Foreign Banks Taking a Short Break in China

The foreign banks are undergoing a slower growth pace in China. The analysts attributed the slowdown to the temporary depression.

When the foreign banks began to flood  China, the Chinese domestic banks were anxious whether the foreign banks could affect their profits and operations.

As time went by, the worries of domestic banks proved themselves unnecessary because the foreign banks cast no influence on their operation. Instead, the foreign banks in China all went through decrease of the market share so they were forced to slow down their pace in China.

In 2008, the market share of foreign banks in China decreased for the first time after several years’ increase. In 2007 the market share they took was 2.38% and in 2008 it was 2.16%. In 2009, the foreign banks only saw 1.8-billion-yuan newly added credit amount, which was much less than the 9.59-trillion-yuan newly-added credit amount achieved by all the financial institutions.

The international financial crisis, the fast development of the domestic banks and the restriction from the Chinese government explained the recession of foreign banks in China.

The question comes up, whether the recession is a permanent trend or just a short break for recovering from the financial crisis.

Decreased Market Share

Nobody had expected the depression of the foreign banks before.

“I always believed that the market share of foreign banks would increase,” said a bank analyst.

When Japan Import and Export Bank was allowed to inaugurate a branch in Beijing in 1979, the foreign banks began their fast and stable development in China. According to Citic Ka Wah Bank’s report issued in 2006, the foreign banks’ market share in China’s banking industry would increase by 4% in the next five years.

This report was supported by the index of total assets, which could prove that the foreign banks were keeping their market share in China increasing in the past few years. According to the reports of China Banking Regulatory Commission (CBRC) in 2007 and 2008, the proportion of foreign banks’ total assets in the banking industry kept increasing, from 1.5% in 2003 to 2.38% in 2007. The total assets of foreign banks in China doubled in only 5 years.

However, the global financial crisis which started in 2008 and the dramatic increase of Chinese domestic banks’ credit amount got in the way of foreign banks’ development. Then the proportion of overseas banks’ total assets in the banking industry fell from 2.38% in 2007 to 2.16% in 2008.

The newly-added RMB credit amount explained pretty much everything. According to the official report, the foreign banks lent 170.4 billion yuan (USD 24.97 billion) in China in 2007, which was a historical high. The whole banking industry in China lent 3.6 trillion yuan (USD 527.44 billion) in the same year. However, the newly-lent credit amount of foreign banks in China fell to 62.8 billion yuan (USD 9.2 billion) in 2008 while the total amount of all financial institutions in China was 4.9 trillion yuan (USD 719.91 billion).

The downward trend continued in 2009. According to the report from the People’s Bank of China (PBOC), or the central bank, the foreign banks only lent 1.8 billion yuan (USD 263.72 million) in 2009. In comparison, the financial institutions in China lent 9.59 trillion yuan (USD 1.40 trillion) in that year.

A source said that the capital sufficiency rate of foreign banks in China rose from 18.45% in 2008 to 21.22% in 2009 when the domestic banks were hindered by the rate of capital sufficiency. This rate was much higher than the watchdog’s deadline for the banks’ rate of capital sufficiency, which meant that the business of foreign banks in China did not really develop significantly.

Notable was the newly-lent credit amount of foreign banks in China in the first three quarters of 6.5 billion yuan (USD 952.33 million) which was a decrease compared to other times. That even happened after the watchdog’s restriction on the domestic banks’ newly-lent credit amount, which gave a little space for the foreign banks.

A source from an overseas bank said that the foreign banks in China must act in accordance with the domestic banks. A manager of a domestic bank shared the opinion. He said that the foreign banks’ competitive power was too small even though they had certain advantages in some aspects.

Trauma from Financial Crisis

While talking about the fall of the market share in China, a municipal government official in charge of attracting foreign capital said that the foreign banks were monitored by the Chinese regulatory department as well as its parent company. In addition, the foreign banks’ primary task was to understand the market instead of growing assets. Their parent companies suffered a lot from the financial crisis in 2008, forcing them to divert their focus on the Chinese market. Some of them were even forced to sell their assets in China. That was enough to explain the fall of their market share.

It came to our attention that the Royal Bank of Scotland which was aided by the British government, was planning on selling their assets in Asia, including the retailing and commercial banks in India, China and Malaysia in order to raise 3 billion pounds.

Selling assets was only one way of contracting. According to Lu Zhengwei, senior analyst of China Industrial Bank, the financial crisis forced the foreign banks to focus on the risk control more than ever before and therefore they were more cautious in developing their business in China.

According to He Guohao, president of Wing Hang Bank (China), “contracting” is the universal measure adopted by the foreign banks which was damaged by the financial crisis.

The Wall Street Journal published an analysis report, saying that the 15 largest financial institutions in the USA saw their credit amount fall by 2.8% in the second quarter of 2009. More than half of the lent credit amount came from the re-financing and the credit extension, instead of the newly-lent credit. The banks were reserved in lending loans. The Bank of America, JP Morgan and Citibank once reduced the credit amount of 1.5 trillion US dollars in a single week in 2009.

Correspondingly, the demand for credits was decreasing. The exporters and importers were the major customers of the foreign banks in China. Therefore, the drop of market share was somehow connected with the adverse foreign trade.

According to the statistics from the customs of China, the total imports and exports value of China in 2009 was 2.207 trillion US dollars, which has a decrease of 13.9% compared to 2008. The Sino-European trade volume was 364.09 billion US dollars, decreasing by 14.5%; the Sino-US bilateral trade volume fell by 10.6% to 298.26 billion US dollars; the Sino-Japanese trade volume was 228.85 billion US dollars, a loss of 14.2%.

Then, more and more Chinese enterprises began to sell their products which were previously exported to the foreign countries in China. With the records of tax submission, these companies could get loans from the domestic banks more easily, which helped the domestic banks to seize the market share of the foreign banks.

Meanwhile, the financial crisis cast a shadow over the credit standing of the foreign banks. Many enterprises and high-end individual customers who previously hired the foreign banks as their financing agents now turned to the domestic banks.

Another reason to explain the fall of the market share of foreign banks in China was definitely the drastic expansion of credit amount of the domestic banks in 2009, in which the Chinese government adopted the positive financial policies and loose monetary policies. Capitalizing on this opportunity, the domestic banks significantly increased their credit amount, causing a lot of stress for the foreign banks.

Restriction on Loan-deposit Ratio

However, the financial crisis was not the only explanation for the deliberate development of the foreign banks.

He Guohao said that previously the regulatory department set up strict standards for the foreign banks to open branches in China. Now most restrictions have been canceled. However, one restriction, which was applicable for the domestic and foreign banks, still bound the foreign banks, which were usually independent.

According to the laws, the ratio between the credit balance and deposit balance should not be larger than 75%.

According to He Guohao, previously the branch of a foreign bank in China could make use of its parent company’s capital to develop the business. At that time they were free from the restriction on the loan-deposit ratio and their credit balance was much larger than their deposit balance. So when the restraint came out in 2006, the foreign banks had their problems adapting to it.

In addition to the real improvement of receiving deposit, the foreign banks had to control the increase of credit amount in order to meet the regulatory requirements, which affected their development in China.

According to the report from the CBRC, the total assets of foreign financial institutions in China reached 1.3 trillion yuan (USD 190.46 billion) in 2008, with an increase rate of 7.37% annually. The credit balance reached 730.5 billion yuan (USD 107.02 billion), which is a boost of 5.09%. The deposit balance reached 597.4 billion yuan (UDS 87.52 billion), an increase of 34.82% compared to 2007.

It is obvious that the foreign banks were striving to gain more deposit and control in order to increase the credit loans. However, the deposit-loan ratio of foreign banks in China was still 122% in average, much higher than the required cap.

It was reported that there are only two foreign banks whose deposit-loan ratio meet the standards while the others are all striving to reach this point. A Hong Kong-based bank director said that his bank would recruit more than 100 experienced professionals in Mainland China to improve its ability of attracting deposit, which aims at doubling or trebling the deposit and reaching the requirement of cap in 2011.

Worries about Localization

The foreign banks should find some spontaneous factors to explain their stagnant development in China.

After 30 years of development, the localization of foreign banks in China was not satisfactory. Some senior directors complained that it was only a dream to develop business in China based on localization.

According to the introduction of He Guohao, the foreign banks in China usually list the branches of the companies from their countries as their basic customers but they are not putting any efforts in attracting Chinese local customers.

Take Wing Hang Bank where He Guohao is employed as an example. Although the Hong Kong banks have advantages regarding the communication with the Mainland China compared to the foreign banks, Wing Hang Bank’s major customers are still the enterprises headquartered in Hong Kong and Macau. He Guohao said that it is Wing Hang Bank’s primary task to settle down in China and then attract the local customers.

Not focusing on the local customers leads to a major loss of business opportunities in China for the foreign banks. It also reflects their insufficient localization in China.

Another binding factor was the operation based on the theory of the parent company. According to a director of a Chinese company, most of his company’s loans come from the domestic banks, because the communication with these domestic banks is easier and their cooperation has been lasting for a long time.

After all, it is hard to communicate with the foreign banks. Though many of them have Chinese staff, their decision-makers have different points of view than the local enterprises and they don’t understand the ways of local companies. Although their services are as good as, or even better than the services of the domestic banks, the Chinese local companies still prefer the local banks, especially since the domestic banks are improving their service quality.

Slowed Pace or Short Break?

The blurring prospect may last for a while.

According to the survey made by PricewaterhouseCoopers in April and May 2009, only a few of the 41 interviewed foreign banks thought that their market share would increase in 2009, while in 2008, 75% of them were convinced of that. They all attributed to the bleak prospect of a realistic competition with the local banks, economic factors, different operation environment and decreased trade volume.

However, the survey proved that many foreign banks were still very interested in increasing their brand awareness and business in China in the next three years.

The good news is that the foreign banks have found more and more ways to attract deposit; the restriction on deposit-loan ratio could also be loosened; the foreign banks are even allowed to issue RMB bonds in China to raise money. These are the important steps so that foreign banks have a possibility to recover in China.