Foreign banks eye retail banking sector
(Shenzhen Daily)
Updated: 2005-11-25 13:58

Foeign banks are zeroing in on China’s fast-growing and profitable retail banking sector, an area they are better equipped to take advantage of than their domestic competitors, said a senior executive at consultancy firm McKinsey & Co.

“The opportunity in the retail sector is driving foreign banks into China,” David Von Emloh, a partner at McKinsey in Shanghai, said.

“If you look at Chinese banking today, all the future growth and profitability will come from retail, small-business lending and fee-based businesses,” he said.

“In each of these areas, Chinese banks are relatively weak and for foreign banks it’s a good opportunity.”

Von Emloh said Chinese banks, which have focused on corporate lending for decades, don’t have the same skills for retail banking that foreign institutions possess.

“The traditional areas of banking in China, such as deposits and lending, will not grow much over the next eight years,” he said.

Chinese bank profits are aided by an unusually wide margin between lending and deposit rates. Von Emloh said he expects margins will begin to decline in the next five years as interest rates in China are deregulated, which will negatively affect the profitability of traditional banking services.

As the Chinese Government continues to deregulate interest rates, pricing competition among banks will kick in. Banks will then be forced to look for other revenue streams.

By contrast, fee-based banking business is expected to grow 30 percent a year over the next eight years. “This is why foreign banks are excited about the prospect of deregulation in the Chinese banking sector,” said Von Emloh.

As matters stand, foreign investors can hold a combined 25 percent stake in a Chinese bank, while a single foreign investor can hold a maximum 20 percent stake.

Despite being relegated to minority shareholders with no legal control over their investments, foreign investors have spent US$10.3 billion so far this year on minority stakes in Chinese banks, according to Dealogic, a capital markets data provider. In 2004, foreign banks invested a total of US$3.2 billion in Chinese banks.

Von Emloh said the recent slew of foreign investments in Chinese banks has been a way for foreigners to tap into the fast-growing retail-banking market, and for Chinese banks to get the technology and capital they need to compete on a global level.

So far this year, major bank deals include Bank of America Corp. and Singaporean state-owned investment company Temasek Holdings Pte. Ltd. investing US$3 billion and US$2.4 billion, respectively, in China Construction Bank Corp.

China’s controlled policy to attract foreign capital to China’s banking system is part of its agreement with the World Trade Organization. Prior to joining the WTO in December 2001, China had to agree to increased levels of foreign participation in its financial-services sector. This includes allowing foreign banks to provide foreign-currency services and local-currency products to Chinese enterprises.

Von Emloh said the next major change will be in 2007 when foreign institutions can participate in local-currency business with all domestic customers.

“You have banks that have already set up business in China that are getting ready to take advantage of this new local-currency business. This is a clear opportunity for foreign banks, more so than foreign banks setting up joint ventures,” said Von Emloh.

Even so, there still isn’t a fixed timetable on when foreign institutions can take a majority stake in Chinese banks or in joint ventures. Von Emloh said that, in the meantime, foreign investors may be able to get around the minority stake-holding rule by forming non-equity partnerships with credit-card or mortgage-lending businesses.

“You are seeing service agreements between domestic businesses and foreign banks in things like credit cards that are actually 50/50 now. While they are not joint ventures, they are formal agreements,” he said.

“Foreigners getting majority control in this kinds of business will happen much faster than in banks.”