Banking sector needs to enhance capital management to meet new challenges

Beijing – Despite risks of decreasing growth and economic hard landing, the Chinese banking sector continued to report remarkable profits and maintained high growth in 2011, according to Deloitte's report on the Top 10 Trends & Prospects of the Chinese Banking in 2012. At the same time, Chinese banks should be aware of the potential risks and implications brought by other international and domestic uncertainties, such as the deteriorating European debt crisis and pressure from local financing platforms and real estate loans on their asset quality.

According to data published by the China Banking Regulatory Commission (CBRC) in mid-February 2012, the total assets of financial institutions in the Chinese banking sector reached 113.28 trillion yuan by the end of 2011 with a year-over-year growth of 18.9 percent. Chinese commercial banks made a cumulative net profit of 1,041.2 billion yuan in 2011, rising by 277.5 billion yuan or 36.3 percent from the previous year. They also achieved a cumulative net interest income of 2.15 trillion yuan in 2011, up 29.3 percent year-on-year.

The report analyzes the potential risks and challenges that the Chinese banking sector will face in 2012 supported by vast data and expert opinions. It also provides a forecast on the sector's development trends. Deloitte hopes that the report will open a closer dialogue with professionals from banking and other sectors to address challenges and risks in the ever changing financial market and economic environment. Furthermore, the report also examines the top 10 issues that will influence the Chinese banking sector in the next two to three years. The highlights of those issues are as follows:

1. By 2012, it is expected that loan risks of financing platforms of the local government will be fundamentally under control. However, the non-performing loan ratio of banks will rise moderately. Although loans of these financing platforms still present potential risks, they will not result in a large scale of bad debts.

2. Regulated by stringent policies, the real estate sector has shown a weakening trend, which is likely to continue in the first half of 2012. As shown in the data published by the National Bureau of Statistics, investment on property development was up to 6,174 billion yuan by the end of December 2011, up 27.9 percent year-on-year and down for five consecutive months. The financial condition of real estate companies has become a concern in the context of an overall depressed market. As a major financing channel for property enterprises, the banking sector should consider the macro trends of the real estate market and address the property credit risks prudently.

3. Small and medium enterprises (SMEs) are a dynamic economic group and playing an increasingly significant role in driving the China's economic prosperity. The growth of SMEs has been hampered without solid improvement to address their funding problems. Today, 70 percent of SMEs are still facing financing issues. Though SMEs face various challenges and risks when developing their business, it has become inevitable for banks to integrate SMEs business into their asset and revenue structure in order to achieve sustainable growth. Therefore, commercial banks should be active in helping to resolve the financing issues of SMEs.

4. The government and regulators will continue to encourage and strengthen agricultural financial services of financial institutions. Besides rural financial institutions, commercial banks will also speed up the development of rural financial services. In response to the requirements of the CBRC, financial institutions will extend more loans to key agricultural areas, including water conservation, grain production and drought and disaster relief. Moreover, the joint stock reform of rural financial institutions will be accelerated. The system for rural banks will be built and improved gradually and the overall functions and core competitiveness of rural financial services will be enhanced significantly.

5. With the continuous economic globalization and reform and liberalization of the China market, the Chinese banking sector is accelerating its internationalization process. However, the sector is still at the early stage of such development. Many Chinese banks are facing challenges from their strategic positioning, organizational network, services level, risk management and talent. When expanding overseas, Chinese banks have to focus on market, credit and operational risks as well as even more complex international political, legal, country-specific and international market risks.

6. Mobile banking is growing steadily in China. By the end of October 2011, the number of Chinese mobile users has reached 964 million, of which 3G subscribers were more than 110 million, providing banks with the opportunity to develop mobile banking into more integrated mobile financial services. Since the population in remote areas is the key potential customer cluster, the development of mobile finance will heavily concentrate on rural areas in the future.

7. In 2011, individuals with a net worth or wealth of tens of millions, and hundreds of millions totalled 960,000 and 60,000 respectively in China, both increasing by more than 9 percent as compared to 2010. Commercial banks are competing for businesses in private banking as an emerging strategic market. When developing such a market, however, banks need to have sufficient know-how, and deal effectively with challenges, including lack of differentiation and diversification of wealth management services and shortage of local professionals.

8. With the reform and liberalization of the Chinese banking sector, foreign banks have grown to become an integral part of the sector. Foreign and Chinese banks will achieve a win-win situation through competition and collaboration. Foreign banks have a different market positioning, rigorous risk management practice and wealthy experience in investment banking and merger and acquisition. Chinese banks' expertise in local operations and its stable client network are believed to offer positive impact on foreign banks when they optimize their business strategies and process.

9. At the economic and financial situations briefing held in the first half of 2011, the CBRC identified underground financing or shadow banking as currently one of the top three major risks for the banking sector. According to estimates, the size of shadow banking activities is approximately 11.5 trillion yuan in China, accounting for about 20 percent of the credit size of banks. To some degree, shadow banking is a driver of financial growth. However, its nature has imposed conflicting forces to the government's macro-control measures and given rise to some systemic risks. This has increased the difficulties for regulatory control and it will become more demanding for regulators to balance risk and efficiency.

10. With the rapidly developing global financial market and increasingly intensifying market competition, financial innovation has driven product diversification, which adds to the difficulties of risk management and control. Recently, Chinese financial institutions have been actively involved in revising the international financial standards, helping to improve the regulatory requirements in the Chinese financial industry. The subsequent issuance of relevant guidelines and administrative measures also enhanced the regulation of the banking sector. For example, the CBRC placed even more stringent capital requirements than BASEL III in 2011. Looking ahead to 2012, it will be a key challenge for banks to deal with the adoption of International Financial Reporting Standards 9 Financial Instruments published by the International Accounting Standards Board.

"Overall speaking, the Chinese banking sector will maintain an excellent growth momentum and evolve towards a healthier direction," indicated Dr. Pengcheng Wang, Partner and Co-leader of Deloitte China Global Financial Services Industry. "Of course, the banking sector will continue to face challenges due to the unstable global economy. However, I believe that improving risk control and exploring innovation to address the financial needs of customers will be the key drivers for the sector's continuous growth."