The comments made last Thursday by Chinese premier Wen Jiabao about the monopolistic nature of lending in the mainland points to significant changes that are afoot in China's financial services, and the many more significant changes that are to be anticipated.
Last week's brief-but-meaningful comments alluded to an issue that has gained much traction of late: that Chinese borrowers, especially small and mid-sized companies, have no choice but to deal with the large-bank "monopoly"- primarily the Big Four state-owned banks. The premier's "monopoly" statement also brought to the surface the issue of "super-profits"- that guaranteed interest margins in an era of hyper-lending have created record profits that seem out of touch with China's slowing economy.
(We point out however that "super-profits" is a term that we at IDC Financial Insights have discussed to some extent in previous reports, even as the trend has until now been largely brushed aside within Chinese banking.)
What then can we expect from different types of players in China's banking sector, especially in light of the premier's comments?
First, the Big Four. In the long term, the Big Four will have to pay attention to the non-lending parts of their business, if only to show that their super-profits do not necessarily come because of the guaranteed lending margins. To be fair, these banks have recently scaled up their non-interest-based activities, especially in two main areas: yuan settlement services and bancassurance. We expect the Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Agricultural Bank of China (ABC) and Bank of China (BOC), to further intensify efforts in these two areas. Fifth-ranked Bank of Communications, perennially receiving special mention because it can be lumped together with the Big Four, will also push for further diversification of its business. The bank is acquiring a two-third stake in Shanghai Securities, which not only sets a precedent of a domestic commercial bank owning a local brokerage, but also sets the course for more involvement by the Big Four in the mainland's equities market.
Mid-sized and small-tier players will prepare to scale up their lending business, especially if loan targets for these city-based banks will be increased and regulations related to their lending activities are relaxed. We expect new lending in China to grow by about 8% this year - a rate that is seen to balance concerns of overheating on one end, and on the other, ensuring continued growth despite weak global conditions. Ordinarily, a huge part of lending growth would be expected out of the largest banks. Moving forward, the small-tiers would have to carry more than their fair share.
China's bank regulators are seen to relax new capital adequacy requirements as well as postpone implementation of more stringent capital and liquidity guidelines to reduce pressure on bank balance sheets - good news especially for the mid- and small-tier banking segments. This will also ease pressure for banks in these groups to merge or go for public offerings.
Foreign banks will have to step up their game, and finally play a more significant role in Chinese banking. To this end, Wen has been recently quoted to have stated that China would further open up its financial sector to the outside world. This rhetoric is matched by recent moves by Chinese regulators, which include more local banking licenses issued, liberalization of branch network expansion, and last month's moves to raise the quota for stock investments by qualified foreign institutional investors (QFII).
We note that foreign participation in China's banking sector is still weak - with foreign institutions accounting for just about 1% of total assets in the system. In recent years, foreign banks, particularly Western players have been seen to waver on their commitments to the newly opened Chinese banking market - examples here include Bank of America's gradual reduction of its stakes in China Construction Bank (CCB) and complete divestments by Goldman Sachs (in Industrial and Commercial Bank of China [ICBC]) and UBS (in Bank of China). The China Banking Regulatory Commission recently reported that Shanghai's foreign banks (accounting for 83% of total foreign assets in the mainland) slashed revenue growths on the back of lower loan growth projections. In an earlier report (see Business Strategy: Mergers, Acquisitions, and Consolidation in Asia/Pacific Banking - Where Are the Hot Spots? IDC Financial Insights #FIN231313, November 2011), we commented that contributing to these reduced targets is the rule mandating that all banks in the mainland meet loan-to-deposit ratios of 75%. This has put further urgency on deposit-taking activities that most of the 40 locally incorporated foreign banks already struggle with. Naturally, foreign banks reacted by slashing loan targets instead).
However, without a lot of home market distractions, it is the segment of banks that originated from the Asia/Pacific region (OCBC, DBS, UOB, ANZ Bank, Commonwealth Bank of Australia and the Taiwanese banks) that seems to have become more aggressive in the mainland. The group in general is seen to open up more branches - and more quickly, and pursue local business more intensely.
Finally, the technology investments implications. We do not expect changes to the relative priorities given to specific technology functional areas - in a high-growth market like China, all areas received their fair share of attention from banks anyway. We believe this to be true, except for the increasing profile of technology investments in credit risk management systems, especially within the mid-tier banking segment. These include spending on a wide variety of solutions for credit origination, credit scoring, document and credit line management, policy decisioning, portfolio, and counterparty risk management. These modern risk management systems will add powerful capabilities to the core systems being run in the second tier of banks. Hopefully, these modern core-plus-modern risk systems will allow these banks to compete more favorably against the Big Four players - and report more impressive profitability levels in the process.