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China’s economic strength in recent years has led foreign banks to enjoy a continuing growth and success in the market, despite concerns about the Chinese economy, according to a PwC report.
The report, based on interviews with 41 foreign banks in China, showed that foreign banks experienced their most profitable year in China during 2011. Their profit after tax leapt 115% to RMB 16.73 billion in 2011 up from RMB 7.78 billion in 2010. Their total assets increased by 24% to RMB 2.15 trillion at the end of 2011. Market share of the foreign banks increased to 1.93% from 1.83%.
Foreign banks’ growth
The report indicates that strong result arose despite difficulties in their home markets, a subdued outlook for the China and global economy. The 41 banks interviewed in this survey employ more than 35,000 people and expect to increase this by 56% to more than 55,000 by 2015.
Parent banks remain committed to their China operations and have increased again this year. It has now returned to the level reached in 2008.
Asian banks recorded the highest score among all the bank groups. There is no evidence that foreign bank head offices have moderated their interest. Indeed, 26 banks said that the agenda for China has changed positively.
According to the report, the foreign banks envisage continued revenue growth, most expect 20% or greater in 2012 and around three quarters of respondents expect this annual rate to continue through to 2015.
In their pursuit of growth, the banks have four targets namely, financial institutions, multinational corporations (MNCs), State Owned Enterprises (SOEs) and Privately Owned Enterprises (POEs).
Loan caps imposed by regulators and relatively slow branch approvals are limiting the growth options for foreign banks. To overcome these challenges, they are continuing to explore new channels and customer segments by recruiting local, experienced relationship managers to target SOEs and POEs customers. A substantially bigger workforce will help foreign banks achieve this growth, with the 41 banks surveyed predicting they will hire nearly 20,000 new employees by 2015.
The report pointed out that in addition to loan and deposit services, foreign banks can provide further offerings such as trade finance and cash management services. Many of these firms are expanding offshore and are keen to capture a share of the accelerating trade flows across emerging markets such as Asia and South America. Foreign banks are well positioned to assist these firms with established global networks and trading expertise. Access to funding remains a key challenge for foreign banks, with their lending activities heavily dependent on deposits. Foreign banks hope to increase the scale of lending activities by growing their corporate deposit book. By 2015, foreign banks predict both a diminished reliance on their parent company for funding and a greater proportion of corporate deposits to finance their activities.
Another major source of poten- tial income lies in developing financial institution (FI) businesses such as treasury products and bond trading. Foreign bank CEOs ranked regulatory approval to underwrite bonds as the most important driver for future growth. However, access to this market is limited with only a handful of foreign firms receiving approval to issue bonds.
Foreign banks are also focused on keeping pace with the expansion plans of MNCs based in China. Many are shifting their operations away from manufacturing exports towards production, distribution and marketing products for the local market. The Chinese government’s efforts to rebalance the economy towards domestic consumption are driving this realignment as outlined in its 12th five year plan.
Foreign banks will have more opportunities to diversify and differentiate themselves among certain market sectors as they mature. The 12th Five-Year Plan outlines several Strategic Emerging Industries: biotechnology, new energy, high-end manufacturing, energy conservation, and next-generation IT. These industries have been singled out by the government to be the pillars of China’s next-generation, innovation-driven economy. The expertise of foreign banks in developing these industries in other markets may provide them with a distinctive advantage over their local counterparts. But this will require significant focus, planning and commitment of resources to capitalize on this opportunity.
China’s buildup of innovation-focused industries is creating new opportunities for foreign banks. Foreign firms are increasingly acquiring or partnering with local companies seeking to develop new technologies and build R&D capabilities. They are seeking financiers with expertise in these industries and can provide solutions in term of cash management, investment and financing activities.
The ongoing euro zone crisis and subdued state of the US economy continues to speed the pace of RMB internationalization. Pressure on the Euro and Greenback is driving greater use of RMB to settle trade arrangements. This is further bolstered by China signing multiple currency swap agreements with many of its key trade partners in major developed and emerging markets. Foreign banks, particularly those with cross-border trade settlement and cash management capabilities in place stand to benefit in the longer term. As the US and Europe begin to recover, their priority will be on moderate and sustainable growth, with trade and settlements in RMB being more commonplace.
The development of the RMB is also being enhanced by the growth of cross-border RMB trade through Hong Kong. This will create arbitrage opportunities in both interest rate and currency trading activities, particularly among Chinese import and export companies. Offshore RMB debt and investment markets will further develop as trade volumes grow.
Foreign banks are establishing China desks, manned by locally trained relationship managers to capture the trade flows associated with the offshore expansion of Chinese SOEs and POEs.
Although the revenue generated from cross-border activities are yet to be reflected in local books, this will eventually contribute to the success of the foreign banks in China, said the report.
The pace of financial reform has gained pace over the past six months with several major policy announcements. During this time, foreign debt quotas were increased, and interest and exchange rate bands widened.
Furthermore, China’s credit asset securitization pilot program was expanded, QFII scheme entry require- ments relaxed, and equity investment holdings for foreign companies have been loosened. Other programs such as the Wenzhou pilot scheme will allow mainland residents to invest directly overseas and help widen China’s capital account. These continuous financial reforms will provide opportunities for foreign banks to leverage their global networks and risk management expertise to create a competitive advantage. While it cannot be predicted how quickly reforms will continue, the moderate pace of the program so far should provide foreign banks with distinctive windows of opportunity.
Growth opportunities
The report showed that foreign banks continue to identify opportunities across the financial spectrum. The growth and dispersal of wealth means that a group of foreign banks are renewing and developing their presence in the retail sector and in wealth management. Others have benefited from their presence in trade finance, treasury, foreign exchange, commodity financing, fixed income products, bonds etc.
The foreign banks believe that further deregulation will add impetus to their efforts to broaden and expand their activities in the Chinese financial market. Many banks will place major emphasis on organic growth but acquisitions in different parts of the financial sector remain a key part of banks’ strategies. Future RMB internationalization and interest rate reform will open the door to a range of new opportunities for the foreign banks. They believe this will enable them to leverage their expertise in debt capital markets, structured products, interest rate and currency swaps.
Securitization has gained increased attention but some participants believe it could still be five years in the future. The broader distribution of wealth, the increase in the number of high networth individuals and future financial reform means that participants predict significant growth in the upper end of the retail sector.
Investment products, mortgages and private banking continue to attract attention. Some foreign banks are also expanding into consumer finance.
Participants in the report have consistently highlighted debt capital markets as the area offering greatest future opportunity. Structured products and interest rate and currency swaps are also critical areas for growth.
On the retail side, investment products were ranked in first place perhaps recognising the transformation that will take place if and when interest rates are finally de-regulated.
The foreign banks surveyed by the report identified several opportunities to grow including traditional trade finance, proprietary trading and treasury businesses. Expansion by Chinese companies into offshore markets will prompt wider use of RMB in international settlements. This will create opportunities for foreign banks to facilitate cross border activities for their customers and have access to China’s SOEs.
For larger foreign banks, new product development and enhancing risk management functions will feature heavily in their growth plans as China’s market continues to open.
Additionally, a number of foreign banks surveyed are planning to launch new derivative products such as credit default swaps and RMB options in China. Others are targeting key industries supported by Shanghai’s fiveyear plan namely shipping, aircraft and infrastructure through structured financing offerings.
Challenges ahead
The report finds out that the impact of regulation remains the primary concern and challenge for foreign banks operating in China. Foreign banks have indicated numerous reasons including lengthy product licensing approvals, documentation and reporting requirements, as well as localized versions of global regulation.
In this report the foreign banks have been subjected to new regulations on fee income, last year it was the “three measures one guideline”. Foreign banks also feel challenged by staged approval processes. For example the inability to seek simultaneous branch approvals or the three year wait period for the granting of a RMB license.
The participants scored a number of key regulatory restrictions that they would like to see relaxed. In order of importance the top five were bond underwriting, access to the derivatives market, capital requirements, CNAPS membership (currently closed until CNAPS II is available) and equal treatment on QDII.
International banking groups are experiencing an unprecedented period of legal and regulatory change, globally. The scope of reforms is affecting many aspects of banks’ operating models, creating operational challenges around capital, liquidity, organizational strategy, governance structures and operating models. For foreign banks with subsidiaries in China, this adds further complexity around compliance with domestic legal and regulatory requirements while operating in the context of a broader institutional strategy.
The report believed the differing needs of ‘Home’ and ‘Host’ regulators will be increasingly difficult for multinational institutions with few easy answers. The fundamental challenge for the foreign banks operating in China over the next three years will be how to balance the investment and sophistication needs of a high-growth and dynamic market against the significant regulatory and profitability constraints of their ‘Home’ businesses.
The CBRC has formulated and revised a set of regulatory guidelines during the past 12 months with respect to capital management, liquidity risk management, corporate governance, assessment and supervision of systemically important commercial banks. These rules apply to foreign banks as well as domestic ones. The changes, with transitional mechanisms were introduced to strengthen risk management across the sector. However, a number of surveyed banks continue to suggest there are material legal and regulatory burdens to the development of their businesses.
In addition to the above changes, CBRC requires banking institutions to exercise greater control in setting fees and managing their operations with a view to safeguarding depositors and consumers’ rights and improving customer satisfaction. These changes aim to improve the stability and robustness of the China banking industry and in a number of areas move towards greater policy harmonization with the rest of the world such as capital and liquidity. These changes emphasize that foreign banks must continue focusing on regulatory complexity in China despite continued moves to liberalize capital markets activities.
Most foreign banks believe that liberalization will play to their advantage. A more open market will make them more competitive against the local banks. However, they stressed the uncertainty on timing, the extent of liberalization (most believe it will be a stepped process) and the reaction of the big banks are yet to be determined. They believe the big banks’ scale could simply overwhelm the foreign banks’response to interest rate liberalization.
The fundamental challenge for the foreign banks over the next three years will be balancing the investment and needs of a dynamic and fastdeveloping Chinese market against the constraints of a slowing economy back home, said the report. In the long run, foreign banks in China will be in a better position if they continue to view and engage with regulators like any key client relationship.
Like most industries, talent remains a major challenge for foreign banks. So much so, more than half of the survey respondents believe talent shortage would have a “significant” or“very significant” impact on their top line growth. Despite this, many foreign banks are on an aggressive recruitment drive, aiming to increase the industry’s headcount by 56% to 55,000 by 2015.
Suggestions for foreign banks
The PwC report suggested that foreign banks continue to learn and adapt to the local operating environment if they are to succeed long-term in the China market. Some have been responsive to the changes in the macro and regulatory environment, to date. But are they properly equipped to adopt a more proactive approach and, indeed, grow beyond their expectations?
As financial reforms gather pace, opportunities will emerge for foreign banks to capitalize on their global scale and expertise, said the report. Additionally, China’s five year plan outlines fresh opportunities to diversify and grow. New pathways for growth are continuing to emerge, but will ultimately require a renewed strategic focus by the foreign banks.
Although 21 banks said they had made major adjustments and 6 banks have made fundamental adaptations to the China market some contend that many senior bankers are still unable to successfully address its special needs and characteristics. Those supporting the need for significant market adaptation argue that China is different.
Understanding and responding to the needs of the Chinese banking and markets regulators is, and will continue to be, a critical success factor for foreign banks in China. It is increasingly clear that a number of institutions are benefiting from significant efforts and investments in this area. However, accessing appropriate skills in compliance such as regulatory engagement specialists continues to be a significant issue for foreign banks operating in China, said the report.
The report, based on interviews with 41 foreign banks in China, showed that foreign banks experienced their most profitable year in China during 2011. Their profit after tax leapt 115% to RMB 16.73 billion in 2011 up from RMB 7.78 billion in 2010. Their total assets increased by 24% to RMB 2.15 trillion at the end of 2011. Market share of the foreign banks increased to 1.93% from 1.83%.
Foreign banks’ growth
The report indicates that strong result arose despite difficulties in their home markets, a subdued outlook for the China and global economy. The 41 banks interviewed in this survey employ more than 35,000 people and expect to increase this by 56% to more than 55,000 by 2015.
Parent banks remain committed to their China operations and have increased again this year. It has now returned to the level reached in 2008.
Asian banks recorded the highest score among all the bank groups. There is no evidence that foreign bank head offices have moderated their interest. Indeed, 26 banks said that the agenda for China has changed positively.
According to the report, the foreign banks envisage continued revenue growth, most expect 20% or greater in 2012 and around three quarters of respondents expect this annual rate to continue through to 2015.
In their pursuit of growth, the banks have four targets namely, financial institutions, multinational corporations (MNCs), State Owned Enterprises (SOEs) and Privately Owned Enterprises (POEs).
Loan caps imposed by regulators and relatively slow branch approvals are limiting the growth options for foreign banks. To overcome these challenges, they are continuing to explore new channels and customer segments by recruiting local, experienced relationship managers to target SOEs and POEs customers. A substantially bigger workforce will help foreign banks achieve this growth, with the 41 banks surveyed predicting they will hire nearly 20,000 new employees by 2015.
The report pointed out that in addition to loan and deposit services, foreign banks can provide further offerings such as trade finance and cash management services. Many of these firms are expanding offshore and are keen to capture a share of the accelerating trade flows across emerging markets such as Asia and South America. Foreign banks are well positioned to assist these firms with established global networks and trading expertise. Access to funding remains a key challenge for foreign banks, with their lending activities heavily dependent on deposits. Foreign banks hope to increase the scale of lending activities by growing their corporate deposit book. By 2015, foreign banks predict both a diminished reliance on their parent company for funding and a greater proportion of corporate deposits to finance their activities.
Another major source of poten- tial income lies in developing financial institution (FI) businesses such as treasury products and bond trading. Foreign bank CEOs ranked regulatory approval to underwrite bonds as the most important driver for future growth. However, access to this market is limited with only a handful of foreign firms receiving approval to issue bonds.
Foreign banks are also focused on keeping pace with the expansion plans of MNCs based in China. Many are shifting their operations away from manufacturing exports towards production, distribution and marketing products for the local market. The Chinese government’s efforts to rebalance the economy towards domestic consumption are driving this realignment as outlined in its 12th five year plan.
Foreign banks will have more opportunities to diversify and differentiate themselves among certain market sectors as they mature. The 12th Five-Year Plan outlines several Strategic Emerging Industries: biotechnology, new energy, high-end manufacturing, energy conservation, and next-generation IT. These industries have been singled out by the government to be the pillars of China’s next-generation, innovation-driven economy. The expertise of foreign banks in developing these industries in other markets may provide them with a distinctive advantage over their local counterparts. But this will require significant focus, planning and commitment of resources to capitalize on this opportunity.
China’s buildup of innovation-focused industries is creating new opportunities for foreign banks. Foreign firms are increasingly acquiring or partnering with local companies seeking to develop new technologies and build R&D capabilities. They are seeking financiers with expertise in these industries and can provide solutions in term of cash management, investment and financing activities.
The ongoing euro zone crisis and subdued state of the US economy continues to speed the pace of RMB internationalization. Pressure on the Euro and Greenback is driving greater use of RMB to settle trade arrangements. This is further bolstered by China signing multiple currency swap agreements with many of its key trade partners in major developed and emerging markets. Foreign banks, particularly those with cross-border trade settlement and cash management capabilities in place stand to benefit in the longer term. As the US and Europe begin to recover, their priority will be on moderate and sustainable growth, with trade and settlements in RMB being more commonplace.
The development of the RMB is also being enhanced by the growth of cross-border RMB trade through Hong Kong. This will create arbitrage opportunities in both interest rate and currency trading activities, particularly among Chinese import and export companies. Offshore RMB debt and investment markets will further develop as trade volumes grow.
Foreign banks are establishing China desks, manned by locally trained relationship managers to capture the trade flows associated with the offshore expansion of Chinese SOEs and POEs.
Although the revenue generated from cross-border activities are yet to be reflected in local books, this will eventually contribute to the success of the foreign banks in China, said the report.
The pace of financial reform has gained pace over the past six months with several major policy announcements. During this time, foreign debt quotas were increased, and interest and exchange rate bands widened.
Furthermore, China’s credit asset securitization pilot program was expanded, QFII scheme entry require- ments relaxed, and equity investment holdings for foreign companies have been loosened. Other programs such as the Wenzhou pilot scheme will allow mainland residents to invest directly overseas and help widen China’s capital account. These continuous financial reforms will provide opportunities for foreign banks to leverage their global networks and risk management expertise to create a competitive advantage. While it cannot be predicted how quickly reforms will continue, the moderate pace of the program so far should provide foreign banks with distinctive windows of opportunity.
Growth opportunities
The report showed that foreign banks continue to identify opportunities across the financial spectrum. The growth and dispersal of wealth means that a group of foreign banks are renewing and developing their presence in the retail sector and in wealth management. Others have benefited from their presence in trade finance, treasury, foreign exchange, commodity financing, fixed income products, bonds etc.
The foreign banks believe that further deregulation will add impetus to their efforts to broaden and expand their activities in the Chinese financial market. Many banks will place major emphasis on organic growth but acquisitions in different parts of the financial sector remain a key part of banks’ strategies. Future RMB internationalization and interest rate reform will open the door to a range of new opportunities for the foreign banks. They believe this will enable them to leverage their expertise in debt capital markets, structured products, interest rate and currency swaps.
Securitization has gained increased attention but some participants believe it could still be five years in the future. The broader distribution of wealth, the increase in the number of high networth individuals and future financial reform means that participants predict significant growth in the upper end of the retail sector.
Investment products, mortgages and private banking continue to attract attention. Some foreign banks are also expanding into consumer finance.
Participants in the report have consistently highlighted debt capital markets as the area offering greatest future opportunity. Structured products and interest rate and currency swaps are also critical areas for growth.
On the retail side, investment products were ranked in first place perhaps recognising the transformation that will take place if and when interest rates are finally de-regulated.
The foreign banks surveyed by the report identified several opportunities to grow including traditional trade finance, proprietary trading and treasury businesses. Expansion by Chinese companies into offshore markets will prompt wider use of RMB in international settlements. This will create opportunities for foreign banks to facilitate cross border activities for their customers and have access to China’s SOEs.
For larger foreign banks, new product development and enhancing risk management functions will feature heavily in their growth plans as China’s market continues to open.
Additionally, a number of foreign banks surveyed are planning to launch new derivative products such as credit default swaps and RMB options in China. Others are targeting key industries supported by Shanghai’s fiveyear plan namely shipping, aircraft and infrastructure through structured financing offerings.
Challenges ahead
The report finds out that the impact of regulation remains the primary concern and challenge for foreign banks operating in China. Foreign banks have indicated numerous reasons including lengthy product licensing approvals, documentation and reporting requirements, as well as localized versions of global regulation.
In this report the foreign banks have been subjected to new regulations on fee income, last year it was the “three measures one guideline”. Foreign banks also feel challenged by staged approval processes. For example the inability to seek simultaneous branch approvals or the three year wait period for the granting of a RMB license.
The participants scored a number of key regulatory restrictions that they would like to see relaxed. In order of importance the top five were bond underwriting, access to the derivatives market, capital requirements, CNAPS membership (currently closed until CNAPS II is available) and equal treatment on QDII.
International banking groups are experiencing an unprecedented period of legal and regulatory change, globally. The scope of reforms is affecting many aspects of banks’ operating models, creating operational challenges around capital, liquidity, organizational strategy, governance structures and operating models. For foreign banks with subsidiaries in China, this adds further complexity around compliance with domestic legal and regulatory requirements while operating in the context of a broader institutional strategy.
The report believed the differing needs of ‘Home’ and ‘Host’ regulators will be increasingly difficult for multinational institutions with few easy answers. The fundamental challenge for the foreign banks operating in China over the next three years will be how to balance the investment and sophistication needs of a high-growth and dynamic market against the significant regulatory and profitability constraints of their ‘Home’ businesses.
The CBRC has formulated and revised a set of regulatory guidelines during the past 12 months with respect to capital management, liquidity risk management, corporate governance, assessment and supervision of systemically important commercial banks. These rules apply to foreign banks as well as domestic ones. The changes, with transitional mechanisms were introduced to strengthen risk management across the sector. However, a number of surveyed banks continue to suggest there are material legal and regulatory burdens to the development of their businesses.
In addition to the above changes, CBRC requires banking institutions to exercise greater control in setting fees and managing their operations with a view to safeguarding depositors and consumers’ rights and improving customer satisfaction. These changes aim to improve the stability and robustness of the China banking industry and in a number of areas move towards greater policy harmonization with the rest of the world such as capital and liquidity. These changes emphasize that foreign banks must continue focusing on regulatory complexity in China despite continued moves to liberalize capital markets activities.
Most foreign banks believe that liberalization will play to their advantage. A more open market will make them more competitive against the local banks. However, they stressed the uncertainty on timing, the extent of liberalization (most believe it will be a stepped process) and the reaction of the big banks are yet to be determined. They believe the big banks’ scale could simply overwhelm the foreign banks’response to interest rate liberalization.
The fundamental challenge for the foreign banks over the next three years will be balancing the investment and needs of a dynamic and fastdeveloping Chinese market against the constraints of a slowing economy back home, said the report. In the long run, foreign banks in China will be in a better position if they continue to view and engage with regulators like any key client relationship.
Like most industries, talent remains a major challenge for foreign banks. So much so, more than half of the survey respondents believe talent shortage would have a “significant” or“very significant” impact on their top line growth. Despite this, many foreign banks are on an aggressive recruitment drive, aiming to increase the industry’s headcount by 56% to 55,000 by 2015.
Suggestions for foreign banks
The PwC report suggested that foreign banks continue to learn and adapt to the local operating environment if they are to succeed long-term in the China market. Some have been responsive to the changes in the macro and regulatory environment, to date. But are they properly equipped to adopt a more proactive approach and, indeed, grow beyond their expectations?
As financial reforms gather pace, opportunities will emerge for foreign banks to capitalize on their global scale and expertise, said the report. Additionally, China’s five year plan outlines fresh opportunities to diversify and grow. New pathways for growth are continuing to emerge, but will ultimately require a renewed strategic focus by the foreign banks.
Although 21 banks said they had made major adjustments and 6 banks have made fundamental adaptations to the China market some contend that many senior bankers are still unable to successfully address its special needs and characteristics. Those supporting the need for significant market adaptation argue that China is different.
Understanding and responding to the needs of the Chinese banking and markets regulators is, and will continue to be, a critical success factor for foreign banks in China. It is increasingly clear that a number of institutions are benefiting from significant efforts and investments in this area. However, accessing appropriate skills in compliance such as regulatory engagement specialists continues to be a significant issue for foreign banks operating in China, said the report.