Taiwan's Unknown Competitors
The Red Banks Are Coming
Twenty years after the end of the Cold War, the communists' banks are about to set foot in Taiwan. Far larger than their Taiwanese counterparts and reflecting China's national will, these new entrants in Taiwan's financial sector are potentially tenacious foes.
The Red Banks Are ComingBy Yi-shan Chen
From CommonWealth Magazine (vol. 422 )
At the third round of talks between Taiwan and China in late April, the two countries signed an agreement to complete a memorandum of understanding (MOU) on cross-Taiwan Strait financial supervisory cooperation within two months.
For Taiwanese financial institutions that long had ambitions to extend their presence to China, it was cause for celebration. But for Taiwan and its financial services sector, it foreshadowed a huge transformation, a complex battle that will begin in the second half of the year at the earliest.
China has now embraced the capitalist path, but it has maintained control of larger state-run enterprises while letting smaller enterprises fend for themselves. Its banks occupy such a critical position that China cannot, is not willing to and does not dare set them free.
Yet sources indicate that China's Bank of China has appointed the head of its Xiamen bank to lead a special Taiwan task force on a fact-finding trip to the self-ruled island to chart a future course. The Hong Kong branch of Industrial and Commercial Bank of China (ICBC) has already gathered and analyzed the necessary intelligence.
What kind of transformation will these tenacious competitors, these new and unknown additions to Taiwan's financial circles, bring about?
The Rebirth of China's Banking Sector
China's top four banks, including Bank of China and ICBC, have made a great leap forward over the past decade, and are no longer the institutions that began the 21st century technically bankrupt and with nonperforming loan ratios of up to 50 percent.
In an exclusive interview with CommonWealth Magazine, ICBC Chairman Jiang Jianqing said Chinese society's sensitivity to financial risk grew after the 1997 Asian Financial Crisis, and from that point on, the financial sector was listed as a major target for reform.
Yi Wang, McKinsey & Company China partner, says financial reforms launched in 1999 focused on divesting nonperforming assets, but after the campaign concluded, bad debts quickly returned.
In its financial reforms of 2004, however, China's government not only encouraged financial restructuring, it also promoted systematic reforms, turning banks into shareholding institutions with the goals of soliciting top European and American financial institutions as strategic partners and eventually listing the banks. Erh-Cheng Hwa, the chief economist of China Construction Bank and the senior economist in the International Monetary Fund's China mission in the 1990s, describes the process as a "rebirth" of the country's banking sector.
China's banks began introducing foreign investment, building risk control systems, and establishing corporate governance boards when going public that met Hong Kong's standards, achievements that were all considered major breakthroughs for the PRC's financial services sector.
In the past five years, China's banks have built closer shareholding and investment ties with top international counterparts than have Taiwanese financial institutions. Goldman Sachs, Allianz Group and American Express became strategic investors in ICBC while Bank of America bought a stake in China Construction Bank.
As foreign investors became stakeholders, China's bankers had their eyes opened.
In his interview with CommonWealth, ICBC Chairman Jiang spoke of "seeing the CEOs of Goldman Sachs and Morgan Stanley" as naturally as he would an encounter with familiar neighbors.
China Construction Bank, which has cooperated with foreign investors more closely than any other Chinese bank, has obtained advice from 50 to 60 consultants from Bank of America annually for the past seven years on bank operations, retail banking, risk control and credit evaluation systems.
Official Control and Protection
Despite these advances, Chinese banks still depend heavily on government control and protection. The China Banking Regulatory Commission allows individual foreign banks to only set up a handful of branches every year while routinely authorizing Chinese-invested banks to each set up 20 to 30 branches at a time. China's top four banks have more than 10,000 branches, an 85 percent share of the market.
In addition, Chinese interest rates are not freely determined by market forces. Deposit rates are fixed at 2 percent while interest rates on loans are set at 7 percent. This hefty spread led one Taiwanese financial expert with experience at foreign financial firms to say, "whoever can gain control of the market will be the winner."
This protectionism reflects the strategic position of China's financial industry, the country's will, and the role of elite leadership.
When reporting on financial issues in China, the words most often heard are "strategy" and "catching up and surpassing," leading one media figure to observe, "to this day, the communists are still fighting a war."
Always considering issues in strategic terms, the elites of the China Banking Regulatory Commission stand as the guardians of the country's banks, acting like parents supervising their children. The commission's role goes beyond normal supervisory responsibilities. Every time it issues a new directive, it makes sure that China's banks thoroughly understand the policy and is ready to deal with it.
At the same time, the top four banks' chairmen and presidents, with their control of the people's savings, are also the rulers of the country. In terms of the administrative hierarchy, they are at the same level as vice ministers, and China's State Council is directly responsible for their appointment and removal. Aside from the power conveyed on their name cards, the real source of their power is the Communist Party, because the bank president and chairman are usually the party secretaries of the banks' internal party organs, and branch heads are normally party secretaries of provincial banks' party branches.
Barriers from 'Unwritten Rules'
The major shareholder of most of China's biggest banks is either the government or a state-run enterprise, but the Communist Party organization imposes the real "unwritten rules" within modern bank structures. ("Unwritten rules" are informal rules that are commonly obeyed by relevant parties within specific groups.)
These unwritten rules help accelerate the pace and breadth of reform by enabling the party to impose its will at all levels of a tightly knit organization. They also have proven to be an obstacle, however, to the transformation of China's banking industry into a viable service sector and its ability to compete in the international arena.
In China, the top executives at several domestic banks are Communist Party members. As a consequence, Bank of China, ICBC and China Construction Bank have attracted very few foreign professionals or even Chinese nationals returning from abroad, even though they are three of the world's four biggest banks by market capitalization,
"The organizations of China's domestic banks are simply too complicated. To foreigners who only understand professionalism, it's too difficult of a job," said one financial expert in explaining why China has so much trouble recruiting talent.
The chairmen and presidents of these banks in theory have had the power to appoint branch managers since 2000. But even though they are Communist Party secretaries, they must still take into account the opinions of provincial governors, who have the same hierarchical status as minister-level party leaders, when making such appointments.
Some of the unwritten rules have also led China's banking sector to diverge from international norms on transparency and corporate governance.
McKinsey & Company's Wang says that Chinese banks lag behind leading international banks in the areas of corporate governance, organizational structure and management quality.
Meanwhile, because personnel promotions are not fully tied to performance, the customer orientation of Chinese banks tends to be weak. Interbank remittances and withdrawals, for example, can be adventures.
Unlike in Taiwan or most countries in the world where consumers can use a bank card at an ATM to withdraw or remit money, in China, local banks only allow remittances to other branches of the same bank.
Several representatives of Taiwan-based banks point out that Chinese banks will want to maintain a low-profile in Taiwan and primarily serve their own customers. But because of their big scales, extensive retail networks and low renminbi costs, their ability to serve China-based Taiwanese businesses cannot be overlooked.
Economic Stimulus Creating Risks
Many experts believe that Chinese banks' biggest challenge, aside from becoming more internationalized, comes from internal factors. In the first quarter of 2009, domestic banks extended loans worth 4.58 trillion renminbi, more than in all of 2008. The figure caused a commotion when it was announced.
Yi-feng Tao, an associate professor in National Taiwan University's Department of Political Science and a China expert, says that following the global financial crisis, China's central government gave local governments the green light to stimulate the economy and was ready to inject 4 trillion renminbi into the economy.
It has told local authorities that even if they are broke, they should revive projects that were shelved in recent years when pressure was on to cool down economic growth and propose them to Beijing. Once approved, the central government will then figure out to finance them. In March, the National People's Congress even stipulated that local governments could once again accumulate debt.
That worries many scholars, Tao says. Prior to 1996, former Premier Zhu Rongji worked hard to rein in the accumulation of debt by local government and state enterprises that were blindly pursuing economic growth targets, but fears have arisen that China is returning to the old days of accumulated debt and nonperforming assets that Zhu tried to mitigate.
First quarter loan growth was 25 percent at ICBC, 50 percent at Bank of China, and 75 percent at China Construction Bank, all far exceeding China's first quarter economic growth rate of 6.1 percent.
"At the speed at which loans are being made, it's hard to believe that their risk control systems are at all sophisticated or cautious," says one deputy general manager at a Chinese investment consulting firm.
Realizing the high risk potential, the China Banking Regulatory Commission sent a letter to all banks at the beginning of the year asking them to increase their nonperforming loan coverage ratio to 150 percent. But some observers contend that regulatory commission officials at the provincial level have already relaxed the requirement and are directing provincial banks not to worry about the nonperforming loan ratio and instead push loans.
A Lex (an agenda-setting column) in the U.K.-based Financial Times recently issued a warning: China recorded a surge in bank loans in the first quarter and saw M2 (a basic measure of the money supply) soar by 25 percent, easily outpacing China's 6.1 percent economic growth rate, an indication that some of the funding was invested speculatively. As the economy recovers, these funds will cause rapid inflation, but if the economy flounders, they will become nonperforming loans.
This year will be the first year that China's banks operate as the world's biggest banks, but that does not guarantee that they will become highly respected financial institutions. The whole world is watching the future direction they will pursue.
Translated from the Chinese by Luke Sabatier