Opinion piece by Colin Hawes, UTS Faculty of Law lecturer
The past year has witnessed a sudden race by foreign banks to enter the Chinese banking market. In 2005 alone, foreign financial institutions invested over US$17bn buying minority stakes in Chinese national and local banks. Some of these deals, such as the US$3.1bn paid by a Royal Bank of Scotland-led consortium for a 10% stake in Bank of China, rank as the largest ever foreign acquisitions in China (see table below).
Australian banks are involved in the China bank run too, on a smaller scale. Commonwealth Bank and ANZ have purchased minority stakes in municipal-level banks, and NAB recently announced a potential China acquisition later this year.
Juxtapose this headlong rush by foreign banks into China with the following list of recent Chinese banking scandals. From 2003 to 2005, four top executives at the Bank of China (BOC), one of China's biggest, were sentenced to jail terms ranging from 12 years to a suspended death sentence, all for serious bank fraud. Most of the cases involved huge loans to shady businesses with little expectation of repayment, in return for personal favours and bribes for the bank executives and their assorted cronies. And three managers of BOC's Kaiping branch in Guangdong were recently convicted of absconding with over US$400m in bank funds. They were nabbed in the US trying to launder the stolen money through Las Vegas casinos. This remains the largest case of commercial fraud in Chinese history. BOC's scandals continue right up to this year: in February, a US$53m fraudulent bank acceptance bill scheme made headlines, engineered by yet another BOC branch manager. Many other Chinese banks have been involved in similarly shocking scandals.
Do these banks look like secure investments to you? Shouldn't the shareholders of foreign banks be extremely concerned that billions of dollars are being risked on Chinese banks with no idea when the next massive fraud scandal will hit them?
It's very clear why the Chinese government is so keen for foreign banks to invest. The China Banking Regulatory Commission (CBRC) admits that lax corporate governance and primitive risk-control techniques caused the recent spate of fraud cases and exacerbated the shocking levels of bad loans within China's banking system. Despite the government's recapitalisation of the larger banks since the 90s and ongoing attempts to transform all banks from 'welfare providers' for Chinese business to commercialised financial institutions, it is still true that personal relationships and political influence often trump commercial viability when lending decisions are made. Powerless to change this ingrained mindset of bankers, local businesses and politicians, the central government hopes foreign institutional investors will do the job instead. By taking minority stakes in Chinese banks, the foreign financial behemoths will introduce their latest risk-control systems and innovative financial products, and transform the Chinese banks from within like a financial Trojan horse.
But why are the foreign banks so keen to take on the job? Obviously, they hope to make use of the extensive branch networks of Chinese banks to market their own products, such as credit cards and consumer loans. It should be much simpler to take advantage of the local knowledge and relationships of Chinese banks rather than attempting to build their own branch networks in a market that won't fully open up until December 2006. And they really seem to believe that they can change the way Chinese banks manage themselves, maximising their own profits in the process.
Is this rosy scenario likely to play out? Possibly, but it will surely take longer than many foreign banks can afford to wait, and they will emerge bruised and battered from the struggle to align two starkly different business cultures.
Perhaps most frustrating for the foreign banks will be the sheer length of time required to restructure their Chinese partners. We cite the case of Shenzhen Development Bank, a city bank employing some 7,000 staff. The bank was the first in China to hire a foreign CEO, Jeffrey Williams, in December 2004. But under pressure from its main foreign investor Newbridge Capital, Williams resigned in February after failing to push through reforms forcefully to place the bank on a solid commercial footing. One Chinese executive of the bank stated in Caijing Magazine: "Just because Williams understood Mandarin, it doesn't mean he correctly understood Chinese culture and Chinese people's mindsets. It's no easy task for a foreigner to come in and manage Chinese banks with their bloated staffs in our complex social environment." And as CBRC deputy chair Tang Shuangning made clear in an interview, foreign banks will face even larger obstacles dealing with the big national banks: "Can foreign strategic investors really reform and improve the Chinese banks? Will their new systems be accepted by staff and become normal practice here? It will take a very long time and require a huge effort. It's enormously hard to modify the traditional Chinese habit of placing personal relationships before impersonal systems"!
It is ironic that foreign banks are taking such a huge investment risk when one of their main tasks is to improve risk controls in the Chinese banks! The one consolation for Australian banks is that they have entered the Chinese market in a relatively small way. If things start to get really ugly, they can at least pull out without sustaining huge losses.
Foreign financial institutions in the Chinese banking market, 2005-06
Bank of America US$3bn for 9.1% of China Construction Bank
Royal Bank of Scotland (consortium) US$3.1bn for 10% of Bank of China
Temasek Holdings (Singapore) US$3.1bn for further 10% stake of Bank of China
Allianz US$1bn for 2.5% of Industrial & Commercial Bank
Goldman Sachs (consortium): US$2.6bn for 7% of Industrial & Commercial Bank
HSBC US$1.75bn for 19.9% of Bank of Communications
Citigroup US$3.2bn bid: Guangdong Dev't Bank (approval pending)
Commonwealth Bank US$92m for stakes in Hangzhou/Jinan city banks
ANZ Banking Group US$110m for 19.9% of Tianjin City Commercial Bank
National Australia Bank plans to invest approx. US$370m in Minsheng Bank