Foreign lenders bank on reforms for growth

China is accelerating reforms that will affect foreign banks operating in the country, even as the world's second-biggest economy slows.

Foreign banks that now account for less than 2 percent of total banking assets in China have been active in the past year - hustling to enter Shanghai's new free trade zone, selling stakes in domestic lenders and launching mutual funds businesses.

"Much of their expansion will depend on China's financial reforms, but the general rebalancing of the economy will allow them to grow," said Ernst & Young in its latest report on foreign banks in China's mainland.

There are currently 42 locally incorporated foreign banks, 95 branches and several hundred representative offices of foreign lenders on the mainland.

The asset expansion of foreign banks slowed to 10.7 percent in 2012 from 24 percent in 2011, and was expected to have weakened further last year. An Ernst & Young survey of 33 banks found only 13 predicting asset growth above 10 percent in 2013.

Many foreign banks are looking to Shanghai pilot free trade zone for their salvation. The zone was created by the State Council, China's cabinet, as a testing ground for financial deregulation.

"Overseas banks have been keen to pin their flags in the FTZ as they seek business opportunities from financial reforms like interest rate liberalization and yuan internationalization," Geoffrey Choi, assurance leader of financial services at Ernst & Young for China, said last week.

"Foreign banks are confident about their competitive advantages in a free and open market," he said. "The FTZ will allow them to introduce new services and expand more rapidly in China."

Bank of East Asia, the third-biggest lender in Hong Kong, and DBS Bank, the biggest lender in Southeast Asia, were the first among overseas institutions to open sub-branches in the FTZ. Citi, HSBC, Hang Seng Bank, Deutsche Bank, United Overseas Bank and Australia & New Zealand Bank said in earlier statements that they have received regulatory approval to set up outlets in the zone.

According to Ernst & Young, 10 of 22 banks surveyed said that the FTZ in Shanghai will allow them do new businesses and to achieve fast growth.

"Further clarification is needed to fully understand the benefits of establishing a presence in the zone," Choi said. "Foreign banks are waiting for the People's Bank of China and the China Banking Regulatory Commission to make announcements about the new businesses they can do, as well as other preferential policies."

Although foreign banks have always stressed their strong commitment to the China market, a few of them sold off shareholdings in Chinese banks last year.

Goldman Sachs sold its remaining shares in Industrial and Commercial Bank of China for about US$1.1 billion last May, completing its exit from China's biggest lender after six stock sales since 2009. In September, Bank of America sold the last of its stake in China Construction Bank for US$1.5 billion, ending an eight-year investment in the country's second-biggest lender.

Spain's second-biggest bank, Banco Bilbao Vizcaya Argentaria, sold a 5.1 percent holding in China Citic Bank for US$1.3 billion, keeping a 9.9 percent stake.

HSBC sold its 8 percent stake in Bank of Shanghai last month following the US$7.4 billion stock sale in Ping An Insurance Group. The biggest European bank still owns a 19 percent stake in China's fifth-biggest lender, Bank of Communications.

Smaller lenders

Although the foreigners sold their positions in big Chinese banks, they have tended to hold on to their investments in smaller lenders, Ernst & Young said in its report.

"Over the last decade, foreign banks have taken up to 20 percent shareholding in more than 20 mid-sized domestic banks, which they continue to hold," the report said. "There is no evidence at present that the 20 percent cap will be lifted. However, some participants believe this might happen if the economic rebalancing causes some instability in the banking sector."

The report also noted that some banks have deliberate strategies to expand across the financial spectrum through broadened involvement in asset management, securities and trust companies.

By last October 10 overseas banks have received the green light from the China Securities Regulatory Commission to sell mutual funds on the mainland. They were Bank of East Asia, Citi, DBS Bank, Hang Seng Bank, HSBC, JPMorgan, Nanyang Commercial Bank, OCBC Bank, Standard Chartered Bank and United Overseas Bank.

Prior to the receipt of mutual fund distribution licenses, foreign banks had restricted access to the retail fund market in China.

They were allowed only to sell Qualified Domestic Institutional Investor funds to Chinese institutional clients investing in offshore securities and bond markets.

Foreign bankers would like to see a further overhaul of regulations, including the foreign debt quota that limits the money they can bring into the country, the loan-to-deposit ratio that restricts their asset expansion, and the foreign guarantee quota.

They also are clamoring for access to China's bond market, now the world's fourth biggest.

Apart from regulatory challenges, the foreigners also face operational issues such as the rising cost of attracting and retaining professional talent.