Financial Reform in China: what next?
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Financial Reform in China: what next?Financial Reform in China: what next?
Howard Davies
Director - London School of Economics
Hong Kong TheatreLSE
17 October, 2006
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Global Financial Stock 2004 (%)Global Financial Stock 2004 (%)China is becoming a significant part of the global system
Source: McKinsey Global Institute, 2006
236
15
4.5
16.535
USEurozoneUKJapan ChinaRest of World
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Global Financial Stock Growth Rates (%) Global Financial Stock Growth Rates (%) 1993-20041993-2004
Source: McKinsey Global Institute, 2006
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Financial Depth – Financial Stock as % Financial Depth – Financial Stock as % of GDP 2004of GDP 2004China’s financial system is already well-developed
Source: McKinsey Global Institute, 2006
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Bank Deposits as % of Financial StockBank Deposits as % of Financial StockBut it is very heavily dependent on banks
Source: McKinsey Global Institute, 2006
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Chinese Share of Global Financial Stock Chinese Share of Global Financial Stock (%) 2004(%) 2004And the capital markets are relatively small
Source: McKinsey Global Institute, 2006
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Private Debt GovernmentDebt
Equities Bank Deposits
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China’s Banking Industry StructureChina’s Banking Industry StructureState Council
Central Bank: PBOC
China Banking Regulatory Commission: CBRC
Commercial Banks • State commercial Banks• National commercial banks• Regional commercial banks• City commercial banks• Joint-venture banks• Foreign bank branches
Policy Banks• China Development Bank•Export/Import Bank• Agricultural Development Bank
Joint Stock Banks• Bank of Communications •CITIC Industrial Bank •China Everbright Bank•Huaxia Bank etc
State Owned Banks• Industrial & Commercial BoC (ICBC)•Bank of China (BOC)•China Construction Bank (CCB)•Agricultural Bank of China (ABC)
Other Commercial Banks•112 city commercial banks• 1,049 urban credit cooperatives• 40,000 rural creditcooperatives
Foreign Banks•191 foreign operational entities
Other Institutions •136 trust and investment companies• 71 financial companies•12 leasing companies
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A Market dominated by the “Big Four”A Market dominated by the “Big Four”
Joint stock banks 13.2%
ICBC 24.9%
BOC 23.9%
CCB 22%
ABC 16%
ICBC 30.9%
BOC 23%
ABC 21.6%
CCB 17.6%
Joint stock banks 6.9%
Consumer Deposits Consumer Loans
Corporate Deposits Joint-stock
Banks 20.7%
ICBC 27.8%ABC 18.7%
BOC 16.5%
CCB 16.4%Joint-stock Banks 30.7%
ICBC 23.9%CCB 17.8%
ABC 14%
BOC 13.7%
Corporate Deposits Corporate Loans
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The ‘Big Four’ StrategyThe ‘Big Four’ Strategy
• Strengthen balance sheets
• Strategic shareholders– Strengthen management capacity– JV partners
• IPOs in Hong Kong and Shanghai (? and later London) to aid corporate governance reform
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The Non-Performing Loan ProblemThe Non-Performing Loan Problem
• A residue of the casualties of economic reform• The Government’s response a combination of:
– worst loans moved to asset management companies: ‘bad banks’
– capital injections– enhancement of recovery rates– restrictions on ‘political’ lending
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China Banking Landscape StatisticsChina Banking Landscape StatisticsBank Foreign Partner (s) Total Assets (US $Bn)
Big 4
ICBC Negotiating with GS, Allianz, Amex (10%) 737.1
BOC RBS, ML, Li Ka-Shing Foundation (10%), UBS (1.6%) 515.7
CCB BAC (8.7%), Temasek (6.0%) 510.1
ABC - 422.0
Joint-Stock Banks
Bank of Communications HSBC (20%) 156.1
China Merchants - 81.1
Shanghai Pudong Dev Citigroup (5%) 59.5
Minsheng IFC (1%), Temasek (4.55%) 61.9
CITIC Industrial - 40.5
Industrial Hang Seng (16%), GIC (5%), IFC (4%) 41.1
Everbright ADB (3%) 39.7
Huaxia DB (14%), Pangaea Capital Management (6.9%) 39.1
Guangdong Dev - 26.5
Shenzhen Dev Newbridge (18%), GE (7.3%) 24.8
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Chinese Bank IPOsChinese Bank IPOs
2005 China Construction Bank
9.2 $bn (HK)
2006 Bank of China 10.0 $bn (HK)
3.0 $bn (Shanghai)
2006 Industrial and Commercial Bank of China
? 16.0 $bn (HK)
? 5.8 $bn (Shanghai)
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WTO FrameworkWTO Framework
Steps Towards WTO Reform
WTO Accession (Dec 2001)
Business Scope
Cities to be opened
Opening of foreign currency accounts for local enterprises and individuals
RMB Business open to all enterprises in China
Dec 2002
Dec 03
Dec 04
Dec 05
Dec 06
RMB Business open to all enterprises and individuals in China
Shenzhen, Shanghai, Dalian, Tianjin
Guangshou, Qingdao, Nanjing, Wuhan
Jinan Fuzhou, Chengdu, Chongqing
Kunming, Zhuhai, Beijing, Xiamen
Shantou, Ningbo, Shenyang, Xian
No more geographic restriction
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WTO Implications for Foreign BanksWTO Implications for Foreign Banks
• National treatment
• Allowed to conduct RMB business (but with some restrictions)
• Encouragement to establish in North East and West
• Common regulatory standards
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Key Challenges for Chinese Banking SystemKey Challenges for Chinese Banking System
• Fundamental banking industry reform is far from complete
- Ensure large state-owned banks that have been cleaned up and recapitalised do not repeat past mistakes
- Upgrade management expertise
- Improve Risk management and internal control
- Adopt risk-based pricing
- Standardise processes and centralise IT
- Implement proper incentive system
- Further lower high NPL ratios and address thin capitalization of other underperforming banks
- Eliminate influence by central and local governments
- Further improve regulatory/legal framework
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Moody’s Ratings of China’s Big Four Banks
Bank Deposit Senior Long- Financial
Long-term Short-term Term Debt Strength
Bank 1997 2006 1997 2006 1997 2006 1997 2006
Agricultural
Bank of China Baa2 A2 P3 P1 Baa2 NA E E
Bank of China Baa2 A2 P3 P1 Baa2 A2 E+ D-
China
Construction Bank Baa2 A2 P3 P1 Baa2 NA E D
Industrial
and Commercial
Bank of China Baa2 A2 P3 P1 Baa2 NA E E+
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Key Challenges for Chinese Financial SystemKey Challenges for Chinese Financial System
•Banks still serve as the primary channel for corporate financing with very limited ability to lay off risks outside the banking system
- Domestic stock market was closed for new issuance for some time.
- Domestic bond market remains significantly underdeveloped.
• Emerging universal banking trend poses increasing complexity for regulation
- Banks are now allowed to set up asset management companies on a pilot basis
- Increasing desire by banks and insurers to get into each other’s business (currently not allowed)
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Key Challenges for Chinese Financial SystemKey Challenges for Chinese Financial System
•But the biggest issues are probably cultural
- Credit focus, not formula lending allocations
- Creative tensions within banks, and between banks and regulators
- Institutional loyalties
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Stock exchange indices: Shanghai v IndiaStock exchange indices: Shanghai v India
Source: Yahoo! Finance, 2006
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Capital Market Reforms Capital Market Reforms
a) Equity marketa) Equity market
- selling Government shareholdingsselling Government shareholdings
- - investor compensation schemeinvestor compensation scheme
- overseas investmentoverseas investment
- regulatory enforcement/closure of securities regulatory enforcement/closure of securities firmsfirms
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Capital Market Reforms Capital Market Reforms
b) Bond marketsb) Bond markets
- pricing benchmarkspricing benchmarks
- - rating agenciesrating agencies
- derivativesderivatives
- secondary/repo marketssecondary/repo markets
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Capital Market Reforms Capital Market Reforms
c) Corporate Governancec) Corporate Governance
- CSRC Code of PracticeCSRC Code of Practice
- role of independent Directors- role of independent Directors
- distributed ownershipdistributed ownership
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Regulatory Reform Regulatory Reform
- 3 commissions: CBRC, CSRC, CIRC- 3 commissions: CBRC, CSRC, CIRC
- International Advisory CouncilsInternational Advisory Councils
- Training- Training
- Culture of challengeCulture of challenge
- Overarching body to resolve inconsistencies Overarching body to resolve inconsistencies and promote co-operationand promote co-operation
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Implications for the Global Financial System
• Huge new competitors with regional/global ambitions– Adequately capitalised to operate overseas (probably)
– Supported by knowledge transfer from strategic shareholders, but
– Not as margin sensitive as other banks with more demanding shareholders
• New openings in China for foreign institutions with targeted competitive offerings
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Relative size of Chinese and other Asian Relative size of Chinese and other Asian banks ( $bn)banks ( $bn)
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Financial Reform in China: what next?Financial Reform in China: what next?
Howard Davies
Director - London School of Economics
Hong Kong TheatreLSE
17 October, 2006