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New Competitive Strategies of Foreign Banks in China

时间:2010-03-03  来源:  Author : ZHANG Dongxiang and Z 点击:

Introduction

There are commonly two methods by which financial institutions, such as multinational banks, seek to do business in foreign countries. One is to register as a new financial institution and the other is to purchase the equity of a bank in the host country. In the case of the former, the international bank may establish a branch as a direct operational institution, or subsidiary or sister bank of an existing institution. In the case of the latter, the bank may buy a percentage of the shares of a bank in the host country. In each case, the background and manner of expansion may vary. This paper will examine the manner of expansion of foreign banks in China and discuss whether and why certain methods may be preferred in the attempts to enter the Chinese financial market.

Establishment of New Banking Institutions

Based on the experience of multinational banks in seeking expansion abroad, the normal approach is to establish a new institution such as a branch, subsidiary or sister bank. The branch office is often preferred to other forms.


The Branch Bank

The foreign branch represents a direct form of operation established by a multinational bank, and as an organic part or an unregistered extension of the parent bank. The branch bank may not be an independent legal entity, instead, it must conform to the policy and scope of business of the parent bank in accordance with the principle of the "Grandparent Clause" in international banking law.

There are certain advantages for a multinational bank to set up a branch bank in a foreign country. Firstly, the parent bank has full control over its branches and is thus able tc manage its business worldwide. Secondly, a branch conducts business in the name of its parent bank. It is thus free of such limitations as to its capital and assets. Thirdly, a branch can take full advantage of its parent bank's capital, credit and global networks to improve its services to customers. Lastly, opening a branch is more cost effective than alternative forms. No registered capital is required to set up a branch bank. It also requires less working capital than a newly-established body. Current regulations in China, for example, specify an amount of RMB100 million or an equivalent in foreign currency as the minimum capital required to set up a branch by a foreign bank. But to establish a subsidiary of a foreign-owned bank or a Sino-foreign joint-venture bank would require capital investments of RMB300 million and RMB200 million respectively or equivalent amounts in foreign currency. It is thus clear that setting up a branch bank is the preferred form of entering the Chinese market by multinational banks (中国银行业监督管理委员会 / China Banking Regulatory Commission, 2003).

Multinational banks of the world have currently established 10,000 branches worldwide. Citigroup has set up nearly 1,000 branches in more than 100 countries and regions (袁方 / Yuan Fang, 2003). Up to April 2004, 157 branches of foreign banks have appeared in China, out of 192 financial institutions of all types established by multinational banks from 19 countries and regions (中国银行业监督管理委员会网站 China Banking Regulatory Commission website, www.cbrc.gov.cn).

Different countries and regions have different rules and regulations on the entry of foreign banks and the establishment of branches. One rule is to place restrictions on the number and location of branches. In the initial phase of opening of the financial sector to foreign banks, some countries allow the establishment of branch banks but only in limited numbers and in specific locations. In Thailand. Taiwan. Hong Kong and certain East European countries, foreign banks were initially permitted to set up a single branch each, and normally in a designated location (张东祥 / Zhang Dongxiang, 1990). Bangladesh, for example, allows a foreign bank to open only one branch in a port city, and in South Korea, approval is restricted to no more than two branches in the same city. Restrictions on number and locations were also spelt out by China before 1999 (薛魏贤等 / Xue Weixian et al., 2003). From 1981 to 1989. four cities in China, namely. Shenzhen, Zhuhai, Xiamen, Shantou and the province of Hainan were open to foreign banks. In 1990. the Pudong district of Shanghai joined the list and in 1992, seven more coastal cities including Guangzhou. Qingdao and Dalian were added. In 1995, foreign banks were allowed to conduct business in 11 inland cities including Beijing. Wuhan. Shenyang, Xi'an and Chongqing. By 1999, the restriction on location was removed when all large and medium-size cities were eligible to deal with foreign banks (薛魏贤等 / Xue Weixian et al., 2003).

Another rule is to forbid the entry of foreign banks. Prior to the 1980s, some countries including Canada, Australia, Holland. Mexico and Florida state of the US did not allow foreign banks to set up branches. Some countries regard the branch bank as a direct part of a multinational ban! in which the parent bank had full control and are able to find loopholes in the regulations governing banking in the host countries (张东祥 / Zhang Dongxiang, 1990).

The Subsidiary Bank

The subsidiary bank is an alternative to the branch bank. Although opening a banking company allows a multinational bank to control risks and the subsidiary bank can conduct business that the parent bank is not able to, there are many disadvantages to contend with. The parent bank has to invest more capital and the subsidiary bank has to operate under certain restrictions. Multinational banks will venture into a new market only after careful study. At present, there are 15 foreign banks including subsidiaries and joint-venture banks in China, accounting for 8 per cent of all foreign banks in the country (中国银行业监督管理委员会网站 / China Banking Regulatory Commission website: www.cbrc.gov.cn.).

When a host country forbids foreign banks to open branches, such banks may turn to establishing subsidiary banks. From this perspective, the subsidiary bank will serve as a substitute for a branch bank. For example, Canada and some states in the US would only allow foreign banks to open a subsidiary (张东祥 / Zhang Dongxiang, 1990). These countries hold that as the branch is under the full control of its mother bank and, as the assets and liabilities are combined with those of its mother bank, it would be difficult to regulate and supervise the branch.

But there are also countries that limit the opening of subsidiaries of foreign banks and insist that local residents hold a majority of the shares in these banks. The alternative is often one of restricting the equity share of the parent bank. This was the case in Thailand in the late 1980s when foreign banks were limited to a maximum share of 10 per cent of a subsidiary (张东祥 / Zhang Dongxiang, 1990).

Joint-venture Banks

Developing countries normally allow multinational banks to open a branch or a subsidiary and to impose restrictions on the ownership of shares of local banks during the early phase of the opening of their own financial sector to foreign investment. They think that allowing foreign funds to hold a substantial or controlling share of local bank equity would subject the host country's financial system to manipulation by foreign funds. This would also jeopardize the development of the financial industry and the stability of the banking system. Hence most developing, and even some developed, countries strictly restrict foreign banks in holding shares of local banks. In 1969, Colombia made it illegal for foreign banks to purchase the equity of local banks, and in 1971 Bolivia enacted similar legislative measures (张东祥 / Zhang Dongxiang. 1990).

Generally, a host country would encourage foreign banks to establish joint-venture banks. In contrast to the branch or subsidiary banks, joint-venture banks would allow the host country to benefit, through the foreign partner, from the use of advanced technology and managerial experience, to enter the international market to reduce the adverse effects of foreign funds, and to strengthen the control over tbreicn funds.

Expansion through Equity Acquisition

Many multinational banks choose to participate in the financial sector of the host country through equity acquisition when they have acquired a good understanding of the financial market and the regulations concerning the inflow of foreign funds. This often turns out to be the major method of expansion after a period of operation in the host country. Expansion through equity acquisition is generally more effective than forming a new financial establishment and the advantages are numerous. For example, the cost to the multinational banks is lower than opening a new establishment. Addition benefits are also derived from the location of the existing bank, easy adjustment to the cultural identity of the host country, existing customer relations and social networks, and business transactions in the domestic currency. These factors can enhance the market share of the multinational bank and strengthen its overall competitiveness in the hosv country. Good examples are such financial institutions as the Standard Chartered Bank (HK.) and Citigroup. The latter was formed through a merger between Citibank and Travelers Group in the US in 1998.

In 1999, Standard Chartered Bank invested $310 million to purchase 75 per cent of Nakornthorn Bank of Thailand which boasted a total asset of $1.6 billion spread over 67 branches. In 2002, it invested another $1.34 billion to purchase Grindlays of Pakistan. Through equity acquisitions, Standard Chartered Bank rapidly increased its market shares in various countries such as Thailand, India, Pakistan, Sri Lanka and United Arab Emirates. In 2002, it paid out $1.32 billion to acquire the retail banking business of the Bank of Chase Manhattan in Hong Kong. The bank is thus able to raise its market share in the credit card business in Hong Kong from 15 to 25 per cent, making it the biggest credit card operator in the city (程继明  / Cheng J urn ing, 2004).

Similarly, Citigroup's global acquisitions confirm the strategy of expansion through equity acquisitions and it is now one of the foremost financial groups in the world. It has continued to acquire equity shares, especially in emerging markets. In 2000, it invested $12.5 billion to acquire Banamex, which was the second biggest bank in Mexico. Banamex earned a profit of $930 million and Citigroup's reached $960 million in the same year. The year 2000 also saw Citigroup gaining a 15 per cent stake in Fobon, a famous financial holding group in Taiwan, for a sum $750 million, and instantly gained access to Fobon's business in insurance, securities, banking and investment. In 2001, Citigroup's acquisition of Handlowy Bank in Poland at a cost of $1.2 billion allowed it to expand its market share rapidly from 1 per cent to 11-12 per cent. In South Korea, despite being the largest foreign bank in the last 30 years or more, Citigroup had only two branches dealing with leasing and security respectively. In early 2004, Citigroup became the fifth largest bank by taking over Hanil Bank, the sixth biggest bank in South Korea. In Saudi Arabia, Citigroup owns 30 per cent of Saudi American Bank, reputed to be the best bank in Saudi Arabia. It also holds a fifth of the shares of Nikko Cordial, the third biggest security company in the country (袁方 /  Yuan Fang, 2003). Many countries place restrictions on equity acquisitions by multinational banks, either to forbid them from holding shares of local banks or to limit the proportion of shares that may be held. For example, during the 1980s, Canada placed a ceiling on the foreign ownership of local banks to 25 per cent. In 1988, this rule was relaxed when the proportion was raised to 49 per cent (张东祥 / Zhang Dongxiang, 1990).

In other countries the business of the bank is restricted if the proportion of foreign funds exceeds a certain limit. In the case of Peru, banks with less than a fifth of their shares held by foreign interests are regarded as domestic corporations. In Venezuela, banks with foreign interests holding more than a fifth of the shares could accept deposits not exceeding six times the sum of its capital and reserves, compared with 20 times for local banks. Similar regulations also apply in China, in which foreign ownership of the shares of domestic banks is restricted to one-fifth of the total. If this proportion is more than 25 per cent, the bank would be regarded as a Sino-foreign joint-venture bank (中国银行监督管理委员会规则 / China Banking Regulatory Commission, 2003).

Acquiring Local Banks as an Option in China

In China, a branch of the Nanyang Commercial Bank was the first foreign bank to become an operational entity in Shenzhen in 1981. Since then, in the 24 years of opening of the banking sector in China, 61 foreign financial institutions from 19 countries and territories have established 192 operational institutions, and 155 foreign banks from 40 countries and territories have established 209 representative offices. In 13 cities, 88 foreign banks are permitted to conduct business in RMB. The total assets of foreign banks in China amount to $49.5 billion and the number and quantity of foreign bank assets continue to increase (丁剑平等 / Ding Jianping etal., 2004).

However, foreign banks still account for a small share of the Chinese market, and this share has declined in the last two years, from 2 per cent in 2001 to 1.4 per cent in April 2004. The proportion of all deposits of foreign exchange also declined from 15 per cent in 2001 to 13 per cent in April 2004, and was as low as 7.4 per cent at one time. The number of foreign banks has remained stagnant at about 192 during this period (丁剑平等 / Ding Jianping eta/., 2004). This could be linked to the manner of entry of multinational banks into China. These banks had hitherto opted to open new financial establishments as the chief means of expansion in China. This had seemingly not given rise to the expansion that foreign banks had wished for. Foreign banks face serious constraints in building up the institutional structure, establishing a customer network, and obtaining approval to conduct business in RMB. All these have hampered their scale of business. Some foreign banks from Europe, US and Japan eventually chose to withdraw after suffering losses for years. One source stated that four European banks, namely, Societe Generale, Dresden, Holland Business and BNP Paribas, withdrew from Shenzhen. The number of Japanese banks in Shanghai also declined from 12 to four and more than ten foreign banks in Beijing also terminated their operation (刘和平 / Liu Heping, 2004).

The biggest constraint on foreign bank operation in China is the limitation placed on location. Four state-owned commercial banks dominate the Chinese banking scene and are the main competitors of foreign banks. Together, they control up to 20,000-30.000 operational institutions and dominate 60 per cent of the market. They have a huge workforce of 200,000 to 500,000 persons. It would take foreign banks 100 years or more to open an equal number of branches even if they have the capacity or the will to do so (程继明 / Cheng Juming, 2004).

Another disadvantage faced by foreign banks is the relations with local clients. The main clients of foreign banks are drawn from foreign companies operating in China and the expatriate community and their business is largely confined to wholesale transactions. Differences in culture and in the settlement system or dealing in RMB, foreign banks face an uphill task in attracting local customers.

Yet another disadvantage faced by foreign banks is related to the availability of RMB. Although 100 foreign banks have been given approval to transact in RMB by July 2004, the size of deposits and loans denominated in RMB of foreign banks is minuscule, accounting for less than 1 per cent of the total amount in RMB (丁剑平等 / Ding Jianping et a/., 2004). Consequently, the shortage of RMB hampers attempts by foreign banks to widen their network of Chinese clients and to enhance their market share. In addition, certain restrictions on the type of transactions are still imposed on foreign banks, such as sole rights in the issue of credit cards.

Foreign banks with ambitious business plans would take into account all these considerations. Although some problems may be transitory, others may be more persistent, as in the case of choice of location. In view of the enormous size and market potential of China, an effective way for foreign banks to gain entry into priority locations would be through holding or controlling the shares of domestic banks on the basis of co-operation. This would allow foreign banks to co-operate with Chinese banks in the transfer of technology, business mode and integration of products among others.

Certain foreign-funded financial institutions including Hong Kong and Shanghai Banking Corporation (HSBC ) and Citigroup are indeed making an effort to co-operate with Chinese banks and have had some early successes. Ever since International Finance Corporation (IFC) held 5 per cent of Bank of Shanghai in 1995 and Asian Development Bank held 3 per cent of China Everbright Bank in 1996, more than ten foreign-funded financial institutions now hold shares of various domestic banks (Table 14.1).


Characteristics of Foreign Banks

From Table 14.1, some characteristics of foreign banks holding shares in Chinese banks may be identified.

There are basically two types of foreign financial institutions that hold shares of Chinese banks: one is the international or regional financial institutions such as IFC and Asian Development Bank for which shares are held as investment; the other is the multinational banks such as HSBC and Citigroup which buy into local banks in order to expand their business in China.

IFC currently holds shares of China Minsheng Banking Corp, Bank of Shanghai, Nanjing City Commercial Bank, Xi'an City Commercial Bank and Industrial Bank. It is reportedly planning to increase its stakes in Xian City Commercial Bank to 12.5 per cent and to purchase equities of other financial institutions including commercial banks, securities companies, insurance companies and reinsurance companies.

HSBC Holdings both directly and indirectly hold substantial stakes in the shares of six Chinese financial institutions including Bank of Communications, Bank of Shanghai, Asian Bank of Fujian, Ping An Insurance Company, Minsheng Insurance, Industrial Bank (through Hengsheng Bank which controls 62.14 per cent of Industrial Bank). HSBC continues to explore opportunities to acquire shares of other banks and related businesses, as are many other foreign banks such as Citigroup, JP Morgan Chase Hengsheng, Standard Chartered Bank and Scotiabank. Standard Chartered Bank is eyeing the shares of China Everbright Bank after it lost out to HSBC Holdings in the tussle to gain entry into the Bank of Communications.

Chinese banks which foreign banks have bought into are generally small or medium in size including Bank of Communications. This is related to China's policy on foreign banks operating in the country. In 2002, the Bank of China publicly encouraged foreign banks to acquire shares of small and medium-size commercial banks as strategic investors in order to strengthen these banks. Interested foreign banks will preferably target those banks whose shares are dispersed and have a desire to welcome an injection of foreign funds. Foreign banks will have relatively easy access to equity ownership of local banks and at the same time lower their overhead cost in embarking on the banking business in China. Moreover, foreign banks may increase their shares of equity in the future, even to the extent of gaining control of the local banks.

The China Banking Regulatory Commission announced in 2004 that it would allow some well-managed city commercial banks to operate in different regions of China. This is encouraging news to commercial banks especially those based in Shanghai, Beijing, Zhengjiang, Nanjing, Shenzhen and Jinan, and to foreign banks that plan to purchase shares of Chinese banks. Foreign banks are also keen to buy into listed banks in the stock exchange and nationwide joint-stock commercial banks. Compared with other banks, these banks have relatively reasonable structure of equity, sound operation, quasi-nationalized institutions and business licenses. For example, the Bank of Communications has a network of 2,700 offices including 86 branches throughout China. Minsheng Banking Corporation too has over 200 offices including 16 branches in China. When HSBC acquires some shares of the Bank of Communications, it indirectly gains access to the vast network of institutional sites.

Foreign banks commonly hold minority shares in local banks. Prior to 2003, foreign-funded financial institutions were permitted to hold a maximum of 15 per cent of the shares of local bank and, at the end of the year, the figure was raised to 20 per cent. Official regulations stipulate that if the proportion held by foreign banks is below 25 per cent, the property and business scope of the Chinese financial institutions remain unchanged. Beyond this limit, the local financial institution would be viewed as a Sino-foreign joint-venture and would cease to enjoy the treatment accorded to Chinese financial institutions (except for those to which specific exemptions have been granted by the State Council). For the duration of the "transitional period", foreign banks are governed by regulations that are different from those imposed on local banks. This separation of identity is deemed to be mutually beneficial to local and foreign banks.

Foreign participation in local banks has shown positive effects. In the first place, foreign banks have been able to broaden the scope of their business in China. For example, Citigroup and Shanghai Pudong Development Bank have jointly issued credit cards denominated in domestic and foreign currencies, and so have HSBC and the Bank of Shanghai. The credit card is the core retailing business of Citigroup and made possible through its shares in the Shanghai Pudong Development Bank. Holding common shares allows foreign banks to co-operate in the borrowing and lending of RMB. This will also lead to an increase in market share of foreign banks. By holding shares in the Bank of Communications, HSBC is able to stake a claim in the expanding banking market in China. The total assets of the banking industry in China was RMB27.64 trillion at the end of 2003 and the current assets of the Bank of Communications are RMB1 trillion or 3.62 per cent of the national total.

By virtue of its 19.9 per cent stake in the bank, HSBC will have an indirect 0.72 per cent share of the China market out of the aggregate foreign share of 2.1 per cent.

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Prospects for Foreign Banks

With the implementation of regulations governing equity investment in Chinese financial institutions by foreign banks, the end of the transitional period and the restructuring of joint-stock domestic banks, including the four stated-owned commercial banks, it is likely that foreign share holdings of Chinese banks will increase considerably. Many more local banks ranging from the small to the major state-owned giants will become the object of equity investment by foreign banks. Under the current trend of mergers and acquisitions in international banking involving major banks, leading multinational banks are likely to focus their interests on the four state-owned banks by virtual of the latter's advantages in terms of brand, size, distribution, reserves of RMB and their dominance in the domestic banking industry. Foreign banks are in a race to seek equity co-operation with the state-owned banks to stake a claim in the vast Chinese market. That foreign banks will work towards holding higher shares of equity ownership of Chinese banks is a foregone conclusion. It is even likely that foreign banks might seek a controlling stake if allowed to do so. After the Asian financial crisis, some Southeastern Asian countries were forced to relax their rules by allowing foreign funds to hold 50 per cent of local banks (向文华 / Xiang Wen Hua, 2004).

It is envisaged that only a handful of major foreign banks would succeed in winning a large market share in China in the future (程继明 / Cheng Juming, 2004). Such banking giants as HSBC, Citigroup and Standard Chartered Bank have paid particular attention to the Chinese market and they may probably emerge as likely winners in the future. In addition to holding shares in six Chinese financial institutions, HSBC Holding has opened 20 more branches in China. In 2003, it recorded a net profit of HK$230 million from its Chinese operations.

The market share of foreign banks is likely to increase through the use of holding and controlling shares in Chinese banks. Estimates by professional banking circles foresee that the proportion of market shares occupied by foreign banks will increase to about 10 per cent in aggregate ten years after China becomes a member of WTO (连和 / Lian He, 2002). Other estimates even place the figure at 30 per cent 10-15 years after China's entry into the WTO (潘园 / Pan Yuan, 2001). This proportion is basically within the range allowed by the government.

The market share of foreign banks exceeds 20 per cent in Australia, Argentine, Malaysia and above 10 per cent in Japan, South Korea, Indonesia, Thailand and Taiwan. Based on the experience in other countries, it is probably safe to say that the economic and financial safety of China would be sufficiently safeguarded if 10-20 per cent of the market share of the banking sector is under foreign ownership.

Conclusion

Equity investment has become a new strategy to expand the market share of foreign banks in China. This strategy will bring opportunities and challenges to local banks. Local banks stand to benefit from equity co-operation with foreign banks in terms of improving their corporate governance and management. At the same time, such co-operation would intensify fierce competition in the banking industry in China as foreign banks endeavour to take full advantage of the many benefits from equity investment.

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