Foreign Competition, Public Listing, and WTO Entry
Although banking inefficiencies and distortions appear to have diminished under the reforms of the 1990s and after, it is clear that China’s banking and financial institutions still have a long way to go to match the more- established systems in place in much of the West.
Guariglia and Poncet (2006) suggest, however, that China’s large levels of foreign direct investment (FDI) have played a significant role in helping insulate the economy’s growth rates from financial distortions. Guariglia and Poncet (2006, p. 20) conclude thatprivate firms, which are generally discriminated against by the local financial system, might be able to use foreign joint-ventures as sources of finance, and might consequently achieve higher productivity and growth rates. FDI could therefore provide an explanation for why... China is a counter-example to the findings of the finance-growth literature, being characterized by malfunctioning financial institutions and phenomenal growth rates.
Since China’s 2001 WTO entry, increasing amounts of this FDI have actually been channeled into the banking system itself. The sheer size of China’s deposit market acts as a magnet in this regard. Despite declines in early 2007 that appeared to reflect the attractiveness of China’s stock markets (see Chapter 8), December 2007 household deposits stood at just under RMB 18 trillion - or approximately $US 2.5 trillion. The first case of partial foreign ownership predated WTO membership, with the Asian Development Bank’s purchase of a stake in China’s Everbright Bank in 1997. In December 2001, HSBC bought a piece of the Bank of Shanghai quickly followed in 2002 by Citigroup, who bought a 5% stake in Shanghai Pudong Development Bank. Pudong and Shenzhen offered test cases in which foreign banks were granted access to domestic markets, while by no means dominating them. More complete nationwide access to Chinese markets was provided, in theory, with legislation that allowed foreign banks to offer a full range of services to local customers as of December 2006.
The burdensome requirements imposed by this legislation, which forced such foreign banks to incorporate locally and barred them from accepting deposits under RMB 1 million in the absence of a local subsidiary, however, suggests that the authorities still felt the need to buffer the domestic banks against foreign competition (Dickie and Tucker, 2006, p. 1).[122]China’s 2001WTO membership did seem to be associated with a welcome shift in central government rhetoric toward outwardly encouraging bank profitability. More importantly, the authorities set out specific guidelines for future progress, stating that the SOCBs should lower their NPL levels by at least 2% to 3% a year so that NPLs would be down to 15% by the end of2005.
Table 7.4. Bank of China and China Construction Bank after the 2003 Recapitalization
| BOC | CCB | 2004 Target | 2005 Target | 2007 Target | |
| Return on assets | 0.6 | 0.9 | — | 0.6 | ≈ 1.0 |
| Return on equity | 10.0 | 17.3 | - | 11.0 | ≥ 13.0 |
| Cost/income ratio | 40.0 | 39.2 | - | 35-45 | 35-45 |
| NPL/loan ratio | 5.1 | 3.9 | 3-5 | 3-5 | 3-5 |
| Capital adequacy | 10.0 | 11.3 | ≥ 8.0 | ≥ 8.0 | ≥ 8.0 |
| NPL coverage | 68.0 | 70.0 | - | 60-80 | > 60-80 |
Source: Podpiera (2006, p.
5).
Table 7.2 shows the overall progress achieved in NPL levels between 1999 and 2005. Meanwhile, the 2003 recapitalization of BOC and CCB was accompanied by strengthened corporate governance and provisions for qualified external auditing and oversight. The targeted NPL to total loan ratio of 3% to 5% for 2004 was met by CCB and essentially achieved by BOC - while both banks achieved a capital-asset ratio above 8% (see Table 7.4).[123] Both banks also became joint-stock companies with independent directors. On May 16, 2006, the CBRC served notice that it expected the SOCBs to maintain NPL levels below 5% going forward. NPL ratios below this threshold have been realized recently but only in the immediate aftermath of the 2003 and 2005 recapitalizations of BOC, CCB, and ICBC.[124]
CCB achieved an NPL level of just 3.9% in 2004 - and 3.8% in 2005 - thanks to its major 2003 recapitalization, compared to the 15% that the government had itself projected in 2002. CCB also drastically increased its NPL write-offs and was particularly aggressive in disposing of bad debts through Cinda and diversifying its loan base, actually achieving control of a majority of the mortgage market in Shanghai. The newfound strength of CCB’s balance sheet made possible its successful IPO on the Hong Kong market in October 2005. Earlier in 2005, Bank of America acquired an 8.67% ownership share (Ernst & Young, 2006, p. 11).
Meanwhile, BOC prepared for its eventual full Hong Kong listing (garnering $US 9.73 billion in May 2006) by first raising $US 2.8 billion in selling a 25% stake in its Hong Kong operations in the first IPO of a major state-owned bank on July 26, 2002. BOC hired Goldman Sachs to manage the process, and the 2002 partial IPO was pushed through quickly - only one year after BOC’s ten subsidiaries in Hong Kong were merged together and even amid a banking scandal and a sagging market.[125] In August-September
2005 an investor group including Royal Bank of Scotland and Merrill Lynch invested $US 3.1 billion for a 10% stake in BOC - and additional holdings were acquired by Singapore’s Temasek Holdings (one of the sovereign wealth funds discussed in Chapter 2) at 10%, UBS at 1.8%, and the Asian Development Bank at 0.24% (Ernst & Young, 2006, p.
11). Interest in the2006 IPO was spurred by the earlier share price gains of 50% and 100% enjoyed through mid-May 2006 by CCB and Bank of Communications shareholders, respectively, since those banks’ own 2005 Hong Kong share flotations.
ICBC actually hired Solomon Smith Barney as early as 2001 in order to begin merging its branches and preparing its own Hong Kong listings for an IPO (Clifford, Balfour, and Webb, 2001, p. 50). Its 4.7% NPL level in 2005 can be compared to an historical NPL level that had gradually declined from 34.4% in 2000 to 19% in 2004 (see Table 7.2). The gradual decline in ICBC’s NPL ratio was accompanied by a fivefold profit increase over 2000-2004, combined with a halving in the number of branches and an employee head count reduction of around one-third. Public listing required a more dramatic drop in ICBC’s NPL ratio, however, which was achieved during 2005 thanks to a government support package estimated at $US 80 billion in the first half of that year. ICBC achieved a capital adequacy ratio of over 10% at year-end 2005 and realized over RMB 90billion in profits (People’s Daily Online, January 20,2006a). With ICBC’s transformation into a shareholding company, Goldman Sachs, Allianz, and American Express subscribed to $US 3.78 billion in ICBC shares in 2006 to attain a 10% stake (Ernst & Young, 2006, p. 11).[126] However, neither ICBC’s foreign investors nor those of BOC and CCB have demonstrated any real involvement with the bank’s core operations. This limits the likelihood that such foreign participation will produce meaningful changes in bank behavior. Indeed, the foreign investments in noncore areas could remain profitable even if the banks’ overall performance failed to improve (see Leigh and Podpiera, 2006).
Repeated corruption scandals themselves hardly seem consistent with an improved corporate culture in the SOCBs. CCB and BOC were both embroiled in scandals in 2001-2002 that pointed to a severe lack of oversight.
In the first case, the former president of BOC and CCB Wang Xuebing allegedly made improper loans to his wife. Second, on a smaller provincial level, three BOC bank branch managers in Guangdong laundered $US 480 million over nine years. With top officials at the four major banks only making between $US 3,600 and $US 4,350 annually at the time, while exercising control over huge stocks of funds, the temptation to steal was obvious (Clifford and Fong, 2002, p. 48).24 Although the authorities dealt harshly with the guilty bank officials and pushed through the 2002 partial IPO of BOC, these episodes served as a reminder of underlying problems. Indeed, there were further fraud cases in 2003, including fraudulent home loans by officials at eight CCB branches in Guangdong province (Leggett, 2003). A new embezzlement scandal emerged at BOC in June 2006, right on the heels of its full Hong Kong IPO (Dickie, 2006). Although such developments surely continue to raise questions about the soundness of the banks’ internal controls, public interest in the newly available BOC, CCB, and ICBC shares seemingly remained unabated.ABC was left as the only SOCB without foreign ownership in 2007 and without any specific timetable for going public. Although Premier Wen Jiabao stated in January 2007 that ABC would be put on a path to its own IPO, the potentially long road ahead is highlighted by the fact that, at the end of September 2006, ABC’s bad loans of $US 95.5 billion accounted for over half the bad loans in the entire Chinese banking system.25 It has obviously
rising share price subsequently made it the world’s biggest lender by market capitalization as of July 23, 2007 (Ren, 2007).
24 The government-controlled oversight procedures were also at fault. As a general rule, Barth, Caprio, and Levine (2006, p. 256) have found that “official supervisory power is associated with greater corruption in lending.” In this regard, the 2003 establishment of the CBRC did at least lead to some separation in authority by establishing a nominally independent regulatory body.
25 Assuming its balance sheet could be cleared up in time, ABC’s potential 2008 IPO was estimated to be about $US 10 billion (see Carew, 2007). continued to lag well behind the other SOCBs and its 2005 cost-to-income ratio was more than twenty percentage points above those of BOC, CCB, and ICBC (see Podpiera, 2006, p. 8). In mid-2007, estimated restructuring costs for ABC exceeded $US 100 billion, comprising approximately $US 76 billion to reduce the bank’s NPL ratio to 5% (from a 2006 ratio of 23.4%), plus another $40 billion or so to boost ABC’s capital adequacy ratio to the international standard of 8% (McGregor, 2007, p. 18). Fraud has been an issue at ABC as well. A June 2006 audit conducted by China’s National Audit Office suggested that ABC had irregular deposits of RMB 14.27 billion, problem loans of RMB 27.62 billion, and fraudulently issued debt securities totaling RMB 9.72 billion in 2004 (Areddy, 2006).