Institutional Investor: China’s banks look to the world – on their terms

Institutional Investor, November 2009

One of the quirks of the Chinese banking industry is that, while the biggest banks in the world are now Chinese, they have achieved this apparent world dominance without really leaving home. The world’s three largest banks by market capitalisation are Industrial & Commercial Bank of China (ICBC), China Construction Bank and Bank of China – all of which are chiefly domestic enterprises. Even ICBC, among the most internationally intrepid of Chinese banks, generated less than 2% of operating income from outside China in its most recent full financial year.

But, with cash behind them, Chinese banks have the opportunity to expand and become more global players if they want to. And, in a limited sense, there are signs of international expansion.

ICBC is the bank that has made the most eye-catching acquisitions. In September it bought a 19.62% stake in ACL Bank, a Thai institution, from Bangkok Bank, and will make a tender offer for the remaining shares. This follows the 2008 purchase of 20% of the shares in Standard Bank of South Africa, making it the largest single shareholder.

These transactions tell us a lot about the way further acquisitions are likely to take place. Most obviously, they both involve institutions in emerging markets rather than the developed world. It makes a lot of sense for a bank like ICBC to seek a foothold in Africa, because many of China’s bigger companies – and in particular its energy giants Petrochina (and its unlisted parent CNPC), Sinopec and CNOOC – are expanding rapidly in the continent a bid to secure energy reserves. By the end of March 2009, the two banks had carried out 65 collaborative programs and completed nine, among them a co-lead financing for China Oilfield Services to purchase Awilco. Another example: the two banks were appointed by the government of Botswana to arrange a syndicated loan and take charge of export buyers’ credit for a coal power plant in which China Electrical Equipment Corporation is the general contractor for the power generation segment.

A deal like this makes a lot of sense to analysts. “It has multiple purposes,” says Victor Wang, an analyst at UBS. “One, it is in line with large banks’ intentions to gain expertise in more business areas. China will open up more and will need more sophisticated financial products to support economic growth. It makes sense for them to learn through an acquired organization. Secondly, it is virtually impossible for them to outgrow their peers in the domestic market, so they can leverage their healthy balance sheet and expand selectively overseas.”

The appeal of Thailand is less obvious, but reflects a likely strategy to engage in Asian markets rather than the west. “ICBC has always attached great importance to the Thai market,” said Dr Jiang Jiangqing, ICBC chairman, in a statement announcing the purchase on September 29. “This transaction will be of great significance to ICBC in the expansion of its business and network in the Mekong River region and also the South East Asia region. ICBC will endeavour to contribute to the development of the Thailand economy and bilateral trade between China and Thailand.”

Hong Kong is also a natural draw, although strictly speaking it is now a special administrative region of China rather than a separate state. In June 2008 China Merchants Bank bought a 53.12% stake in Hong Kong’s Wing Lung Bank for HK$19.3 billon, as part of what CMB chairman Xiao Qin described as “our international expansion strategy”, which “allows CMB to enter a strategically critical and highly sophisticated market”. CMB was founded in Shenzhen, the city on Hong Kong’s border.

Contrast this with the experience of Chinese financial services groups trying to buy assets in the west. In October 2007 Citic Securities announced it would acquire 9.9% of Bear Stearns under a joint venture, the first time any Chinese-controlled entity would take a major stake in a Wall Street investment bank. The deal eventually fell apart in 2008, and it’s just as well: Bear Stearns collapsed later that year. Ping An, the insurance group that hopes to become a major playing in banking and asset management as well, was less lucky, proceeding with a landmark purchase of a stake in the Belgian banking and insurance group Fortis; the write-downs on that purchase almost wiped out a year’s profit.

Consequently it’s easy to see why China prefers the allure of emerging markets: better potential returns, greater familiarity, and apparently less chance of the entire institution being brought down by risky behaviour. “With hindsight, not getting into Bear Stearns was a good thing,” says Nick Lord, analyst at Macquarie Research. “What that tells you, and what Chinese banks learned from that, is that you don’t necessarily buy things because they are cheap, you buy things because there is a strategic reason to buy them. There will be much more of a degree of caution: I don’t know that any Chinese banks have appetite for a big deal at the moment.”

There may, though, be an exception: as this article was being written it was widely believed that China Minsheng Bank, the country’s first privately owned bank, was seeking to raise its stake in UCBH Holdings, a San Francisco bank, from 9.6% to 50% or more and was approaching the regulators for approval. UCBH, while not exactly a distressed asset, needs to bolster its capital base and has already been a recipient of $298 million of Troubled Asset Relief Program (TARP) funding. Minsheng, considered something of a visionary first mover in Chinese banking, is already UCBH’s biggest shareholder and has approval to increase its stake to 20% already. Wan Qingyuan is Minsheng’s appointee on the UCBH board.

Alongside these occasional acquisitions have come some organic growth into other markets. Big Chinese banks typically have offices all over the world: for example, China Construction Bank opened a subsidiary bank in London and a branch in New York in June, bringing its total worldwide to seven branches, two subsidiary banks and one investment bank.

If Hong Kong is considered an overseas market, then the clearest example of organic expansion is Bank of China, which broke off its Hong Kong branch into a separate entity, Bank of China Hong Kong, in 1998; this vehicle is listed in Hong Kong quite separately from the Bank of China parent. A full service commercial bank, it offers retail and corporate services, notably deposits, personal loans, wealth management and mortgage lending; it has over 200 branches in Hong Kong, over 450 ATMs, and is a designated clearing bank for personal transactions in renminbi. It also has a Hong Kong subsidiary, Nanyang Commercial Bank.

Outside of Hong Kong, though, opening a few branches doesn’t make a Chinese bank a full service player. “If you look at the very tight regulatory environment in China, banks have a lot of limitations in terms of the products they can offer their clients,” says Wang. “If you look at international banks most of them are one stop shops providing commercial banking, retail and wholesale services, products like derivatives and rates, brokerage, and asset management. In China the preliminary business is still lending. They are trying to do some wealth management, but they don’t get the full licence to provide insurance or brokerage. As a result, their expertise in operating in very sophisticated financial markets is still very limited.”

Consequently, branches in New York or London are chiefly for corporate wholesale business. Many Chinese companies are Fortune 500-ranked these days, and Chinese banks can help them with their overseas operations. None of the Chinese banks yet have a sufficient network overseas to attract personal banking services in those markets, for example.

Lord at Macquarie says that “syndicated lending is the obvious thing you’ll see them do” as they expand overseas. This is already clear in Hong Kong where Chinese banks participate aggressively. “You’ll also see them build up trade finance capabilities, really focusing on Chinese firms’ outward and inward investment, and over time you’ll see them develop forex capabilities” although in the short term this is obviously impeded by the fact that the RMB is not fully convertible. In time, they may develop derivative structures for clients, and eventually will become more active in advisory, although the focus will be very much on things like Hong Kong listings of Chinese companies. “It’s going to be a long time before you see Chinese banks advising on non-Chinese related deals.”