FDIC Banking Review Chinas Opening to the World: What Does It Mean for U.S. Banks? by Valentine V. Craig *
China has agreed to open its financial system to full
foreign competition in December 2006 in accordance with its commitments to the
World Trade Organization (WTO). In regard to banking, it has committed to
remove all geographic, client, and nonprudential restrictions on foreign
banks. What does this financial opening
mean for foreign banks? This article
examines in detail the opportunities and risks of entry into the Chinese market
for U.S. banks.
China, with 1.3 billion people, is a huge market, and it has
been growing rapidly since the early 1980s with no end in sight. This growth
has produced abundant opportunities in China for financial services
providers. The article begins with a
review of recent statistics on Chinese growth and prosperity. It then appraises the competitive landscape
for U. S. banks in China, examining the Chinese capital markets, the official
Chinese banks, the informal Chinese banks, and foreign banks currently
operating in China. The article then
looks at the specific opportunities opening up in China in retail, commercial
and investment banking.
Doing business in China is not without risk. There are
economic, political and demographic trouble spots in the economy that could
affect businesses operating in China.
The article examines these risks.
It discusses fears of an overheating market, possible protectionism by
those countries to which it exports its goods, rising economic inequality in
the country, and Chinas rapidly aging population. It then proceeds to look at the risks arising
from an uncertain regulatory environment and a large unwieldy government
bureaucracy. Corporate governance is
generally not good, and the article reviews problems with corruption and lack
of transparency in Chinese businesses, focusing particularly on Chinese
banks. It then appraises the systems for
ensuring a safe return of capital, concentrating on the adequacy of Chinas
bankruptcy laws, the enforcement of contracts and legal judgments, the adequacy
of its credit infrastructure, the availability of crucial personnel, and the
governments commitment to open competition.
The article ends with a summary of the analysis and concluding remarks.
An Overview of Chinas Economy and Financial System
Chinas economy has grown tremendously over the past 20
years, as recent economic statistics make clear. This has created a demand for capital by
private businesses in China, which the official domestic providers of capitalthe
Chinese capital markets and Chinese banksbeset with problems and focused on
state-owned businesses, have not been able to satisfy. However, the government
has been working to make the markets and banks more efficient and competitive
and to combat fraud within them, and has made some progress. Additionally, many of the illegal gray
market banks are currently a competitive force, and foreign banks have doubled
their asset size in China over the past several years.
Recent Economic Statistics
Since the beginning of Chinas open door policy in 1978, it
is estimated that per capita income has increased seven times; 400 million
people have risen from extreme poverty; and a middle class of approximately 100
million people has developed. The Economist credits China with probably
the most dramatic burst of wealth creation in human history.1 Recent economic statistics reveal just how
tremendous Chinas economic growth has been.2
Chinas gross domestic product (GDP) reportedly grew 9.5
percent in 2004, following 9.3 percent (revised) growth in 2003.3
The growth in these two years followed average annual growth in the 1980s of
9.3 percent, and between 1991 and 2003 of 9.7 percent. Industrial capacity grew strongly in 2004,
with industrial businesses value-added increasing 11.4 percent over the
previous year. The sale of consumer
goods increased 13.3 percent. Exports
were up 35.4 percent and imports up 36 percent, with the nation reporting a
trade surplus of U.S. $32 billion for 2004. Furthermore, the WTO reports that
China replaced Japan as the worlds third-largest exporter in 2004.4
Although many of the Chinese people are poor, their
financial situation is improving. Real
per capita growth rates of disposable income for both urban and rural
households in 2004 were the highest they have been since 1997: 7.7 percent for
urban households and 6.8 percent for rural households.5 And as mentioned, approximately 100 million
Chinese are considered middle class and middle income. The urban unemployment rate is a low 4.2
percent0.1 percent less than in 2003.
While inflation has increased (it increased 3.9 percent in 2004,
following a 1.2 percent increase in 2003), it is quite moderate given the
tremendous growth of the economy. Additionally, the Chinese people are great
savers, saving over 40 percent of GDP.
Reported savings of households increased over 15 percent in 2004.
There are two stock exchanges in mainland Chinathe Shanghai
and Shenzhen exchanges. They are
generally considered undeveloped and corrupt.
However, the government has been working to improve the corporate
governance of these exchanges. There is
a large government bond market, but the corporate bond market is insignificant.
Stock Exchanges. The two stock exchanges were formed in 1991
and 1992 primarily to fund the governments bailout of failing state-owned
enterprises. Currently there are approximately 1,300 predominately state-owned
enterprises listed on the two exchanges with a combined total market value of
$400 billion. In most countries,
companies with the best prospects typically launch IPOs, but as the Chinese
governmentrather than independent underwritersis responsible for deciding
which companies to list in China, until very recently, these companies
werewith a few exceptionsfailing state-owned enterprises.
To maintain control of these state-owned assets, the
government issued two general types of securitiesstate-owned shares or
legal-person shares, which are not allowed to trade, and tradable shares. Approximately two-thirds of the shares of
listed firms are the former. With so
many shares not permitted to trade, the market is very illiquid. Fear of the state-owned shares being dumped
on the market has reportedly kept share prices low despite the booming economy
and has discouraged the development of derivative and corporate bond markets.
The exchanges offer A-shares and B-shares. A-shares are denominated in renminbi (or
yuan), the Chinese currency, and are available for sale only to Chinese
nationals; B-shares are foreign currency denominated, and foreigners are
allowed to purchase them.
Domestic companies can also list in Hong Kong (H shares or
Red Chips). This exchange and the
companies it lists are generally considered better than those on the
mainland. However, the Hong Kong exchange
has some governance issues, according to shareholder activists.6
Some domestic companies also list overseas. The best-performing state-owned enterprises
and private companies, in addition to listing in Hong Kong, list overseas on
the New York, NASDAQ, or Singapore exchanges.
The mainland Chinese stock markets have had serious problems
with corruption, cronyism and lack of transparency. Euromoney describes these markets as
mired in corruption, dominated by moribund companies and manipulated by
government and speculators alike.7
Corruption extends beyond the exchanges to include listed
companies. The China Securities
Regulatory Commission (CSRC), which regulates the securities market, reported
in 2004 that 10 percent of its listed companies had doctored their books.
Improvements are being made:
the CSRC has recently taken steps to improve the functioning of the two
exchanges. It is in the process of
ending the differential treatment of its A-shares and B-shares. Additionally, foreigners can now apply to buy
the state-owned shares, albeit with significant restrictions, and more private
companies are being allowed to list. On
May 1, 2005, the government announced a pilot program under which it would
begin to sell a small number of state-owned shares in a controlled way to avoid
any disturbance in the markets. The
expectation is that this will alleviate the depressed value of the listings and
make the market more liquid.
The CSRC is also tackling corruption. It is investigating related-party transactions
to stop the prevalent practice of shifting assets from listed companies to
their unlisted state-owned parents. It
plans to examine all related-party transactions where the price of assets
bought or sold deviates more than 20 percent from an independent
appraisal. Additionally, the CSRC has
been monitoring brokerages for malfeasance and in 2004 it seized control of the
fifth largest broker for corruption and mismanagement.8
Bond Markets. The government bond market is large. But although a great number of government
bonds are issued,9 the four largest Chinese banks typically buy 60
to 70 percent of any treasury issue, effectively setting the bonds price. Doubt about the true value of the debt has
encouraged a buy-and-hold market, and this illiquidity deprives companies of
favored instruments for hedging short-term risk.
The corporate bond market is tiny.
The Chinese banking system is very large because of its
preeminent role in financial intermediation, the large economy, the high level
of household savings, and restrictions on overseas investments.10 It is predominantly state-owned. Given the very weak capital markets in China,
the banking system provides an estimated 80 percent to 90-plus percent of all
business funding. In early 2005, total
bank loans to government-owned and private businesses represented approximately
160 percent of Chinese GDP, up from 120 percent in 2000.11 Consumer loans, a relatively new development
in China, constituted approximately 10 percent of all outstanding bank loans in
early 2005. Of these consumer loans,
mortgages accounted for approximately 90 percent.12
There are four big state-owned commercial banks, established
originally to fund large state-owned enterprises. There are, in addition, 12
joint-stock commercial banks (JSCBs) owned by local governments, domestic
investors, or foreign investors; an estimated 35,000 rural credit cooperatives;
three policy banks, which focus specifically on economic development; over 100
city commercial banks, which are restricted to doing business in their base
city only; and numerous rural commercial banks, urban credit cooperatives, and
The big four banks are the Industrial & Commercial Bank
of China (ICBC), China Construction Bank (CCB), Bank of China, and Agricultural
Bank of China. At the end of 2001,
collectively they employed 1.4 million people and had 116,000 branches across
China. Although the big four banks represent
the largest banking bloc in China, with almost two-thirds of total deposits in
September 2003, the JSCBs have been taking market share from them. In September 2003, the share of deposits held
by the big four had declined to 64.9 percent from 68.3 percent in March 2002,
whereas the share held by the JSCBs had increased to 14.7 percent from 12
percent over the same period.13
The rural credit cooperatives accounted for approximately 12
percent of deposits in September 2003.
These cooperatives are responsible for providing credit to small
factories, farms, and households in smaller cities and rural areas. The government-owned policy banks (China
Export and Import Bank, China Development Bank, and Agricultural Development
Bank of China), the city commercial
banks, foreign banks, rural commercial banks, urban credit cooperatives, and
finance companies collectively accounted for the remaining (approximately) 8
percent of deposits in September 2003.
The countrys central bank, the Peoples Bank of China, is
in charge of monetary policy. One of its
powers is to set interest rates on deposits and loans. The China Bank Regulatory Commission (CBRC),
established in April 2003, regulates and supervises all banks.
Problems with the Banks. The original mission of Chinese banks was to
act as a government-directed funding source for state-owned enterprises. The banks continue to lend primarily to these
dying state-owned businesses, ignoring the growing vibrant private businesses
in their midst. The big four state-owned
banks in particular were used by the Chinese government as instruments to
implement government development policy.
They had little or no discretion as to borrowers or loan terms. Borrowers were approved by the government,
which set identical loan rates for every borrower regardless of risk. These conditions did not support a
market-oriented lending approach: credit
analysis and risk management, for instance, were unnecessary and not performed.
The political interference, along with corruption and lack
of modern management skills, has resulted in high levels of nonperforming loans
in Chinese banks. (This is covered in
greater detail in the section below entitled A Look at the Risks.) Standard and Poors (S&P) estimated in September
2003 that approximately 45 percent of bank loans were bad. In 2005, on the
basis of substantial government assistance to the banking industry, it lowered
its estimate to approximately 31 percent, or approximately $700 billion in bad
Other analysts are less optimistic and believe that the
banks made a substantial number of additional bad loans through early 2004,
before a government crackdown on lending began.
For instance, bank lending increased 56 percent in 2003 over the
previous year, with much of this new lending directed to funding state-owned
businesses and infrastructure improvements at the governments behest. Banks also started aggressive lending to
consumers at this time. Consumer loans
now constitute 10 percent of outstanding bank loans. While it is too soon to estimate the full
extent of new bad loans made during this time, the state National Audit Office
warned in June 2004 that it was beginning to see widespread consumer loan
problems. Auto loans are of particular
concern. Volkswagen of China reported
that 5 percent of auto loans in Beijing are in default. Other reports suggest that approximately 50
percent of car loans are overdue.15
Official government figures for nonperforming loans are
lower than the figures from other sources.
The government estimates nonperforming loans at the end of 2004 at
approximately 13 percent of total loans.
Recent Banking Reform. The Chinese government is trying to resolve
the banks financial problems before national treatment is afforded to foreign
banks in December 2006. The governments
approach is multifaceted: it has given the banks more discretion in their
lending decisions; has tried to help the banks maintain their deposit base
against the inroads of gray-market banking; has provided massive cash
injections to rid the banks of bad loans; is working to improve corporate
governance at the banks, including clamping down on corruption within the
banks; and is trying to attract foreign investment to the banks, hoping that
foreign involvement will spur local banks to acquire Western management
practices, expertise, and capital.
Greater discretion in lending decisions was recently granted
to introduce banks to the concept of risk-based lending. In January 2004, the CBRC permitted banks to
charge risky borrowers up to 70 percent over the benchmark lending rate. Previously they had been allowed to charge a
maximum rate of up to 30 percent over the standard rate, and before that they
had not been allowed to differentiate at all between borrowers in setting
Additionally, to help the official banks maintain their
deposit base in the face of the substantially higher rates on deposits being
offered by the gray-market banks (see below), in October 2004 the central
bank raised interest rates on one-year loans and on deposits by 25 basis
The government has also been pressing the banks to deal with
billions in bad debt before full foreign competition begins. In the late-1990s, the government
triedunsuccessfullyto resolve the banks bad loan problem. In 1998 the government infused $32 billion
into the banks. In 1999 it purchased $170 billion in bad loans (at book value),
which it then transferred for disposal to asset management companies created
for this purpose.
The CBRC is also working to improve corporate governance at
the banks, with particular emphasis on uncovering and preventing
corruption. (Corruption is widespread at
the banks, and is discussed in greater detail in a later section). The CBRC issued new regulations in early
2005 requiring banks to monitor senior management and board members through
internal monitoring and independent external auditors and to establish
internationally accepted risk management controls. To deal with widespread rural bank fraud, the
CBRC is planning to restructure and consolidate the 35,000 rural credit
cooperatives into a more manageable 2,000 institutions by 2007.17 The CBRC has also begun to publicly report
corruption uncovered at the banks.
Finally, the government has been encouraging foreign banks
to take minority positions in Chinese banks.
To make the big four banks more attractive to foreign investors, the
government bailed out two of them in December 2003 and a third bank the
following year. Bailed out were the Bank
of China, which the government plans to list in Hong Kong, and CCB, which the
government plans to list in New York and Hong Kong. The two banks together were estimated to be
more than $65 billion in debt; each received a direct infusion of $22.5 billion
to bring its capital above the minimum set by the Bank for International
Settlements and to lower its nonperforming loans. The government then made a $15 billion
capital infusion into ICBC (the nations biggest bank, with 20,000 branch
offices and 400,000 employees),18 intending to list it in 2006. The remaining big-four banks, Agricultural
Bank of China, and a dozen or so smaller banks are also expected to list their
shares eventually. It is expected that
listing will encourage foreign ownership in the banks.
Gray-Market Banks. The gray-market banks are informal or
sometimes well-organized, groups of lenders/investors. These informal banks reportedly provide much
of the lending to small private sector businesses that do not have the
political connections to borrow from the state-owned banks.19 They may consist of only a few
individualsfamily or friends of the borrowerwith a little money to invest, or
they can be large sophisticated lending cooperatives organized by rich
entrepreneurs in search of higher yields.
Annual interest rates on loans made by gray-market banks range from 8 to
20 percent, providing returns to investors substantially above the 2.25 percent
official bank deposit rate. Consequently, the gray-market banks compete with
the state-owned banks for deposits.20
Some of these informal banks are quite large and highly
efficient, competitive lenders, providing millions of dollars in structured financing
to private businesses. Some of them
reportedly borrow the money for their lending from the big four banks and then
re-lend it to private borrowers at the higher rates.21 Defaults are rare due to the personal nature
of the lending. Although illegal
(organizing a gray-market bank is a capital offense), they are widespread and
are generally tolerated by the government.
In fact, they are so widespread that the CBRC has reportedly begun to
informally monitor prevailing gray-market lending rates.22 The government has also bailed them out on
occasion when they have failed.
At the end of 2004, there were 62 foreign banks with over
200 branches operating in China with restricted licenses.24 Many of these banks had also invested in joint
ventures with Chinese banks. In April
2005, foreign banks accounted for approximately 3 percent of total assets in
the banking system, more than twice the 1.3 percent of total assets these banks
held in September 2003.25
HSBC Holdings and Standard Chartered, both headquartered in the United
Kingdom, and Citibank, a U.S. bank, are considered the major international
banks in China, having built a strong renminbi business.26 Netherlands-based ING Bank also has a large
presence, and Bank of America in June 2005 made the largest investment to date
in a Chinese bank, purchasing 9 percent of CCB for $3 billion dollars.
Branches of Foreign Banks. Foreign banks in China currently operate
under licenses that restrict them to specific clients and to certain geographical
areas. They are permitted to provide
financial services in nonlocal currencies to foreign firms in 18 cities,
including Beijing. The CBRC reported that at the end of 2004, foreign banks had
18 percent market share of loans made in foreign currency. Additionally, by the end of 2004, 105 foreign
branches had received local currency (called renminbi or yuan) licenses,
permitting them to collect deposits and make loans in renminbi in these same 18
cities. Of the 105 foreign branches with
renminbi licenses, 61 have been permitted to provide renminbi services to
Chinese firms in addition to foreign firms.27 A major exclusion for these foreign branches
is that they are not permitted to provide consumer services to Chinese
In addition to client and geographical restrictions, the
government has also used stringent licensing requirements to discourage the
growth of foreign bank branches. Until
recently, foreign banks were required to wait a year between branch openings in
a city, and to maintain high minimum capital levels. In 2004, the government did away with the
years wait and cut the minimum capital requirement for new branches. Foreign bankers claim that the lowered
capital requirement still represents a barrier to entry in smaller cities.
Foreign Joint Ventures. Despite the many problems of domestic banks, many foreign banks have also purchased minority positions in domestic banks to avoid existing client, geographic and branching restrictions and to obtain access to the domestic banks extensive branch systems. The government currently permits up to a total of 24.9 percent foreign stake in any one
domestic bank (19.9 percent by any one foreign entity). The government has also provided incentives
to encourage foreign minority interest in Chinese banks. A significant incentive has been a lower tax
for foreign businesses than for domestic businesses.
In certain cases the government has also permitted
significant concessions to foreign investors in Chinese banks. For example, Newbridge Capital, a U.S.
private equity firm, recently bought 18 percent of Shenzhen Development Bank, a
joint stock bank, and was permitted to appoint a majority of the board, ceding
control of a Chinese bank to a foreign entity for the first time. And American
Express was recently able to negotiate an agreement with Industrial &
Commercial Bank of China under which the bank assumed all risk for the joint
American Express card the two firms issued.
One of the largest foreign investments in a Chinese bank is
HSBC Holdings 19.9 percent share of Bank of Communications (BoCom), Chinas
fifth largest bank, which HSBC purchased for $1.75 billion. HSBC was able to negotiate government
assistance and some protections. The
government bailed out BoCom before the acquisition: BoComs current reported
level of nonperforming loans is 3.4 percent.
Its agreement also permitted HSBC to appoint two of the eight seats on
BoComs board of directors, which is expected to assure some level of control.28 Additionally, PriceWaterhouseCooper is
reorganizing BoComs risk management and accounting systems and Goldman Sachs
is restructuring BoCom in preparation for its public listing.
A Look at Financial Opportunities
The demand for financial services in China is huge and
growing. Foreign bank interest in China
speaks to the attractiveness of this market.
A rising standard of living has sparked a growing demand by Chinese
consumers for financial services, opening up opportunities for banks in wealth
management, credit cards, mortgage loans, auto loans and other consumer
loans. Economic growth has also produced
a growing demand from private businesses for commercial and investment banking
services. Emergent opportunities for
foreign banks include providing loans to smaller businesses, deposit-taking,
risk management services, debt and equity underwriting, mergers and
acquisitions, brokerage, asset management, and disposal of bad loans.
Opportunities: Retail Banking
Some foreign banks view retail banking as a tremendous
opportunity due to growing consumer demand and limited domestic
competition. Chinese consumers are
off-limits to foreign banks until December 2006, which has prompted some
foreign banks to take minority positions in Chinese banks to prepare for this
Although personal financial services account for an
insignificant percentage of the earnings for Chinas banks3 percent in
2003this represents a huge increase over the past few years.29 And,
with a new middle class of approximately 100 million consumers, the demand for
credit cards, mortgage loans, and automobile loans is expected to increase
further. McKinsey, a business consulting
group, is projecting a compound annual growth rate for personal financial services
in China of 31 percent through 2013.30 McKinsey considers two segments of the
population attractive targets: the
affluent, the top 2 percent of banking customers who currently account for over
half of retail banking profits in China, and the mass-affluent, the 18
percent of Chinese bank customers who are responsible for most of the remaining
Existing competition is weak. The personnel and technology
of Chinese banks generally do not meet international standards and the local
banks typically have not made customer service a priority.32 Additionally, recent forays into consumer
lending by Chinese banks have been generally unsuccessful. A lack of experience in consumer lending,
inadequate systems for sharing financial information, falsified financial
documents and other fraud by borrowers, and difficulties in foreclosing and
gaining title to collateral have produced a number of bad consumer loans. (This is covered in greater detail in a later
section on risks.)
As described, many large foreign banks, anxious to get a
head start in consumer banking before the opening, have allied themselves with
Chinese banks to offer wealth management; credit cards; and mortgage, auto, and
other consumer loans. Many foreign banks
have found city banks especially attractive investments. Restricted to operating in a single city,
city banks often have close customer relationships. Additionally, there are 34 cities in China
with more than one million inhabitants, so city banks can provide substantial
penetration. The CBRC has also said that
it may eventually allow city banks to expand into other areas of China.
Wealth Management. Chinese banks are permitted to sell mutual
funds and to provide custody services to bank customers, but not to manage
funds themselves. However, in February
2005 the CBRC initiated a pilot program under which banks would be permitted to
launch funds on their own or with partners.
Firewalls between a commercial banks banking operations and its fund
management business are required.33
The central bank is expected to approve bank mutual funds at the end of
Fund sales have been a significant recent area of growth for
some Chinese banks. In particular, CCB,
the second largest bank in China, has been active in this area. CCB has 136 million active retail accounts
and 14,500 branches across China. It
reports that through March 2004 it sold 26 different mutual funds to investors
with a sales volume of approximately $3.74 billion.34 As mentioned, Bank of America recently
purchased 9 percent of CCB to access its tremendous network and capabilities.
ING Bank of the Netherlands and the International Finance
Corp (World Bank) together own 24.9 percent of the Bank of Beijing, the second
largest of Chinas city commercial banks, which has a large and growing
consumer savings base. ING plans to
offer wealth management services and insurance to these consumers through its
venture partner. ING has stakes in five
other Chinese banks and is engaged in joint ventures with Chinese firms in fund
management and insurance as well.35
Credit Cards. At the end of 2004, credit cards accounted
for 3 percent of consumer purchases in China.
American Express (AMEX) expects that penetration will eventually match
Hong Kongs 20 percent rate.36
McKinsey believes foreign banks have a special advantage in credit cards
because of a traditional Chinese unwillingness to lend without collateral and
domestic banks lack of marketing and risk assessment skills.
Foreign banks have begun to move into the credit card area
through investments in domestic banks.
For instance, Citibank purchased 5 percent of Shanghai Pudong
Development Bank, the ninth largest commercial bank in China, with 270 branches
in major cities.37 The joint
venture recently began to offer Chinese consumers international credit cards,
denominated in renminbi within the country and in U.S. dollars outside of
China. The card carries Citibanks
logo. HSBC has partnered with the Bank
of Shanghai, of which it owns 8 percent, to offer credit cards. AMEX, with ICBC, recently launched the
countrys first dual-currency American Express Card.
Beginning in 2005, the government began to allow
renminbi-currency credit cards to be used outside of China. They can be used in South Korea, Singapore,
and Thailand; transactions related to gambling, interbank transactions, and
capital-account items are prohibited.
Mortgage Loans, Auto Loans, and Other Consumer Loans. Over five million new
homes were built during the past five years in China.38 During the next decade economic growth is
expected to provide home ownership opportunities for hundreds of millions of
Chinese. KGI, a securities firm, reports that the number of mortgages grew at
an annual compound rate of 115 percent between 1998 and 2004.39 As noted above, mortgages account for 90
percent of outstanding consumer loans of $242 billion.
China is currently the worlds third-largest car market
(after the United States and Japan), and some analysts expect it to overtake
the United States (number one) by 2015.
Demand for cars in China increased 56 percent in 2002 and 75 percent in
2003 before falling to a 15 percent growth rate in 2004, as the government
tightened bank lending. Approximately 30
percent of autos were financed by loans in 2003; the figure dropped to 10
percent in 2004 in response to the tightened lending.
The demand for consumer goods of all types has increased
dramatically in China, and not just in the large cities. More than half of the consumption of many
consumer goods has occurred in the nations smaller cities and rural areas. HSBC has positioned itself to take advantage
of this growing demand. Its investment
in BoCom, described earlier, provides HSBCthrough BoComs 2700 brancheswith
access to 139 cities in China and massive consumer lending opportunities.
Opportunities: Commercial and Investment
Foreign banks are currently providing commercial and
investment banking services for foreign businesses operating in China, and have
begun to provide limited financial services for Chinese businesses, as
Foreign businesses in China include multinational businesses,
such as Volkswagen, which produces cars for the domestic Chinese market, and
other multinationals, such as Wal-Mart and General Electric, that are
export-driven. Most foreign businesses
operating in China are smaller, export-driven, mostly Asian-owned businesses;
these businesses represent higher-margin lending opportunities than the
multinationals. Small and medium-sized
Chinese businesses, starved for financing at a reasonable cost by the
state-owned banks, also provide commercial and investment banking
Smaller private businesses present particularly attractive
commercial and investment banking opportunities in China. These growing businesses provide
opportunities in risk-based lending and corporate deposit-taking; equity and
debt underwriting, trade financing, merger and acquisition assistance,
brokerage services, and asset management.
There are also opportunities for foreign banks in disposing of the huge
amount of bad loans held by Chinese banks and asset management companies.
Risk-based Loans and Deposit-taking. Private businesses in
China account for approximately 60 percent of Chinas GDP and 70 percent of
employment. As mentioned earlier,
ignored by the state-owned banks, they are often forced to pay interest rates of
as much as 8 to 20 percent or more for loans from gray-market lenders, if they
are able to get them at all. This market
continues to be underserved. McKinsey
estimates that total bank revenues from loans to small and medium-sized
businesses in China could exceed $25 billion by 2010; in 2002, they accounted
for less than $10 billion.40
HSBC Holdings, in particular, has focused on lending to smaller
companies in China.41
McKinsey also sees corporate deposit taking as an attractive
area of business for foreign banks.
McKinsey estimates that deposits are likely to grow at approximately 18
percent annually through 2010, generating more than $20 billion to banks by
Risk Management Services. In March 2004, the government introduced
rules permitting foreign banks to trade derivatives directly with Chinese
businesses. The new legislation allows
for asset-related derivatives in credit, fixed income, foreign exchange, and
hedging. ABN AMRO estimates revenue from
interest rate derivatives at approximately $500 million a year and increasing,
and plans to expand its derivatives business from foreign-currency hedging to
interest rate swaps and to commodity and equity derivatives.43 By the end of 2004, ten banks had received
licenses to trade derivatives.
Debt and Equity Underwriting, Trade Financing, and Mergers
A recent study by Mercer Oliver Wyman (a global financial services and
risk management firm), in conjunction with Morgan Stanley and UBS AG, estimates
that earnings from fees for investment banking services in non-Japanese Asia
for 2004 were approximately $5 billion, an increase of 30 percent over
2003. Bloomberg News reports that
the market for debt underwriting in non-Japanese Asia doubled in the past five
years and that Citigroup was market leader in debt underwriting in 2004 in this
With the government planning to launch IPOs of state-owned
banks and other state-owned enterprises, equity underwriting is expected to
grow substantially. Increasing numbers
of private Chinese businesses are also expected to go public and to issue
debt. McKinsey projects that revenues
from underwriting equity and debt should grow at a compound annual rate of 13
percent to $2 billion by 2010, with half of this increase coming from medium
and small businesses. Citigroup and
Credit Suisse First Boston are active in underwriting IPOs. There are also opportunities in debt
underwriting of private businesses:
Morgan Stanley has been especially active in underwriting high-yield
Businesses also need trade financing. McKinsey projects that
bank revenues from trade financing could reach $5 to $10 billion by 2010. HSBC Holdings, in particular, has built a
very successful trade financing network for its small corporate clients.45 McKinsey also is projecting that merger and
acquisition revenues will grow by 30 percent a year, reaching $400 million in
fees by the end of the decade.46
Brokerage and Asset Management. Opportunities in
providing brokerage services are opening.
Half of Chinas 130 domestic brokerages are classified at risk and
would find it difficult to provide significant competition to foreign
brokers. However, Chinas WTO
commitments in regard to securities operations are less than its commercial
banking commitments. Foreign firms will
not be permitted to trade A-shares, which have accounted for the vast majority
of Chinese securities firms revenues.47 Foreign investment banks are also limited to
owning a 33 percent share of domestic securities firms, a limitation that is
not slated to change under the WTO agreement.48 However, in December 2004 the government
approved a joint venture between Goldman Sachs and a local securities firm
under which Goldman was granted effective control. The joint venture is permitted to trade
shares on domestic markets.
Asset management opportunities in China are discussed in the
previous section on wealth management.
As in brokerage, foreign ownership restrictions on asset management
firms are to continue, with the maximum ownership by a foreign firm restricted
to the 49 percent that was approved in December 2004. In April 2005, UBS purchased 49 percent of
China Dragon Fund Management, a medium-sized Chinese mutual fund.
Disposal of Bad Loans. China is the worlds second-largest bad-loan
market (after Japan).49
S&P estimates that there are approximately $700 billion in bad loans
in China; other analysts suggest a higher figure. As mentioned, the government has been
pressuring the state-owned banks to dispose of bad loans in preparation for
their IPOs, and it has created four asset management companies to dispose of
the loans. Through the end of 2004, the
companies had sold only one-third of the $230 billion in bad loans acquired
from the banks since 1999.
Some foreign banks have shown interest in this area. Citigroup purchased over 16 percent of Silver
Grant International, a real estate affiliate of China Cinda Asset Management,
one of the four asset management companies.
Credit Suisse First Boston has also been active in this market, recently
purchasing a 2.4 billion yuan ($290 million) package of distressed loans from
China Orient Asset Management Corporation, another of the four asset management
A Look at the Risks
Although the exploding Chinese economy may be the envy of
the world, there are potential economic, political and demographic
problems. Major areas of concern are
that the economy might be overheating, that countries on which China relies to
buy its exports may become protectionist, that growing economic inequality
could produce internal strife, and that the rapid aging of the population may
create economic difficulties.
Other significant problems exist as well. The regulatory environment is uncertain, and
a large unwieldy government bureaucracy continues to play a crucial role in
many areas of business operation. Local
party officials and local government officials are powerful and often corrupt
and obstructionist. Within the banks
themselves, corruption is widespread.
The operations of Chinese businesses, including the banks, lack
transparency. The legal system lacks
impartiality, and it is generally accepted that judges continue to be
influenced by party and government leaders and bribery. Bankruptcy laws are inadequate; enforcement
of contracts and legal judgments is unreliable; there is an inadequate credit
infrastructure and not enough trained personnel in law, accounting, and risk
management; and the governments commitment to an open economic system is not
The Economist Intelligence Unit awards China a rating
of B for macroeconomic risk and B for financial risk. It rates China D for political stability
risk, D for labor market risk, D for government effectiveness risk, and D for
legal and regulatory risk.50
Cause for Concern: An Overheating Economy?
As described above, Chinas growth since the early 1980s has
been phenomenal. Much of this growth is
investment-based: gross fixed investment constituted 45 percent of Chinas GDP
in 2004. This high level of investment
has resulted in overbuilding and excess capacity in some sectors. The government has responded by trying to
stop this overbuilding so that business profitability remains strong and the
banks are not engulfed with new nonperforming loans. Rising inflation is also a concern: if
increasing investment-led demand for workers and materials results in
inflation, it is feared that the value of savings will be eaten away, interest
rates will increase, and the gains in the standard of living that many Chinese
have attained in recent years will be pushed back. This could very well create political as well
as economic reverberations. Another significant source of worry is Chinas very
low level of energy efficiency.
According to the official Xinhua news agency, China consumes 4.3 times
the amount of energy that the United States consumes in producing $10,000 in
GDP.51 China is a net
importer of energy, whose cost has risen significantly. This lack of energy efficiency has both
inflationary and competitive implications.52
To cool the economy, beginning in the spring of 2004, the
government put curbs on new lending and investment activity. Smaller banks were forbidden to undertake new
lending, requirements for investments were tightened, and new price controls
were instituted. Companies were required
to use more of their own capital and less debt; and provincial governments were
directed to carefully review all investments in steel, aluminum, cement, and
real estate andif inflation roseto cap price increases in electricity and
These cooling efforts apparently had some effect. Whereas the annualized increase in the
investment in fixed assets in the first quarter of 2004 had been more than 40 percent,
the increase for the whole of 2004 was 25.8 percent (following a 23.9 percent
annual increase in 2003). But, as mentioned, gross fixed investment still
constituted 45 percent of GDP in 2004.
Government efforts to slow bank lending were not completely
successful either, as local officials proved adept at sneaking projects by
the central government. Whereas credit
growth declined to a 9.3 percent increase in 2004 compared with the previous
years growth rate of 19.2 percent, the CBRC reported that Chinese banks made
over $70 billion in unapproved loans in 2004, up 70 percent over the amount of
the previous year.53
The International Monetary Fund (IMF ) cautions that
to maintain control over its rapidly growing economy, China still needs to rein
in its investment, raise interest rates, and loosen its currency. The IMF continues to be concerned about the
quality of investment in China, and suggests that investment needs to be better
targeted. Furthermore, although the IMF
considers current inflation low given the extraordinary growth in the
economyinflation was 3.9 percent in 2004it sees some evidence of more
widespread cost-push pressures, especially in wages and electricity. Other analysts are concerned by the booming
real estate market in certain parts of the country.
Cause for Concern: Protectionism?
In 2003, Chinas exports to the United States exceeded its
imports by a ratio of 8 to 1. Its trade
surplus with the United States that year was $124 billionthe largest bilateral
trade imbalance in history.54
The next year the trade surplus increased to $160 billion. However, Chinas global trade surplus in 2004
was only $32 billion, for its high level of global imports$561 billion in
goodslargely offset its global exports of $593 billion. Until the end of 2004, Chinas textile
exports were limited by an agreed upon cap with other nations. Following the expiration of the cap, China
increased its textile exports dramaticallyby 29 percent in the first quarter
of 2005. China is now the worlds
largest exporter of clothing, with 28 percent of world market share.55 The magnitude of Chinese exports has caused
consternation in the United States, the European Union, and other countries,
and raises the specter of protectionism.
As an export-dependent nation, Chinas economy would be seriously
derailed by U.S. or E.U. protectionism.
China recently succumbed to pressure from the United States and other countries to raise the value of its currency. The yuan had been pegged at approximately 8.28 to the U.S. dollar for the past decade. The United States accused China of engaging in unfair trade by keeping its currency at an artificially low level against the dollar, making its exports less expensive. In July 2005, China changed the dollar peg to a peg against an unidentified basket of currencies, and at the same time allowed a 2.1 percent upward revaluation of its currency against the dollar. It also promised additional gradual movements over time. This revaluation is small and unlikely to have much effect on its exports or to satisfy its critics for long. The serious nonperforming-loan problem of Chinese banks, however, makes it extremely difficult for the government to respond to its foreign critics and to revalue its currency in a significant way. It is feared that a significant revaluation could result in increased bankruptcies and a deluge of new nonperforming loans, leading to serious economic turmoil and possibly a financial crisis.
Cause for Concern: Growing Economic Inequality
In China over 800 million people, or approximately 60
percent of the total population, continue to live in rural areas. The World Bank reports that although hundreds
of millions of Chinese people have risen from absolute poverty over the past
two decades and the illiteracy rate has decreased by more than half (from 37
percent in 1978 to 17 percent in 1999), great poverty still exists in China,
especially in rural areas. The bank
reports that over 200 million mostly rural Chinese still live on less than
$1.00 a day and lack access to clean water, arable land, and adequate education
and health services.56
Credible unemployment estimates for those living in the countryside are
hard to come by, but The Economist estimates that as many as 150 million
rural Chinese are unemployed.57
As mentioned, official 2004 Chinese statistics report that
both urban and rural households experienced the highest growth rates in per
capita disposable income since 1997.
(The real growth rate for urban households was 7.7 percent, and for
rural households 6.8 percent.) However,
this growth was from very different bases in the two cases. According to official statistics, for city
dwellers in 2004 the average per capita disposable income was 9,422 yuan
($1,138 at the official 2004 exchange rate), compared with 2,936 yuan
($355)less than one-third the income of urban householdsfor rural households.58 Also, much of the growth in income for rural
areas in 2004 was attributed to high grain production and high grain prices,
both of which are unlikely to be sustainable, and to reductions in taxes and
feesreductions that have contributed to a further decline in the availability
of decent education and health services for rural poor people.59
In sum, there exists a real divide in Chinas standard of
living between those who live in cities and those who live in rural areas. This inequality produces political and
economic friction. The government has
been doing a number of things to help the rural poor: it is requiring more
provinces to eliminate the farm tax, directing that 70 percent of additional
provincial expenditures on health and education go to rural areas, and
increasing farm subsidies and government investment in agriculture.60 Even so, economic inequality remains a
Cause for Concern: An Aging Population
Chinas population is probably aging faster than that of any
country in history as a result of the nations one-child policy. Asian Demographics, a demographic research
firm, describes Chinas population trend as a demographic earthquake.61 It estimates that the growth of the under-40
age bracket may have already peaked in China, and is forecasting a decline of
one-thirdor 250 million peoplein that bracket over the next 20 years. By 2024 three-quarters of Chinese households
may be childless.
This rapid aging carries with it not only all the problems
that arise when there are fewer people to care for an aging population, but
also the corresponding negative effect on domestic consumer demand. Based on this projected population decline,
Asian Demographics forecasts annual increases in GDP in China of 4.8 percent
over the next ten years and less than 4 percent thereafter, far below the 7-8
percent growth rate that many foreign investors are assumingor the 7 percent
annual growth rate that the government feels necessary to solve its rural
unemployment problem. According to the
firm, most marketers are not factoring this lower growth into their long-term
Bureaucratic Delay and Political Interference
The Chinese government is more involved in business
operations than most foreign banks are accustomed. And, the government bureaucracy in China
remains unwieldy and opaque. Despite
reforms enacted in response to foreign complaints about the bureaucratic
processreforms such as expedited licensinglong delays caused by bureaucratic
overlap remain a problem. Lone Star
Funds, a global investment firm, closed its Beijing office recently because of
a lack of product (bad loans) due to the long delay in getting the necessary
approvals from the overlapping government offices responsible for these transactions.63 Citigroup had to wait for almost a year for
approval of its offer to buy 1.096 billion yuan in nonperforming loansloans
that the government was anxious to sell.
However, in October 2004 the government announced expedited sales of
nonperforming loansfor foreign buyers only.
Businesses contend not only with an overlapping national
government bureaucracy, but also with local (at the village, town, city, county
and provincial levels) government officials as well as local party
officials. Local governments in China
have exercised a great deal of power since the imperial days, and local
government officials and local party officials continue to have a great deal of
influence on what happens in their villages, towns, cities, and provinces. Their commitment to a market economy is also
sometimes questionable. (The commitment
of the national government is discussed below.)
Local political interference in banks has been especially
widespread. Branch managers have
historically had closer relationships with local government officials than with
their bank superiors, and were rewarded more on the basis of loyalty to party and
local officials than on the basis of market results.64 Until very recently, for all intents and
purposes, bank branches were under the rule of local officials, who set bank
salaries, guaranteed loans, and even were involved in decisions on where the
children of bank employees went to school.65 Local officials guaranteed loans and
recommended branch managers, and branches routinely disregarded risk and return
to promote public purposes at the direction of party and local government
officials. Political interference in
lending decisions reportedly has lessened as the government has encouraged
banks to adopt international banking practices, but it remains a force.
Problems with Corporate Governance
Corruption continues to be a problem in China, although
there have been real improvements here as well.
Transparency International, a global corruption-monitoring group, rated
China 2.16 in 1995 (a rating beneath 3.0 indicates rampant corruption). In 2005, the ranking improved to 3.4, placing
China solidly in the middle in terms of corruption71st out of 146 countries.66 Corruption has been especially a problem
within the banks, and this must be an important consideration for a foreign
bank deciding whether to compete in China through an equity position in a
domestic bank and, if so, how to structure any such relationship.
Corruption is considered to be especially prevalent in
remote branches and rural institutions: private businesses have complained that
in order to borrow from rural banks and credit cooperatives, they are typically
forced to bribe lenders with kickbacks of 10 to 15 percent of the loan value.67 The rural credit cooperatives are reportedly
riddled with fraud and controlled by local government officials.
Corruption appears to be a problem not just in rural banks
or remote branches but also in the big four banks. The central bank recently reported that
40,000 CCB employees and 18,000 Bank of China employees had been disciplined
for misappropriating funds and making unauthorized loans.68 Additionally, the chairman of CCB was forced
to resign in March 2005 for taking bribes.
Significantly, CCB had been considered the cleanest of the big four
banks. The CBRC also recently announced
that it had charged dozens of government officials and bankers at ICBC with
attempting to steal almost $1 billion from the bank. Earlier, the CBRC reported that the director
of a branch of ICBC had disappeared with $120 million of the banks money.
The Washington Post reports that there is also significant corruption and cronyism in the four asset management companies
created by the government to dispose of the banks bad loans. The management companies are staffed with
many of the same bankers who made the bad loans in the first place; and not
surprisingly, the corruption and self-dealing have continued. The government audit office recently reported
that it had uncovered 38 cases of embezzlement and fraud at the four companies,
involving more than $800 million.69
These government disclosures of corruption can be viewed two
ways, however. As mentioned earlier, the CBRC is making a strong effort to
improve corporate governance at the banks, and many commentators see these
public announcements of fraud as positive signsas proof that auditing and
centralized management reforms are detecting fraud and that the government is
serious about stopping it.
The level of transparency in businesses, including Chinese
banks, is also not good. Of particular
concern, the accuracy of bank financial statements is questionable. Although HSBC has taken a minority position in
many Chinese banks, its Asia chairman has cautioned that outside investors in
Chinese banks need to be extremely careful, for they have found bank financial
statements to be unreliable and the banks uncontrollable.70 Some of the problem may be that the banks
themselves do not keep track of operating data.
McKinsey reports that one state-owned bank had to spend a month
reviewing records and interviewing personnel to arrive at an estimate of its
losses and recoveries from defaulted loans.71 International accounting standards are only
used on the small number of publicly listed businesses.
Poor Systems for Ensuring the Return of Capital
China has poor systems72 to ensure the safe
return of capital. Its current laws and
foreclosure procedures are ineffective, and creditors have few rights. The judicial system is considered biased and
corrupted by local officials and bribery.
Enforcement of contracts and of legal judgments is problematic. The credit infrastructure is inadequate, and
there are shortages of trained personnel in crucial management areas. The commitment of the government to a market
economy is not always clear.
Inadequacy of Bankruptcy Laws. China lacks effective
bankruptcy laws and foreclosure procedures.
The bankruptcy law enacted in 1986 has been described as incomplete,
inconsistent, and opaque.73
It required criminal fraud investigations in the case of bankrupt
companies, and liquidation was the only way to resolve bankruptcy. The law gave creditors few rights and was ineffective
in enforcing contractual obligations.
With the government acting as shareholder, arbiter, and creditor, there
was also an inherent conflict of interest.74 The government was responsible for approving
bankruptcy petitions and appointing liquidators (often local government
A new bankruptcy law has been pending for a decade and is
expected to be enacted sometime in 2005.
The current version of the proposed law has many of the elements of U.S.
law and is expected to conform to WTO requirements. It would apply uniformly to both state-owned
and private enterprises, with some exceptions.
A court rather than the government would rule on bankruptcy
petitions. Liquidation of the assets of
the bankrupt entity would be the responsibility of an administrator selected by
the court rather than by the government, and the administrator would be
supervised by a committee of creditors who would have the right to approach the
court to replace the administrator. The
current version of the proposed law also recognizes that businesses may fail
for a variety of reasons other than criminal mismanagement, and it is similar
to Chapter 11 proceedings in U.S. law in that it would allow for corporate
reorganization under a bankruptcy courts advisement, with the approval of
major creditors. Security interests
would be honored (that is, collateral would be sold to satisfy the debt).75 The draft law provides an exemption period
for some state-owned enterprises.
Failure to Enforce Contracts. China has severe problems
with the enforcement of contracts and legal judgments. The China Law and Governance Review
(2004) finds that Chinas courts lack the authority and stature to enforce
their decisions, especially when other branches of the government, or
government officials, are parties to the case.
The Review estimates that approximately 30 to 60 percent of legal
judgments in China are enforced. Because local protectionism is an important
factor in the enforcement of judgments, this number can drop to 10 percent in
areas outside the geographical jurisdiction of the court. The enforcement of legal judgments of all
kinds is problematicwhether the issue is compensation for damages, repayment
of debt, or enforcement of property rights.
Enforcement of a judgment is often a contest of influence or power.76
Commercial and economic judgments are especially difficult to enforce. The China Law and Governance Review reports that during the first half of 2003, there were twice as many unexecuted civil and economic judgments in Beijing as executed
judgments. Most of these unexecuted judgments were for either bank loan defaults or real estate judgments. A third major category of unexecuted judgments was wages: as of 2003, migrant workers in China were owed approximately $12.5 billion in unpaid wages.
Inadequacy of a Credit Infrastructure and Trained Personnel. An additional systemic problem is the inadequacy of the credit infrastructure and a lack of crucial personnel. As mentioned above, Chinese statistics, including trade statistics, are not considered trustworthy. China also does not have a highly functioning credit culture or highly functioning credit systems. Only the relatively few public businesses use international accounting standards. Systems for uncovering and discouraging fraud are inadequate: external auditing, and internal control systems are undeveloped, and business transparency is not typical. Personal income statements are easily misrepresented, credit-rating services are immature, banks do not have easy access to other banks data to check on unreported debt or default histories, and the foreclosure process, as described earlier, is in flux.77 Few channels for risk shifting exist because the government has not permitted the securitization of loans.78 The markets are illiquid and lack good risk-hedging instruments. Consequently, as mentioned earlier, Chinese banks have begun to experience serious problems with many of the consumer loans they have made, especially auto loans, in a large part due to the inability of the banks to substantiate consumer information and to repossess property.
Regarding personnel, despite the abundance of unskilled labor in many parts of China, unskilled labor is in short supply in the south of the country, and skilled labor is even harder to find. In addition, insufficient local personnel are available for top and middle level management. The Economist believes that although for most firms production in China remains cost-effective, a growing shortage of executives requires that substantial time be directed away from sales to human resources, with the result that growth may be slowed. Businesses in China complain about not being able to find personnel with "creativity
. . . an aptitude for risk-taking and . . . an ability to manage in everything from human resources and accounting to sales, distribution, branding and project-management."79
Uncertainty about the Governments Commitment to Open Competition. It is not always clear how committed the government (even the national government) is to free competition. The Chinese media recently reported a statement by the Vice-Chairman of the CBRCsubsequently disavowedthat after 2006 China might continue to limit the expansion of foreign banks to protect local banks from excessive competition. He stated that the government might restrict foreign banks to the poorer western areas of China and that foreigners might be forbidden to invest in more than two local banks. The Vice-Chairman defended his position by emphasizing that foreign banks held only 3 percent of the assets of the banking system but had a 12 percent share of the market in Shanghai, the business capital of China.80 As noted, this statement was later disavowed.
China presents great opportunities as well as great risksa
combination that each foreign bank must weigh for itself. The opportunities include a booming market of
1.3 billion people, many of whom are rising to middle-class status; stagnant
competition from the local capital markets and banks; and emergent
opportunities for banks in retail, commercial, and investment banking.
The risks are also substantial. There are risks of an overheating economy, of
rising protectionism in those countries which buy Chinas products, of growing
economic inequality in a non-democratic society, and problems associated with a
rapidly aging population. Additionally,
there is a slow moving bureaucracy; government interference in business
operations at both the national and the local level; and poor corporate
governance, including corruption and lack of transparency. The legal system in China, in its current form,
cannot be relied on to protect creditor rights.
Moreover, the degree of government commitment to an open market is not
There have been improvements, however, and when (if) the new
bankruptcy law is enacted, banks will have more protection. The Chinese banks in particular, with their
massive portfolios of bad loans, should benefit and become both more
competitive and more attractive as investments.
The business of buying and selling nonperforming loans should also
benefit. However, enactment of the
bankruptcy law alone will not solve the bad loan problem. The law will have to
be enforced, and enforcement requires unbiased courts, a government willing to
remain neutral, harmonization of this law with other laws, and a cadre of legal
and business professionals.
Each foreign bank must decide for itself whether the
opportunities of doing business in China outweigh the risks. Banks that have decided to enter this market
must also decide whether to enter independently or as a partner with a Chinese
bank. Because of a history of government-directed
lending, political interference, corruption, and lack of modern management
skills and systems, many Chinese banks are badly functioning institutions that
are kept alive by government assistance.
The lack of transparency of Chinese banks also makes them
uncertain investments. Skepticism about
the health of bank portfolios is widespread, even after massive bailouts. Nicholas Lardy, a renowned China expert at
the Institute for International Economics, doubts the value of recent bank
bailouts, suspecting that these massive infusions of government capital are too
little and too soona waste of money until basic market reforms are made within
the banks. His estimate of the amount of
money needed to bail out the entire banking system is approximately 30 percent
of Chinas GDP over the next several years.81
Potential investors in China must recognize the corporate
governance problems, including corruption and the lack of transparency in
Chinese businesses, including the banks, and must negotiate significant
protections. They need to be very
careful in their investments and seek out relationships that either provide
them with substantial control or otherwise limit their risk. As we have seen, the Chinese government and
Chinese businesses have shown themselves willing to craft special arrangements
that provide some protection for foreign investors. However, competitive forces can obviate even
standard protections. For example, in
the area of debt underwriting, local Chinese firms have resisted strict
covenants typical of junk bond issues, and with the strong demand for Chinese
debt, there is concern that a race to the bottom could begin with underwriters
agreeing to do away with standard investor protections.82 Such actions would be dangerous given the
conditions described in this article.
* Valentine V. Craig is a Chartered Financial Analyst in the Division of Insurance and Research of the FDIC. The author would like to thank Alicia Amiel in the FDIC library for her assistance in the writing of this article.
2Some analysts believe that growth has not been as great as
officially reported because of suspect data. Official Chinese economic
statistics, although improving, are generally considered unreliable. The World Bank estimates that China
overstated its growth between 1978 and 1995 by 1.2 percent a year; the OECD
believes the overstatement was 3.8 percent between 1986 through 1995 (Lardy
2002). Unlike most developed countries,
China does not seasonally adjust its statistics, and the lack of seasonal
adjustment can distort recent activity.
Other analysts question the accuracy of the raw data themselves. Business Report (2004) suggests that
economic figures should be viewed as highly manipulated political statements
rather than hard numbers. Even trade
statistics are not considered reliable.
The New York Times (2004) reports that some companies exaggerate
exports to claim tax credits, and others underreport imports to avoid customs
duties. Despite all these
qualifications, however, there is general agreement that Chinas economy has
grown tremendously over the past two decades, although less than officially
14As a means of comparison, at the height of the U.S. savings and
loan crisis of the 1980s, nonperforming loans (defined most broadly) of U.S. thrifts
never reached 5 percent of total loans of U.S. thrifts.
20Real interest rates on deposits at the official banks are negative
because of low interest rates (raised from 2 percent to 2.25 percent in October
2004) and inflation of 3.9 percent in 2004.
23In reporting on the activity of individual foreign banks in China,
the author relies upon publicly available informationfor the most part, news
reports or bank press releases. The
activities of some very active foreign banks may be overlooked and others
overstated depending upon the extent of public coverage of their activities.
24Foreign banks additionally had established over 200 representative
offices in China by mid-2004.
Baglole, Joel, and Loretta Ng. 2004.
China Licenses Banks for Derivatives.
Bloomberg News. Reprinted in International Herald Tribune. October 12.
http://www.iht.com/articles/543158.html. [October 21, 2004].
The Wall Street Journal. 2004. As Government Eases Restraints, Financial
Sector Makes a Shift to Lending for Profit, Not for Party. July 9.
The Washington Post. 2005. Chinas Unyielding Banking Crisis. June 6.
2005. Safe Haven? The Slippery Slope; Market Watcher David Webb
Says Shady China Deals Threaten Hong Kongs Once Sterling Reputation. Newsweek International Pacific Edition. http://integrate.factiva.com/search/article.asp.