China

1
Chinas Banking and Financial System

• Xingmin Yin
• China Center for Economic Studies
• Fudan University

2
Contents

1. Introduction
2. Financial and banking system
3. Financial markets
4. Regulation of the financial system
5. Performance analysis
6. Non-performing loans and the reform of banking
   system
7. Reform progress Recapitalization
8. New Policies for the reform of banking system
   Strategic investors
9. Conclusions
10. Questions and Problems

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1. Introduction

• Overview of banking industry in China.
• The banking industry has been growing at an
  average annual rate of more than 19 in assets
  for the past two decades.
• Total banking sector assets reached 37.5 trillion
  yuan in 2005, or 209 of GDP, one of the highest
  in the world, for example, 140 of GDP in Japan,
  146 in Germany, and 297 in UK.
• China today boasts one of the largest banking
  industries in the world.

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• The state-owned commercial banks dominated the
  banking system.
• In recent years, the reform of state-owned banks
  has been pushed forward steadily due to the
  pressures imposed by many new issues in the
  globalization of economy.
• The objective of state-owned bank reform is to
  transform these banks into modern financial
  institutions with good governance and operations,
  clear business targets and sound financial
  performance.

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A. New Development of Chinas Financial Industry

• Chinese economy is distinguished with the
  manufacturing power in development, but tertiary
  industry gradually increased its share in GDP,
  from 32.8 percent in 1996 to 40 percent in 2005,
  and financial industry accounted for 3.4 percent.
• Financial sector development helps economic
  growth through more efficient resource allocation
  and productivity growth rather than the scale of
  investment or saving mobilization.
• What is the major function of financial industry?

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• Countries with better developed financial system
  experience faster economic growth, measures of
  financial development, such as the ratio of M2 to
  GDP yield similar results.
• Credit to GDP is a standard measure of financial
  intermediary development and in the ratio of
  claims by deposit money and other financial
  institutions on the domestic non-financial sector
  to GDP.

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Financial Development
M2/GDP Deposits/GDP Loans /GDP
1990 81.92 62.38 81.24
2001 144.36 130.97 141.24
2006 163.89 159.08 106.87
2007 2008 163.16 157.81 157.49 151.83 106.67 106.31
More savings for economy growth.
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Financial Development

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Discussion

• More savings contributed to Chinas economic
  development in the past 20 years.
• Is it possible for China to continue its
  investment growth in the support of high saving
  rate?

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B. Household Savings in China

• What is the feature of household savings?
• High level of household savings, which increased
  from 7.38 trillion yuan in 2001 to 22.5 trillion
  yuan by end-2008.
• Discussion on the Chinese Saving Puzzle and the
  Life-cycle Hypothesis by Franco Modiglian and Shi
  Larry Cao, Journal of Economic Literature, March
  2004.

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Comparison on Saving Amount
China 2001 2006 2007 2008
Household saving, RMB billion 7376.2 16158.7 17253.4 22200.0
USD, billion 891.17 2026.99 2268.99 3248.18
Gross saving, RMB USD, billion 47800.0 6993.83
USA, billion Q.2, 2008
Gross saving 1657.6 2038.5 1956.0 1672.9
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Year-on-Year Increases
Billion yuan
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• The situation with bank deposits increasing
  amount has continued to decrease since 2006,
  although total deposits with the system in
  December 2007 still keep its rising level, but
  small numbers with 1.1 trillion yuan in
  comparison with 2.15 trillion yuan in 2005.
• In 2008, households increased their saving amount
  of 4.75 trillion yuan, accounting for 92.22 of
  net increases of GDP (5.15 trillion yuan).
• What direction for the year of 2009?

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Discussion on Global Savings Glut

• Federal Reserve Chair Ben Bernanke called the
  global savings glut the enormous financial
  surpluses realized by certain countries.
• Chinese households save an astonishing 40 percent
  of their incomes. Why?
• Different views on this issue

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2. Financial and Banking Systems

• A. Peoples Bank of China
• B. Policy banks
• C. Depository institutions (commercial banks)
• State-owned commercial banks
• Joint-stock commercial banks
• Regional commercial banks
• Urban and rural credit cooperatives
• Joint-venture Banks and foreign-funded banks

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• D. Contractual Saving Institutions (Insurance
  Companies)
• Domestic funded insurance corporations
• Joint-venture insurance corporations
• E. Investment intermediaries
• Securities firms
• Finance companies
• Credit and investment companies
• Investment funds

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A. Peoples Bank of China PBC

• The unified function of the central bank and
  commercial bank.
• The State Council issued the policy on the
  function of PBC as the Central Bank in September
  1983.
• The People Congress issued The Law of PBC in
  March 1995.
• The PBC set up its 9 regional PBC Branch-Banks
  throughout the country, which is regarded as the
  action to follow the Fed System of the USA.

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The Functions of the PBC

• To promote economic growth
• To stabilize the price
• To supervise the financial system
• To make monetary policy under the leadership of
  the State Council
• How independent is the PBC in special reference
  to other countries?

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B. Policy Banks

• Suggestions from the World Bank.
• Practically all developing countries possess
  specialized public sector financial institutions
  such as a variety of development banks.
• These development banks have been established to
  attract foreign resources, to mobilize domestic
  savings (in part by developing capital markets),
  and to allocate investable funds efficiently.
• Three policy banks provide policy lending
  functions on behalf of the central government.

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Breakdown of Policy Banks
Institution Established Time Capital Assets (2002) Sources of Funds
National Development Bank March 1994 50 1041.71 Bonds, Loans
Export-Import Bank of China April 1994 3.38 110.18 Bonds
Agricultural Development Bank of China November 1994 20 764.47 Bonds, Loans
Unit billion yuan.
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Debating on Policy Banks

• The development banks were viewed and acted as
  tools of development policy, channeling resources
  to publicly promoted or state-owned enterprises
  and to priority sectors which commercial lenders
  were unwilling to finance.
• Different views on the establishment of the
  development banks
• The development banks are no panacea for solving
  the basic problem of credit allocation.
• The specialized financial institutions set up to
  support a problem sector of the economy itself
  becomes a problem institution.

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C. Depository Institutions

• Structure of Banking Industry.
• There are 133 domestic banking institutions
  operating at national and regional level,
  offering deposits and loan products to retail and
  corporate customers.
• The four tiers of banking industry may be
  classified in China state-owned banks,
  joint-stock banks, regional and local banking
  institutions, and foreign-funded banks.

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Market Structure(billion yuan)
Assets Liabilities
Banking industry 26729.5 96.7 25805.8 97.1
Policy banks 2124.7 7.7 2029.1 7.6
State-owned banks 15194.1 55.0 14576.2 54.9
Joint-stock banks 3817.0 13.8 3683.1 13.9
Urban commercial B. 1609.0 5.8 1558.7 5.9
Rural credit coop. 2689.3 9.7 2702.6 10.1
Postal savings bank 898.4 3.3 898.4 3.4
Foreign-funded banks 396.9 1.4 357.7 1.3
Non-banking industry 910.0 3.3 768.3 2.9
Total 27639.5 100.0 26574.1 100.0
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Four Tiers of Banking industry

• 1. Four state-owned commercial banks dominate the
  banking industry, in spite of the decreasing
  shares in deposits and loans business.
• 2. Joint-stock banks
• 3. Regional and local banking institutions such
  as urban commercial banks, rural commercial banks
  and rural credit cooperatives, and postal saving
  banks
• 4. Foreign banks, after 25 years of Greenfield
  development committed by foreign banks, the
  foreign banks activity in China still accounted
  for a paltry 1.3 of total assets and liabilities
  in 2003.

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Commercial Banks

• Banks are financial intermediaries in the
  business of earning profits.
• In China, four large state-owned commercial banks
  dominate the banking industry, while in the
  United States there are on the order of 9000
  commercial banks.

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State-owned Commercial Banks
Banks Assets (2002) Share of Total Assets () 2002 2007
Industrial and Commercial Bank of China (ICBC) 4734.24 24.03 18.33
Agricultural Bank of China (ABC) 2976.57 15.11 14.28
Bank of China (BOC) 2905.71 19.82 14.15
Construction Bank of China (CBC) 3083.20 15.65 15.57
Sub-total 13699.72 74.61 62.33
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Joint-Stock Commercial Banks
Banks Assets (2002) Share of Total Assets() 2002 2007
Bank of Communications 766.87 3.89 4.96
CITIC Industrial Bank 335.16 1.70 2.39
China Everbright Bank 328.34 1.67 1.74
China Minsheng Bank 246.28 1.25 2.17
China Huaxia Bank 178.15 0.90 1.40
China Merchants Bank 371.66 1.89 3.09
Sub-total 2136.46 11.3 15.75
CITIC Chinas International Trust Investment
Co. . Unit billion yuan.
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Regional Commercial Banks
Assets (2002) Share of Total Assets() 2002 2007
Shanghai Pudong Development Bank 279.30 1.42 2.16
Guangdong Development Bank 219.32 1.11 1.03
Fujian Industrial Bank 178.28 0.90 2.01
Shenzhen Development Bank 166.17 0.84 0.83
Yantai Housing Savings Bank 15.66 0.08 /
Sub-total 858.73 4.35 6.03
A few of regional banks have been established in
the past five years. Unit billion yuan.
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Discussion

• What will the structure of the Chinese banking
  industry look like in the future?
• Are private banks good things for the development
  of the Chinese banking industry?
• Is it a long-term trend of separation of the
  banking and securities industries?
• An imitation of the Glass-Steagall Act?
• More choices?
• Future Prospects

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Effects of Financial Crisis on Chinas Banking
System

• China is little affected by the crisis, and its
  entire financial system plays a relatively small
  role in its economy, and it apparently has no
  exposure to the toxic assets.
• However, the Chinese government attitudes to
  financial innovation have changed to be much
  cautious in the short and medium term.

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D. Contractual Savings Institutions

• Insurance is a growing industry in China.
• The annual revenues of insurance companies
  exceeded 400 billion yuan and 703.6 billion yuan
  in 2004 and 2007, and further to 978.4 billion
  yuan in 2008.
• Special business opportunity and the emergence of
  foreign-funded insurance companies.

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Insurance Companies

• Insurance companies are considered financial
  intermediaries for several reasons
• They receive investment funds from their
  customers.
• They place their money in a variety of
  money-earning investments.
• So they take in funds from one sector and invest
  it in another.

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Growth of Premium, Claim and Payment in Insurance
Companies
Billion yuan
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Technical Indicators of Property Insurance
Companies (2004, 2007)
Item 2004 2007 Premium Pre. CP 2004 CP
Enterprise Property Insurance 13.4 11.91 18.7 10.1 6.9 11.92
Motor Vehicle Insurance 74.5 66.22 148.4 79.0 41.6 71.85
Freight Transport Insurance 4.6 4.09 6.3 2.3 1.6 2.76
Agriculture Insurance 5.3 3.0
Accident Injure Insurance 7.4 2.3
Other Insurance 15.1 14.85 208.7 5.4 10.36
Total 112.5 100 57.9 100.0
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Economic Indicators of Life Insurance Companies
(2004, 2007)
Item Premium Percentage() Claim payment Percentage()
Life Insurance, 2007, 285.1 446.3 89.26 90.12 30.8 106.4 72.30 88.59
Health Insurance 2007, 25.7 37.0 8.05 8.8 3.0 20.66
Unforeseen Human Injury Insurance 2007 8.6 11.6 2.69 3.0 10.7 7.04
Total 2007 319.4 494.9 100 100 42.6 120.1 100 100
Unit billion yuan.
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Discussion on the Case of China

• Why do people pay for insurance when they know
  that over the lifetime of their policy, they will
  probably pay more in premiums than the expected
  amount of any loss they will suffer?
• How to explain the behavior of ordinary people in
  China
• Everyone knows that the insurance company would
  help if an emergency occurred, but almost
  everyone would prefer to setting aside reserves
  for emergency case.
• So these reserves could not be invested long-time
  but would have to be kept in an extremely liquid
  form- Household Savings How to resolve this
  paradox in China?

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Fund Use of Insurance Co.
year Fund Uses Deposits G-Bonds Financial Bonds Co. Bonds Invest.Funds
2004 1077.82 507.11 261.84 102.63 63.97 66.63
2005 1409.27 516.55 359.07 180.47 120.46 110.70
2006 1778.54 598.91 364.70 257.53 212.16 91.21
2007 2672.19 100.00 651.63 24.39 396.11 14.82 493.77 18.48 280.17 10.49 253.05 9.47
2008 3340.00 808.76
Unit billion yuan.
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Discussion

• Regulations on the fund use of insurance
  companies.
• Changes of regulations

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E. Investment Intermediaries

• In the last fifteen years, the profitability of
  the securities business became evident, and the
  securities industry expanded so dramatically.
• Many securities firms engage in all three
  securities market activities, acting as brokers,
  dealers, and investment bankers in China.
• Finance companies.
• New phenomenon Investment funds.

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General Information on Investment Funds
2002 2003 2004 2007
Number of Securities Investment Funds 71 95 161 346
Capital of Securities Investment Funds (Billion yuan) 131.89 161.47 330.88 2234
Turnover of Securities Investment Funds (Billion yuan) 116.66 68.27 72.86 862
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Imitation Learning By Doing, 2004
Number
Balanced Funds 16
Bond Funds 11
Value Funds 2
Growth Funds 7
Growth and Income Funds 3
Index Funds 3
Other Kind of Funds 10
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3. Financial Markets

• The Money Markets.
• Inter-Bank Market.
• Bill Market.
• Repurchasing Bond Market.
• The Capital Markets.
• Stock Market.
• Bond Market.
• The Future Markets.
• The Mortgage Markets.
• The Foreign Exchange Market.

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Brief Discussion on Money Market

• The money markets prime function is to assist
  banks in their treasury operationsthat is the
  management of their cash, short-term assets and
  short-term liabilities.
• Commercial paper is a much less important asset
  and, it is mainly held outside the banking
  system.

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• The money markets have been active since the
  early 1990s, and become more important than
  1990s.
• The money markets will be much more important for
  the coming years due to indirect manipulation of
  monetary policy by the PBC.

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• Money market securities have three basic
  characteristics in common
• They are usually sold in the large denominations.
• They have low default risk.
• They mature in one year or less from their
  original issue date. Most money market
  instruments mature in less than 120 days.

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Money Market Instruments,2004
Amount Percentage
Market loans (deposits) 19949 44
Treasury bonds 5042 11.1
Repurchasing agreements 15900 35.1
Commercial paper 4450 9.8
Unit billion yuan.
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A. The Inter-Bank Borrowing Market

• The inter-bank market started in operation on 3rd
  January, 1996
• The number of participants (financial
  institutions) increased from 96 in 1997 to 918 in
  2003.

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Volume of the Inter-Bank Market
49
B. The Repurchase Bond Market

• Repurchase Agreements (repos)
• A firm can sell Treasury securities in a
  repurchase agreement whereby the firm agrees to
  buy back the securities at a specified future
  date.
• Most repos have a very short term, the most
  common being for 3 to 14 days. There is a market,
  however, for one-to three-month repos.

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Open market operation of the PBC

• The PBC uses repos in conducting monetary policy.
• The conduct of monetary policy typically requires
  that the PBC adjusts bank reserves on a temporary
  basis. To accomplish this adjustment, the PBC
  will buy or sell Treasury bonds in the repo
  market.

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The Future of Repo Market

• From the conduct of monetary policy to the
  multiple function of repos.
• To increase the primary money market players
• Commercial Banks
• Businesses
• Investment Funds
• To expand the dealing scope between financial and
  non-financial institutions.

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C. Commercial Paper Market

• Commercial paper securities are unsecured
  promissory notes, issued by corporations that in
  no more than 270 days. Because these securities
  are unsecured, only the largest and most
  creditworthy corporations issue commercial paper.
• The interest rate the corporation is charged
  reflects the firms level of risk.
• Most commercial paper actually matures in 20 to
  45 days.
• Most commercial paper issued on a discounted
  basis.
• The interest rate of rediscount is an important
  instrument for the conduct of PBC monetary
  policy.

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D. New Trends of Money Market

• The reform measure for interest-determination
  should be based on the market.
• 1.Foreign currencies and domestic currency
• 2.Laons and deposits
• 3.Long-term and short-term loans and
  deposits
• 4.Large amount loans and small amount loans.
• Money market funds
• Money broker firms joint-stock firms 5149
  percentage in August 2005.
• More and more reform measures

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4. Regulation of the Financial System

• The financial system is among the most heavily
  regulated sectors of the Chinese economy.
• The government regulates financial markets for
  these main reasons
• To increase the information available to
  investors.
• To ensure the soundness of the financial system.
• To improve control of monetary policy.

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Principal Regulatory Agencies of the Chinese
Financial and Banking Systems
Regulatory Agency Subject of Regulation Nature of Regulations
Peoples Bank of China All depository institutions Examines the books of commercial banks, sets reserve requirements for all banks.
Banking Supervisory Commission State-chartered depository institutions Character and examine the books of state-chartered banks, impose restrictions on assets they can hold, and impose restrictions on branching.
Insurance Supervisory Commission State-chartered insurance institutions Character and examine the books of insurance companies, impose restrictions on assets they can hold.
Securities Supervisory Commission Organized exchanges and financial markets Requires disclosure of information restricts insider trading.
56
Discussion

• Single (China) or multiple regulatory agencies
  (USA).
• From the PBC to CBRC (China Banking Regulatory
  Commission) Political issue in the central
  government.
• Political economy in China

57
5. Performance Analysis

• Banks play such a major role in channeling funds
  to borrowers with productive investment
  opportunities, they are important in ensuring
  that financial system and the economy run
  smoothly and efficiently.
• In China, state-owned commercial banks hold about
  two-thirds of the assets in the banking industry.
• Banks make profits by charging an interest rate
  on their holdings of securities and loans that is
  higher than expenses on their liabilities.

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• Top four state-owned commercial banks dominated
  the Chinese banking system, with more than 60 of
  market share in deposits and loans, and 62 of
  total financial institution assets.
• The target of the central government is to
  conduct joint-stock reform of the state-owned
  commercial banks and establish a modern banking
  system.

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• The objective of state-owned bank reform is to
  transform these banks into modern financial
  institutions with good governance and operations,
  clear business targets and sound financial
  performance.
• In recent years, the reform of state-owned
  commercial banks has been pushed forward steadily
  due to the pressures imposed by many new issues
  and new phenomenon in the emergence of private
  sectors.

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Structure of Commercial Banking4CR,
Loans Profits Deposits Assets Income
2003 79.22 85.24 72.36 68.78 80.41
2004 59.64 89.80 64.26 65.59 78.10
2005 60.75 80.21 62.98 63.95 76.03
2006 60.41 78.31 61.18 62.50 76.33
2007 62.91 74.38 59.35 62.32 73.14
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Market Shares of Top Five Banks, 2007
Deposits () Loans ()
ICBC 18.64 18.36
Agriculture Bank of China 14.39 16.15
Bank of China 11.89 13.22
China Construction Bank 14.43 15.18
Bank of Communication 4.20 5.12
Total 63.55 68.03
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Market Shares for Small Banks, 2007
Deposits () Loans ()
CITIC Industrial Bank 2.13 2.67
Everbright Bank 1.51 1.94
Huaxia Bank 1.81 1.42
Minsheng Bank 1.81 2.54
Guangdong Development Bank 0.95 1.12
Shenzhen Development Bank 0.76 1.03
Merchants Bank 2.55 3.04
Fujian Industrial Bank 1.37 1.86
Pudong Development Bank 2.06 2.56
Henfeng Bank 0.18 0.21
Total 15.13 18.39
63
Discussion on Rural Credit Cooperatives

• Financial system in Chinas rural area.
• Basic policy for rural financial sectors.

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Comments on Performance

• Scale of bank assets US 350-600 billion for
  state-owned commercial banks.
• A basic measure of bank profitability that
  corrects of the size of the bank is the return on
  assets (ROA). ROA is a useful measure of how well
  a bank manager is doing on the job because it
  indicates how well a banks assets are being used
  to generate profits.
• It is reported that global banking institutions
  recorded a 1.2 overall return on assets, while
  the figure for Chinese banks was 0.4 of ROA in
  2004.
• Normal level of capital adequacy ratio is 10 for
  international banks.
• NPL is less than 5 of loans.

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Indicators of Economic Performance
Item ICBC ABC BOC CCB
Profit after tax 6.53 2.90 9.45 4.30
Profit per person 111 21 299 76
Profit per branch 2.03 0.29 4.32 1.42
Return on assets () 3.7 2.1 4.3 4.0
NPL () 25.43 36.63 22.49 15.17
Capital adequacy ratio 5.54 / 8.15 6.91
Unit of profit after tax billion yuan Unit of
profit per person thousand yuan Unit of profit
per branch million yuan. Based on official
data.
66
Bank Capital Requirements

• Banks also hold capital because they are required
  to do so by regulatory authorities.
• It is estimated that the four state-owned
  commercial banks should, at least, increase
  their capital of 340 billion yuan in order to
  meet the standard of capital requirements issued
  by the Basel Committee in July 1992.
• New progress with the government now busy
  vacuuming up nonperforming assets and throwing in
  new capital, insolvency is no longer even an
  issue for top four state-owned commercial banks.

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Income Statement

• Operating income from interest rate accounted for
  more than 90 of total profits in four
  state-owned commercial banks as well as other
  kind of commercial banks.
• Non-interest income accounted for small share for
  most commercial banks in China.
• Of course, Chinese banks will gradually learn to
  generate more fee-based income, but keep in mind
  that margins on regular lending operations are
  currently propped up at artificially high levels
  because of state-controlled deposit rates.

68
Off-Balance-Sheet Activities

• Banks have been aggressively seeking out profits
  by engaging in off-balance-sheet activities.
• Off-balance-sheet activities involve trading
  financial instruments and generating income from
  fees and loan sales, activities that affect bank
  profits but do not appear on bank balance sheets.
• This activity is called income from middle-man
  and service business in China.

69
Ratio of Non-Interest Income to Total Income for
Some Commercial Banks
Bank Non-Interest Income Bank Non-Interest Income
Bank of China 19 CCB 12.5
ICBC 5 Minsheng B. 1.1
Merchants B. 5.9 Huaxia Bank 3.0
Pudon Dev.B. 2.1 Shenzhen Dev.B. 2.5
Singapore B. 36.9 Hong Kong B. 28.9
Unit Percentage.
70
6. Non-Performing Loans and the Reform of Banking
System

• The accumulation of nonperforming loans is
  generally attributable to a number of factors,
  including economic downturns and macroeconomic
  volatility, high interest rates, insider lending
  and moral hazard.
• The problem of NPL in china was widely reported
  in international media, particularly in the
  period 1998-2002.

71

• Causes of NPL in banking system.
• Reform measures for NPL.
• What will be done for NPLs?

72
Causes of NPL in State-Owned Commercial Banks

• Institutional factor
• Fragmentation of market state-owned sector and
  private sector
• Corporate governance
• Short of social credit
• Others

73
Breakdown of NPL in Commercial Banks
First Quarter 2005 Amount Second Quarter 2005 Amount
NPL 1827.45 12.4 1275.94 8.71
Main Commercial banks 1712.84 12.7 1163.73 8.79
State-Owned 1567.05 15.0 1013.47 10.12
Joint-Stock 145.79 4.9 150.26 4.66
Urban commercial banks 107.38 11.5 103.89 10.43
Rural commercial banks 3.62 6.1 4.50 6.38
Foreign banks 3.60 1.2 3.81 1.14
Unit billion yuan. Percentage refers to NPL
ratio to total loans of commercial banks.
74
Ratios of NPL in Commercial Banks

• The occurrence of banking crises has often been
  associated with a massive accumulation of
  nonperforming loans which accounted for a sizable
  share of total assets of insolvent banks and
  financial institutions, especially during
  episodes of systemic crises.
• Ratio of NPL for state-owned commercial banks was
  20.36 on average in end-2003.
• Ratio of NPL in the first half of in 2003 9.34
  for 11 joint-stock commercial banks, 15.8 for
  112 urban commercial banks.
• And high ratio for rural commercial banks in
  2003.
• What can commercial banks do it?

75
Reform Measures for NPL asset Management
Companies

• The reform of state-owned commercial banks has
  been pushed forward steadily.
• In 1998, given the low capital adequacy ratio and
  high ratio of nonperforming loans, the State
  Council decided to recapitalize the solely
  state-owned commercial banks by issuing special
  treasury bond of RMB 270 billion yuan.
• In 1999, four asset management companies were
  established, which took over a portion of
  non-performing assets owned by the solely
  state-owned commercial banks, laying a foundation
  for further reforms. This is the solution with
  Chinese characteristics.
• What are major ways for AMC to deal with NPL?

76
NPL Processing by Asset Management Co.
2005 First Quarter Second Quarter Third Quarter
Total 688.55 717.42 736.66
By Cash 140.89 148.46 155.03
Processing () 54.95 57.28 58.71
Asset Back () 25.50 25.55 25.62
Cash Back () 20.46 20.69 21.04
Unit billion yuan.
77
7. Reform Progress Recapitalization

• Central Huijin Investment Co. Ltd was established
  on December 16, 2003. The company recapitalized
  the Bank of China, CCB with US45 billion at the
  end of the year and fulfilled its rights and
  obligations as a shareholder on behalf of the
  state.
• From the end of 2003 through the first half of
  2004, the Bank of China and CCB strengthened
  their disposal of non-performing assets. They
  wrote off loss loans with their original capital,
  profits of 2003 and provisions, sold doubtful
  loans in market-based ways.

78

• At the end of June, capital adequacy ratios of
  these two banks both exceeded 8 and their
  non-performing assets ratio fell below 6.
• Thus, insolvency is no longer even an issue for
  four state-owed banks.

79
Towards Corporate Governance

• On August 26 and September 21 of 2004, the Bank
  of China Co. Ltd and China Construction Bank Co.
  Ltd were established respectively.
• Both corporations established the shareholders
  meeting, Board of Directors and Supervisory Board
  in accordance with the principles of modern
  corporate governance.
• Special committees and business management and
  risk control mechanism were set up.
  Administrative official titles of their employees
  were cancelled and market-based pricing of human
  resources was introduced.
• Reform of ICBC and ABC is also being advanced in
  2004.

80
Case One Reform of ICBC

• ICBC is the largest commercial bank in China.
• Origin of ICBC.
• Based on the experiences attained in the
  joint-stock reform process of BOC and CCB, on
  April 22, 2005, the Central Huijin Investment
  Company recapitalized the ICBC with foreign
  reserves totaling US15 billion, bringing the
  ICBCs core capital adequacy ratio up to 6.
• The pilot reform of the BOC and CCB also
  progressed smoothly.

81
Case Two Reform of the Rural Credit Cooperatives

• At end-2005, PBC, together with CBRC, following
  strict assessment and examination, made 8
  issuance of special bills worth 156 billion yuan
  in 2263 counties aimed at reforming the rural
  credit cooperative on a pilot basis.
• Recapitalization and equity increases speeded up,
  leading to a rapid increase of the capital
  adequacy ratio. The capital adequacy ratios of
  the rural credit cooperatives, rural cooperative
  banks, and rural commercial banks were raised to
  8.03, 12.93, and 8.78 respectively.

82
Rural Financial Development

• The contents and steps for the reform of rural
  financial sector are as follows 1. to establish
  corporate governance 2. to transfer the
  management of rural credit cooperatives to the
  provincial governments and 3. to provide strong
  support for rural credit cooperatives such as
  issuing special bills and some subsidies.
• By end-2007, 17 rural commercial banks, 113 rural
  cooperative banks, and 1824 rural credit
  cooperatives (under county unit) have been
  established and reorganized respectively.

83
Is it Better Banking Environment?

• The banking environment has changed radically
  over the past 10 years, with better regulation
  and supervision, better macroeconomic policy
  making, better internal controls and better
  borrowers.
• Wont banks get right back into trouble in the
  coming years, with a flood of new NPLs
  overwhelming the system?

84
What Will be Done for NPL?

• The amount of all bank assets reached 40 trillion
  yuan by April 2006, according to a recent report.
  
• It is estimated that the bad assets have been
  accumulated 2.4 trillion yuan for top four
  state-owned commercial banks.
• It is estimated that the magnitude of new NPL
  flows will be much manageable than in the past.

85
8. New Policies for the Reform of Banking System
Strategic Investors

• The joint-stock reform of state-owned commercial
  banks has been taking smoothly.
• To strengthen corporate governance.
• To put in place an independent internal control
  system and risk prevention system.
• To encourage product innovation.
• New policy was advertised for strategic
  investors.

86

• Pioneer programs from the IFC involving Chinese
  local commercial banks in the later 1990s Bank
  of Shanghai, Bank of Beijing, Fujian Industrial
  Bank, Minsheng Bank, Nanjing City Commercial Bank
  and Xian City Commercial Bank.
• More strategic investors

87
Banks On Sale
Strategic Investors Shares Amount
2005 BOC Royal B. of Scotland 10 3.1 bill.
CCB Temasek, Singapore 2.5 bill.
Bohai Bank Standard Chartered 20
Jinan Bank Federal B. of Australia 11
Hangzhou Bank Federal B. of Australia 19.9
ICBC Bank of Comm. Goldman Sachs HSBC 10 19.9 10 bill. 2.25 bil
2006 June CCB Bank of America 9 3 bill.
88
Strategic Investors from OverseasMega-transaction
s

• HSBC bought a 19.9 stake in Bank of
  Communication for a total cost of US2.25
  billion.
• Bank of America announced its US3 billion
  investment in CCB in June 2005
• Huge profits for strategic investors

89
More Transactions

• Royal Bank of Scotland agreed to take a 10 share
  of BOC for US3.1 billion Singapores Temasek
  took a similar stake for the same price.
• Temasek also committed US2.5 billion to invest
  in CCB.
• Standard and Chartered Bank 20 share of Bohai
  Commercial Bank.
• Federal Bank of Australia 11 share of Jinan
  Commercial Bank and 19.9 share of Hangzhou
  Commercial Bank.
• A Goldman Sachs-led group signed an agreement to
  lay down US 3 billion for 10 share of ICBC.
• More strategic investors

90
Debate on the Great Chinese Bank SaleNow
Open-Door Policy for Banking Industry

• At this pace, by the close of 2007 foreign banks
  and other foreign investors could conceivably
  control more than one-sixth of the entire Chinese
  banking system.
• It seems the only brake on the process is the 25
  ceiling on cumulative foreign ownership of
  individual banks a restriction likely to be
  eased in the near future.
• Strong criticism to this kind of sale to foreign
  investors from a couple of sides private sector
  and public opinion
• It seems to be un-reversible for this trend

91
A Win-Win Situation?

• China does benefit from having foreign investors
  buy in, and foreign investors benefit from being
  there.
• Can overseas investors provide a one-stop shop
  for Chinese enterprise reform?
• In most cases, the result has been
  better-managed, more profitable and transparent
  companies, and this is exactly what China is now
  hoping to achieve by selling off stakes in the
  large banks.
• What do foreign investors get? How much?

92
IPOs for the State-owned Banks

• CCB was listed on the Hong Kong stock market on
  October 27, 2005 and issued 30.5 billion new
  shares at HK2.35 per share, raising HK71.58
  billion (or US9.23 billion).
• BOC continued to transform its management
  mechanism and created favorable conditions for
  its listing June 1, 2006. BOC was listed in HK
  stock market (June 2006), and in SSE (July 2006).
• ICBC was incorporated on October 28, 2005, with
  registered capital of 248 billion yuan. The
  Ministry of Finance and Central Huijin Co. each
  hold 50 of its shares.
• ICBC was listed in SSE and HK stock market in
  October 2006.

93

• Bank of Communication was listed in HK (June
  2005), and in SSE (May 2007).
• ABC is working on a joint-stock reform plan in
  line with the reform of agricultural financial
  system
• How many commercial banks will follow this
  pattern of reform?

94
Financial Liberalization?

• A great growth story in Chinese banking
  industry
• More competition is needed for the performance
  improvement of banking industry
• More reform policies and measures will be
  issued
• More discussion on the way of financial
  liberalization.
• Will China follow Latin American story, or take
  different tack?

95
More Competition

• Today, the 200-odd foreign commercial banks
  active in China mainland still accounted for a
  paltry 2.73 of total loans and deposits, and a
  total capital commitment of no more than a few
  billion dollars.

96
Balance Sheet of Financial Institutions (billion
yuan), 2007
Financial Institutions Foreign-funded Banks FFB/ Total
Funds Resources 45427 Total assets 1239.1 2.73
Total Deposits 38937 Various Claims 908.96
Funds Uses 45427 Total Liabilities 1239.1 2.73
Total Loans 26169

97
RMB Business for Foreign-Funded Banks

• China formally eliminated the limitations on RMB
  business for foreign-funded banks in December 11,
  2006.
• China, as a transitional economy, takes many
  transitional steps for reform processing,
  including in the regulation of a transitional
  process for foreign-funded banks to be a new kind
  of local commercial banks.

98
The Localization of Foreign-Funded Banks

• The list of nine localized foreign-funded banks
  that are permitted to operate RMB business
• By end-2006, Citigroup, HSBC, Standard and
  Chartered, total nine foreign-funded banks
  registered in Shanghai, namely, these banks can
  called local legal person entities
• More and more policies will be issued for the
  globalization of Chinas financial and banking
  sectors in the coming years, so keep your eyes on
  it.

99
More Challenges for China

• How about tomorrow?
• More overseas strategic investors
• More IPOs
• More reform policies and measures
• Will China follow Latin American story, or take
  different tack?
• Will more international banks do their business
  in China?

100
9. Conclusions

• It is hardly to change the structure of Chinese
  banking industry rapidly, which is distinguished
  with the dominance of the state-owned banks.
• Non-state banking institutions will increase
  their market shares year by year, clearly, more
  competition will improve the performance of
  Chinese banking industry.
• Gradualism is a major feature in Chinese banking
  reform procedure, which has shown a direction
  towards the diversification of ownership in
  banking industry.

101
10. Questions and Problems

• What kind of challenges is raised by Chinese
  economic development to the banking system?
• The commercial banking industry in China is less
  efficiency due to the market dominated by four
  state-owned commercial banks. Is this statement
  true, or false? Explain your answer.
• How to resolve the issue of non-performing loans
  in the context of Chinas financial regulations?
• Which role will be played by overseas investors
  in Chinese banking reforms?
• Is it really a win-win situation for strategic
  investors and the Chinese government in Chinas
  banking restructuring?

102

• Thank You!