Betting on China's Banks
from January/February 2006
Why pour billions of dollars into an overregulated, overstaffed, undermanaged mess of a business like a Chinese bank? Because China’s banking industry is plugged into millions of upwardly mobile savers and investors—about 15% of the population is already middle-class or better. And China is where tomorrow’s growth promises to be (see the chart at below), poweredby mortgages, corporate treasury services, wealth management, you name it.
The key word is, of course, promise. What Western banks have been buying into—most notably Bank of America’s $2.5 billion investment in China Construction Bank—is a challenge of massive proportions: China’s banks are largely insolvent, thanks to a mountain of nonperforming loans, and Beijing’s commitment to real banking reform is far from certain. As Guo Shuqing, chairman of China Construction Bank, said in June when the BofA deal was announced, “We have much to learn from our partner in serving customers and creating shareholder value.”
Talk about an understatement. China’s banks, including the Big Four state institutions as well as thousands of smaller ones, resemble U.S. banks in name only. For years they have been instruments of government policy, extending loans to inefficient state industries with little or no credit analysis, effectively playing the role of a highly politicized central bank.
Recognizing the problem, China’s government has injected more than $50 billion into the biggest banks, including Bank of China and China Construction. But banks must learn to change their ways—and that’s not yet happening. “Our front-line experience tells us that Chinese banks continue to make astounding numbers of questionable loans atop the existing pile,” says Matt Bekier, a principal in the Hong Kong office of the consulting firm McKinsey & Co.
Reform will have a chance only if Western banks impart their knowledge of everything from risk analysis to fee-based businesses—and if the Chinese government allows this to happen, which means letting go of a powerful tool for controlling the economy. Notes Frank Gaffney, president of the Center for Security Policy in Washington, D.C.: “China’s bank problems do not exist because the government can’t figure out how to run banks. They chose to run banks this way because it serves their purposes.”
Some Western banks, like Citibank and HSBC, are setting up branches in China even though they can engage only in foreign-currency businesses. But in 2007 the currency restriction
comes off, part of the price China was willing to pay to join the World Trade Organization. At that point, these banks will be able to compete with their local counterparts in everything from mortgages to mutual funds. Unencumbered by bad loan portfolios or China-bank bureaucracy, the foreign banks could also move more quickly to snare new business. Of course there’s no
guarantee on the 2007 deregulation promise, and if that deregulation is delayed partnerships like Bank of America’s will most likely prevail. Place your bets.
The Goliath and the Hare
U.S. commercial banks will continue to dominate their industry through2008, when revenues are expected to reach $1.2 trillion. Revenues fromcommercial banking in China will be an estimated $230 billion by then.The comparative rates of growth from 2004 through 2008 tell adifferent story. U.S. commercial-bank revenues are expected to increaseby a modest 4% over those four years, versus a 14% increase for theirChinese counterparts.
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Projected 2008 revenues, in billions
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U.S. Banks
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China Banks | |
| $1,200 | $230 | |
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Projected rate of grwoth 2004-2008
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U.S. Banks
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China Banks | |
| 4% | 14% | |
Sources: Central banks, analyst reports, BCG analysis
