should encourage their managers inChina to identify high-potential local employees,and actively coach and develop them for top man-agement positions.
When they arrive in China, senior leaders must beprepared to tailor their business models to localrealities and continual changes. In Europe, forexample, where mortgage markets are often low-growth and low-margin sectors, players focus onmanaging the same volume with fewer people. InChina the situation is vastly different, as are the req-uisite skills.
On average, the mortgage market in China isexpected to double in size every year during thefirst decade of this century. As a result, players needthe flexibility and capabilities to grow their organi-zations, train and hire people, and cope with mas-sive change on a number of fronts, including gov-ernment regulations, customer needs, and localand foreign competition. This fact has two implica-tions for how they operate:
• Operations in China should be structured toallow for quick and decisive moves. To permit fastresponses to environmental changes, the rightlevel of local decision-making authority isrequired. Product design, for example, should behandled locally, so that products remain in linewith market demand and regulations.
• Entrants should build a strong local work forceas soon as possible, recruiting and training evenbefore local operations begin. Once the opera-tion is up and running, institutions shouldensure that clearly defined career paths and rel-evant people-development tools are in place forlocal staff.
Entrants also require the right processes, tools,and policies to ensure global collaboration.5 Whilelocal conditions should play a major role inshaping these operating models, entrants shouldleverage common global processes—for example,for financial and strategic planning—to allowgreater continuity and collaboration with globaloperations.
Management Priorities in Alliances. Although insti-tutions pursuing alliances will also require excel-lent talent, flexibility, and global collaboration,three additional priorities will prove more pivotalto their success: supporting change, building trust,and monitoring performance.
For foreign investors, the first and nonnegotiablepriority is supporting change at the alliance part-ner. Although foreign institutions, as minorityinvestors, are likely to secure one or two seats on aChinese organization’s board of directors, theboard will likely have limited influence at best,
29Banking on China
BCG recently explored the preferred practices ofmultinational consumer companies that are takingsteps to ensure that their investments in China suc-ceed. Particularly critical is sending not just stars toChina but also people who are prepared to dig in. Anexcerpt from “In Harm’s Way: Getting It Right inChina” (BCG Opportunities for Action in ConsumerMarkets, October 2005) explores this imperative:
Companies that are serious about their Chinastrategy will have to send entire families, andlots of them. Furthermore, those families willhave to stay longer than just a couple ofyears—probably four or five. So persuadingthem to go will be much harder.
D E D I C A T E D E X P A T R I A T E S
The South Koreans, and some Europeans,seem to know what it takes. Americans andCanadians, however, typically go for two-yeartours of duty timed to coincide with the aca-demic schedules of their children. They areoverburdened with ceremonial chores—suchas accompanying far too many visitors fromheadquarters who seek an introduction to thisimportant market. On the personal side, theytend to retain a Western lifestyle, and they areoften insulated from the local community anddependent on a bilingual staff. It is difficult forthem to finish anything they start or start any-thing they have to finish.
5. BCG examines these processes in detail in the report Organizing forGlobal Advantage in China, India, and Other Rapidly Developing Economies,March 2006.
and change will need to be driven through otherchannels. That’s because boards are a novel con-cept to Chinese banks—leaving the role of theboard unclear and management and decision-making processes poorly defined. Against thisbackdrop, three factors are crucial to supportingchange:
• When choosing a target, evaluating the partner’smanagement team is arguably the most impor-tant element of the foreign investor’s due dili-gence. The partner must be able to embrace andexecute change. Among other things, the part-ner’s management should welcome the investor’sadvice.
• Entrants should begin by enabling technicalchanges, since these will be far easier for the part-ner to accept and execute than changes to thecorporate culture. Technical changes often focuson middle- and back-office functions such as riskmanagement and IT rather than product devel-opment and innovation, sales, or client relation-ship management. When they begin to focus onchanging the corporate culture, foreign investorswill need to demonstrate both persistence andsensitivity—supporting change rather than forc-ing it.
• Because local partners can opt to ignore advicefrom minority stakeholders, entrants must bringfocused and relevant expertise that is appropri-ately tailored and delivered. Likewise, theirexperts must possess communication andchange-management skills to help the local part-ner adopt best practices. Because few expertshave operated in an environment like the onetaking shape in China, they’ll need to learnmuch about the country and adapt their recom-mendations to fit its unique conditions.Interestingly, one of the banking leaders weinterviewed told us that his company had dis-patched several retired senior managers to itsalliance partner. These experts had experiencedmarket deregulation before, which gave them an informed perspective on the challengesemerging in China. As a result, their back-ground was highly valued by the Chinesepartner.
As a financial institution forges an alliance with abank in China, its second priority is building trust.
This requires understanding and meeting the goalsof its potential partner and committing to help thepartner succeed. Often, Chinese financial institu-tions seek foreign partners as a way to enhancetheir own management skills in corporate gover-nance, risk management, IT, and internal controls.They might also be looking to launch new busi-nesses or increase the capital adequacy ratio—theratio of capital to total risk-weighted credit expo-sures—to meet the standards set by regulators. Atthe same time, however, they remain wary ofincreased competition in the market and theprospect of ceding management control to a for-eign company.
To assuage any fears and build confidence in theircommitment, foreign investors can work to under-stand the key performance indicators of the deci-sion makers within the partner bank. These offi-cials often have strict management metrics theyneed to meet every year, and some of those metricsmay differ radically from the entrant’s priorities—for example, by emphasizing the importance ofmaintaining (rather than reducing) head count. Byidentifying and addressing these potential conflicts,the entrant can ensure that it works with ratherthan against its partner.
As a third priority, foreign investors must measurehow well the alliance performs. In negotiations,players must specify how the strategic and financialperformance of the alliance will be measured. Andonce operations begin, they must remain vigilant bymonitoring the partnership’s effectiveness, deter-mining, for example, whether any changes in thecompetitive environment challenge the strategiclogic of the alliance. Whether or not measured per-formance meets expectations, the metrics will indi-cate when an institution should execute its plannedexit strategy—either to realize the payoff of itsinvestment or to cut its losses.
Taking the Next Critical Step
Foreign entrants will need to find ways to succeedin an increasingly competitive, rapidly changingenvironment. Given that China is beset byregulatory pressures and pervasive uncertainty,more than one observer has characterized itsfinancial-services sector as a gamble. Just as thejackpot in China promises to be big, so are the risks.
30 BCG REPORT
As they develop or refine a strategic plan for thismarket, therefore, both potential entrants andexisting players must recognize that timing is crit-ical. For companies that have not yet enteredChina, now is the time to examine the opportunityand decide whether and how to approach thismarket. They must understand that a fully com-petitive branch will take at least five years to buildand that the establishment of an alliance mustallow for screening options, selecting partners,and negotiating deals. In the meantime, potentialalliance partners are disappearing and the com-petitive landscape is growing more crowded.
For companies with an established presence inChina, now is the time to ensure that they are opti-mizing all the factors within their control. Theymust confirm that their aspirations are consistentwith their capabilities, that their activities aregeared toward flexibility and high growth, thattheir operations are set up to manage relation-ships with headquarters as well as with local gov-ernment and regulatory authorities, and that theyhave the right leadership in place. The competi-tion will only intensify as uncertainty and changeabound and the stakes rise for playing to win in China.
31Banking on China
For a complete list of BCG publications and information about how to
obtain copies, please visit our Web site at www.bcg.com.
To receive future publications in electronic form about this topic or others,
please visit our subscription Web site at www.bcg.com/subscribe.
Organizing for Global Advantage in China, India, and Other
Rapidly Developing Economies
A report by The Boston Consulting Group, March 2006
Striving for Organic Growth in Retail Banking
A report by The Boston Consulting Group, December 2005
The Role of Alliances in Corporate Strategy
A report by The Boston Consulting Group, November 2005
“In Harm’s Way: Getting It Right in China”
Opportunities for Action in Consumer Markets, October 2005
“Banking on China: Where to Place the Chips?”
Opportunities for Action in Financial Services, July 2005
Succeeding with Growth: Creating Value in Banking 2005
A report by The Boston Consulting Group, May 2005
Overcoming the Challenges in China Operations
A report by The Boston Consulting Group and Knowledge@Wharton,
April 2005
Building Professionalism: The Next Step for Life Insurance in China
A report by The Boston Consulting Group, March 2004
China Crossroads: Competitive Priorities for Chinese Banks
A report by The Boston Consulting Group, September 2002
The Boston Consulting Group publishes other reports and articles that may be of interest to senior
financial executives who are exploring, or are already active in, the financial services sector in China.
Recent examples include:
www.bcg.com
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