China’s advocates for financial reform have certainly talked big this year, but their agenda still remains just that. This year we have heard that the Hong Kong and Shanghai exchanges will link up making two way trading a reality, that private banks will be approved to take on the state banking cartel and that deposit insurance will be put in place this year “probably.” These long past due date ideas are announced to great fanfare then the market waits and waits for actions to follow. It would be great if the central bank and the securities regulator would first announce a detailed timeline to reform that the government stuck to. Instead the serial announcements have begun to seem like signals of the system’s fundamental inability to reform.
The Hong Kong-Shanghai “through train” was first announced to great fanfare in mid-2007, then pulled back. The deposit insurance scheme was also announced in 2007 and never happened. Interest rate reform has attached itself to wealth management products that seem to this analyst wholly out of control and had nothing to do with reform in the first place. And freeing up the upper limits for bank loans is beside the point; the real need is to free up deposit rates, a reform that may happen sometime in the next to years maybe.
Now we have the recent news that ten so-called private companies have been invited by the bank regulator to form five privately invested banks. This has been seen by many commentators as the first step to opening up China’s closely guarded state banking preserve to private investors. Never mind that presumably private investors own large chunks of all listed Chinese banks or that foreign banks have been operating in China for 30 years with little to show for it (foreign bank assets are less than 2% of Chinese financial assets).
These new private banks are meant to do what the state bank cartel and foreigners seem unable to do: lend to small and medium size enterprises. The list of companies that are to promote these new banks does not suggest even a hint of banking expertise. As for Alibaba and Tencent, it is one thing to place buyer deposits in mutual funds or so-called “wealth management products,” and an entirely different thing to establish and run a bank making loans to corporate entities.
Here is the list of invited companies paired with their prospective partners and geographic location:
1) Zhejiang: Alibaba & Wanxiang Holdings – Zhejiang company making auto parts
2) Guangdong: Tencent & Shenzhen Baiyetuan Investment Co. – part of a pharmaceutical group
3) Tianjin: Huabei Group – copper, non-ferrous metals and real estate & Tianjin Shanghui Investment Co. – Tianjin company; part of a pharmaceuticals group
4) Zhejiang: Huafeng Group –textiles, petrochemicals and plastics & Chint Electric – power equipment and supplies
5) Shanghai: Fosun Group – pharmaceuticals to real estate conglomerate & Juneyao Air – a private airline
The bank regulator requires that each new bank have two investors. Thus, for example, Alibaba will team up with Wanxiang the auto parts king. The purpose of this may be to make the bank less beholden to any one investor, but unless there is a clear majority investor the result will be continuous unpleasantness at the board level and in the baby bank’s operations.
What does the bank regulator mean by “bank?” At first I believed that this was a way for the government to bring the deposit taking and investment activities of Alibaba and Tencent under regulatory scrutiny, something which is very much needed. But these activities more properly fall under the purview of the securities regulator which oversees all fund management companies. But it is the bank regulator offering these licenses and by “bank” it means a commercial bank that takes deposits and makes loans. The regulator aims to have each of the new banks operate with a different business strategy and focus.
No matter the strategy, the bank license suggests that the bank entities controlled by Alibaba and Tencent are likely to be loan originators as another type of investment product for Alipay depositors. The strategy of making loans that will be sold off to others is fraught with risk as the wealth management products already show. Adding a banking license to these huge online banking operations will simply add to the regulatory complexity facing China’s weak bank regulator. As for the other corporate sponsored banks, at this point it’s anyone’s guess what their strategies may be.
The biggest challenge for all these bank investors will be to find staff to manage and operate the banks. China has a lot of people working inside entities that are called banks, but not many real bankers, if by that is meant professionals who understand risk and how to manage and price it. Foreign bank branches and subsidiaries in China have an extremely difficult time finding appropriate staff and spend much management time and money on training. These institutions operate in real market economies elsewhere in the world and have modern management, risk control and trading systems that China staff are trained in. With all that plus the support of the WTO agreement why do foreign banks remain negligible players in China?
A major reason is that their China operations remain insufficiently capitalized to support rapid expansion. Why insufficient, because the currency regulator nominally subordinate to the central bank, the biggest financial reform advocate of all, does not permit them to bring in new capital. As the size of bank lending amounts and balance sheets are tied to bank capital levels, this limits the size and kind of business foreign banks are able to do. Nor are foreigners permitted to take a majority interest in any Chinese financial institution, no matter how small. If China’s reformers really want to reform their financial system they would permit foreign banks to grow their operations to a meaningful scale according to their own business strategies.
As for the new private banks the amount of capital is probably not the major challenge, rather it will be the geographic limitations posed by their licenses. As is typical of the Chinese government, the new banks will be allowed to operate in only a limited geographic area, the cities of Tianjin and Shanghai and provinces of Zhejiang and Guangdong. Expansion beyond these areas to any national presence will require intense lobbying of the bank regulator and is nothing to look towards in the near to medium tem future.
If China’s reformers were in a real position to carry out reforms, their traditional “slicing the salami” as thinly as possible does not work as has been demonstrated time and again in the financial sector. China’s private banks and foreign banks should be able to operate based on their own strategies outside of the traditional “bird cage” imposed by an antiquated banking regulator.
