China’s emerging rich drive new private banking industry

Euromoney, April 2008

They are China’s emerging rich: hundreds of thousands of entrepreneurs, making money hand over fist in the world’s most vibrant economy. They want that money to work hard for them. And they are the target market for a whole new domestic industry: private banking.

Offshore banks have long targeted China’s ultra-wealthy through desks in Hong Kong, Singapore and Zurich, but the arrival of specialist private banking or wealth management divisions in China’s own domestic banks is a newer trend. Now most of the bigger home-grown banks have built businesses in this area, and they expect it to be one of the biggest drivers of growth in coming years.

Just how big is the wealth management opportunity in China? One of the most useful sources of data on this is a report published in October by the Boston Consulting Group. It estimates that households own around US$2.5 trillion in China, making it the largest market in ex-Japan Asia; if one considers Greater China collectively, including Hong Kong and Taiwan, it accounts for 45% of wealth in the region ex-Japan. BCG says Chinese wealth grew by a 23.4% compound annual growth rate between 2001 and 2006 – the fastest rate in the world – and at 31.6% in the year running up to the report’s publication, despite the fact that Chinese households have historically put a large proportion of their wealth into cash.

Everything suggests that pace should continue. There’s China’s extraordinary economic growth (11.4% in GDP terms in 2007), a liberalising market and strong asset returns, although recent drops in the stock market have at least temporarily dented the trend. BCG projects an annual rate of asset growth among Chinese households of 17.4% annually over the next few years, with assets under management projected to reach US$5.5 trillion – more than double today’s level – by 2011.

This, though, just tells us about the broader accumulation of wealth in China. What about the rich? Well, BCG estimates that by the end of 2006 there were 310,000 dollar millionaires in China – a 20% compound annual growth rate over the previous five years – meaning that already, China ranks fifth worldwide in the number of millionaires in the country. By 2011, it estimates the figures should have hit 609,000. Once people get wealthy, it seems they build fast: since 2001, households with greater than US$5 million in assets have grown their share of national wealth from 13.3% to 20.1%.

That’s the opportunity. “With economic growth, clients in China will have more and more demand for wealth management products and other private banking services,” says Lynn Zhang, general manager of private banking at China Citic Bank. “Chinese people accept new concepts very quickly. Although Chinese private banking has lagged behind western countries for about 20 years, the speed they are catching up is very quick.”

Citic is one of many institutions to have put into practice a plan to grab a piece of this new market. It set up its own private banking arm last August. It has what it calls a private banking sub-centre in Beijing, and plans to open new centres in the northeast and south of China this year. Other cities are served by dedicated relationship managers.

There’s a similar story at China Merchants Bank, which is setting up a private banking department within its head office, and has built private banking centres in Beijing, Shanghai, Shenzhen and Guangzhou, with relationship managers in each of them to serve customers. “The needs for banking services have changed a lot in China,” says Wang Jing, deputy general manager of the private banking department. “Before, it meant only settlement. Now they need more consultants for wealth management. That’s the trend now.”

Bank of China, working with its major shareholder the Royal Bank of Scotland, set up a business unit management structure for private banking this year, and has built a dedicated product team within it. It is already active in Shanghai and Beijing but this year should roll out outlets in a further eight coastal cities. Industrial and Commercial Bank of China (ICBC) has been targeting the wealthy for several years, and has over 5000 client managers in wealth management, including more than 500 planners with CPA certificates. China Construction Bank had 772 wealth management outlets nationwide by the end of the first half of its 2007 financial year.

The entry level tends to vary from place to place. At Citic it’s RMB8 million in assets, and at China Merchants, RMB10 million. At Bank of China, it’s US$1 million, though as Wang Yan in the private banking team there says, “it is not a very strict standard, we will consider the details of the client.” ICBC classifies two groups: those with over RMB 1 million (eligible for wealth management services) and over RMB 10 billion (private banking).

The trend is towards increasing the entry level, or differentiating a product for the more high net worth individuals. Here, the experience of Bank of Communications is illustrative. Two and a half years ago it started a new service for what Dicky Yip, the bank’s vice president, calls “our up-market customers”, for clients with RMB500,000 and more. After two years, and 300,000 clients, it became clear that most of the customers had at least four times that amount of assets, “so we were actually doing some sort of private banking service before we called it private banking.”

So at the end of 2007 a more targeted private banking service was launched, through a pilot programme in five cities, combining both the onshore service offered on the mainland with the offshore business based in Hong Kong. “Up to a couple of months ago we were focusing on our onshore business, and mainly their wealth inside China,” he explains. “But a lot of our customers already have money and assets outside of China. The idea is to provide Chinese customers with the opportunity to invest outside of China and make use of discretionary investment services.” The service aims to attract clients with a minimum of US$2 million in assets outside of China, and ties up with international managers such as HSBC Asset Management for international expertise.

This raises a key theme: onshore versus offshore. Chinese banks are not just up against one another when it comes to the provision of private banking services, but the allure of offshore private banking from foreign multinationals. Wang Ming at China Merchants says about 50% of her clients have both onshore and offshore accounts. “Maybe they choose the offshore accounts for tax and privacy and secrecy reasons,” she says. “But the Chinese economy and currency are moving upwards; clients have business in China and the majority of their income comes from China. So they choose domestic banks for onshore services.”

This is how the battle lines are typically drawn: offshore might offer expertise in international markets but that’s not really where the growth is these days. “I know a lot of people have offshore private banking accounts, in Hong Kong, Singapore or Switzerland, but they also want to share the benefits of the booming Chinese economy,” says Zhang. “In the last two years a lot of people have transferred their money back to China, to the stock market or real estate market here.”

Yue Yi, global head of private banking for Bank of China, adds: “It is true that some Chinese private banking customers have already received services and used products from foreign institutions offshore. This is quite normal. But this group of people are living and working in China, and the majority of their assets are based in China, so they must need services and products provided by Chinese banks.”

Chinese institutions have a few advantages to bring to bear here, he says. “China’s banks have a time-honoured relationship with their customers, and in this regard we are better than foreign providers,” he says. “Chinese people are improving in corporate governance, narrowing the gap with foreign competitors and increasing our competitiveness. We will catch up with international private banking providers and provide premium services to our customers.”

This makes Bank of Communications’ approach, linking an onshore and offshore offering into a single service, interesting. “Clients can link the onshore and offshore together rather than using offshore banks and service providers who don’t know their background.” It’s trying to bring control over local wealth back home, even if it’s actually being invested overseas. “We are training our account managers, when they do asset allocation or account planning, to inquire about customer intentions and wealth outside China. If you don’t ask them, you may not know.”

At the same time, foreign banks are also trying to go onshore in China. The local incorporation of a number of foreigners, starting with HSBC, Standard Chartered, Citibank and Bank of East Asia, is just one example of the increased penetration of foreign names to the local market.  “That’s the big push for foreign banks, especially those who’ve already developed an offshore model,” says Tang. “A number of foreign banks have set up offshore, opening offices in Shanghai and Beijing, targeting the 10 million-plus (US$) segment. The product set you can offer today is relatively limited, but there’s a recognition you have to be onshore: there are assets to bank, a brand to build, relationships to develop.”

Foreign and local banks alike face a major problem with finding human resources. “It’s definitely very hard to find the right people,” says Zhang at Citic. “Private banking in China is quite new, like a child that was born last year. Training is the most important thing for me and my management team.” Getting around it, in her case, has involved hiring good people, and building up a training system, using overseas trainers with international experience. “That’s what I insist on, because I think in domestic China there are no qualified trainers now.”

Yip at Bank of Communications calls human resources “a real challenge,” and it is reflected in the bank’s gradual approach to expansion with its pilot scheme, which firstly helps the bank to learn about the area but also alleviates the pressure on new hires. It is looking at hiring “half a dozen people in Hong Kong and a dozen in China” to be allocated to its pilot private banking centres to work with account managers. “Yes it is a big challenge but if you do it gradually, hiring a dozen people rather than hundreds, that gives us the time to train our people and engage new recruits to merge with our own business culture.” Others use collaboration to help with the hiring process: Bank of China has an agreement with Singapore’s Temasek to provide training, and the presence of Royal Bank of Scotland also helps.

Wang Jing at China Merchants adds: “Honestly speaking, there is not much choice for us, for investment experts, relationship managers or even product managers,” in terms of the available pool of talent. There is a bright side, though: “At least the foreign banks with private banking services on the mainland face the same problem. We select the right people from our existing staff and try our best to train them.”

Having found customers and the staff to advise them, the next challenge is in deciding what to tell them to do. The behaviour of the wealthy is different in China to elsewhere. For a start, the source of that wealth tends to be a lot newer. Whereas western millionaires have often inherited fortunes that may go back centuries, that’s not the case in China; being wealthy in the Cultural Revolution was a very dangerous way to be. Instead, most of the wealthy in China today have become so during the last 20 years; BCG estimates that 90% of high net worth individuals in China are entrepreneurs, most of them first generation.

This tends to be reflected in asset allocation. BCG reports that many of this group tend to take a bi-polar approach to asset allocation: they hold significant levels of cash, for security, but are also highly speculative with a high tolerance for risk, reflecting their entrepreneurial backgrounds. Some, for example, will purchase high volumes of FX derivatives. Other characteristics are that they want to be in charge and involved in their investments; prefer investments in physical assets such as real estate or businesses; they want privacy; they use many different private banks; and are still somewhat suspicious about entrusting the management of their wealth to a third party.

Attitudes to allocation “depend on the different educational background, or their working experience,” says Zhang. “Most of them know they should allocate their assets to different categories, currencies and risk classes, but some need to be educated. That’s the real situation in China.” Most banks undertake this education both through one-on-ones with clients and through seminars around the country.

Zhang describes some interesting services beyond the transactional. Immigration services is one example, and another is targeted at second generation wealthy: the bank has organised summer camps to Switzerland for children of the wealthy to attend, “to help them know what wealth management is, what private banking is, what services we can provide. A lot of our clients are very interested.”

The Qualified Domestic Institutional Investor (QDII) programme, which allows some Chinese banks to offer international investment products, has had some impact here, in that it increases the range of products banks can offer to their clients. It’s not, though, the only way of achieving international exposure; anyone with an offshore private wealth advisor has been exposed to a greater range of much more sophisticated international equity products for years, and local banks can also offer structured products to give synthetic exposure to international indices. “QDII gave us an opportunity to invest globally, but clients are not familiar with global markets,” says Wang Jing. “Even our existing investment experts are not very familiar with global markets.”

Besides, international stock markets haven’t done much for investors anywhere in recent months. “Chinese investors are quite nervous to invest in offshore QDII products, as the products were launched at a time [of] high volatility in the global financial market,” says Rex Chan of China Hedge, a mainland research platform. “Most products now have an NAV of around RMB 0.7 to 0.8,” having started at 1. He instead sees more interest in Chinese local equities, mutual funds, futures, real estate and even oil paintings, reflecting the strengthening of the Chinese currency. Also, “most HNWIs are also aggressive to do private equity investments, as their circle is known among each other, so they can invest in their friends’ projects by referral instead of doing strict due diligence.”

Generally speaking, there is considered to be a shortage of product for onshore private banking clients. “Today’s offerings are still characterised typically as more ‘hardware’ than ‘software’,” says BCG. “Chinese banks have established luxurious wealth management centres across the major cities in China and launched new customer offerings based on the overall value of their local relationships. However, these superior facilities are not complemented by tailored products, service levels and advisory expertise that are common in international markets.”

The formation of domestic private banking services has been made tricky by a regulatory environment which has always insisted on a strict separation between commercial and investment banking, funds management and other areas of financial services. Private banks really need to draw on all these resources, so the fact that these restrictions appear to be easing is being welcomed by Chinese institutions. “The regulator will be more and more accepting of new concepts,” says Zhang. “For example there is a department in CBRC [China Banking Regulatory Commission] called the financial innovation department. The regulator is realising financial innovation is very important to the public.” Yue at Bank of China adds:  “In private banking, our government is very proactive in encouraging institutions to be innovative. Regulation is open and practical.”

That’s a more positive appraisal than those who look at the environment from the outside, but even among that group there is a sense that the regulator is trying to help move things forward. “Regulations are quite restrictive,” says Tang. “But they are trying to allow more and more product to become available in the market. It’s a learning process, but they’re open to understanding what these products are and how to regulate and manage them. I would expect in the coming few years the regulatory environment to loosen.”

Getting private banking right is a huge opportunity but it’s also fraught with challenges, many of them new: building the right brand for the rich, dealing with the client correctly. “One certain way to lose money in private banking,” says Tang, “is to go from a business model where a relationship manager might manage 1000 clients, to 25 clients but without generating the revenues to justify it.” But that’s not going to stop Chinese banks pouring more and more resources into this most lucrative part of the market. Says Yue: “It will be a top priority.”