FOREIGN DIRECTORS OF CHINESE BANKS HELPING TO

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E.O. 12958: N/A
TAGS: EFIN EINV PGOV CH
SUBJECT: FOREIGN DIRECTORS OF CHINESE BANKS HELPING TO
IMPROVE GOVERNANCE


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1. (SBU) Summary: During a lunch on April 19 lunch with
analysts from the New York Federal Reserve Bank, three
foreign directors of four Chinese banks (Minsheng Bank,
China Everbright Bank, Bank of Beijing and Xi'an City
Commercial Bank) shared their experiences. On the question
of governance, they all highlighted the continued control
of the Communist Party over key decisions such as bank
leadership, but were upbeat on their assessment of
improving governance standards. Developing a credit
culture remains a major challenge, especially since China
still lacks an effective legal system and credit
information bureaus. Still, all of the directors agreed
that foreign directors are having a positive impact and
that the Chinese leadership supports foreign participation
in Chinese banks. End summary.


2. (U) On April 19, a delegation of analysts from the New
York FRB met with three foreign directors who sit on the
boards of several Chinese banks: Jim Stent of Minsheng
Bank, Frank Hawke of China Everbright Bank, and Michael
Ipson, banking specialist from the International Finance
Corporation (IFC) Beijing rep office, who represents IFC on
the boards of the Bank of Beijing and the Xi'an City
Commercial Bank.

Party Influence
--------------


3. (SBU) One of the issues complicating the reform of
Chinese banks is the continued influence of the Communist
Party on management decisions. Despite this, Ipson of IFC
believes that the banks have actually made progress in
improving corporate governance. He reported that the Party
Secretary of one of his banks has even praised IFC's role

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in improving governance standards. Stent of Minsheng
agreed, saying his bank generally wants to reach
international standards, but it is a difficult process, as
Chinese companies have had boards of directors for less
than 20 years. He stated that the Party appoints the
Chairman and President of every bank, with nominations
going to the Party Secretary at the China Banking
Regulatory Commission for approval. Because of this, Hawke
said his bank has changed the name of the "Nomination
Committee" to the "Human Resource Subcommittee."


4. (SBU) Regarding the Party's influence over credit
allocation decisions, Hawke averred that the Party has not
been making these decisions at Everbright Bank, but joked
that given the bank's poor track record, even the Party
could have done a better job. In his view, the
Government's biggest quandary for the state-owned banks is
how to get them to act like Western banks without losing
control. Hawke expressed pessimism that the banks will
succeed, predicting that the banks will need to be
recapitalized again at some point in the future.

No Credit Culture
--------------


5. (SBU) Stent said one of the biggest challenges is the
lack of a real credit culture. In the past, they were
simply arms of the Ministry of Finance, and even now they
are not used to the credit culture concept. The Minsheng
Bank has only existed for ten years and only has experience
with a growing economy. Although Minsheng's NPL ratio is
under 2 percent, the ratio could go up if the economy
falters and companies begin to fail. Banks continue to
favor lending to state-owned enterprises and to state-
sponsored projects because the state stands behind them.
Eventually the banks will have to start doing a "means and
purpose test" for loans. Ipson commented that the banks
will continue lending to SOEs because they are the lowest
risk borrowers. From the Everbright bank experience, Hawke
pointed out that "before you build, you have to put out the
fire." Before Everbright could change its lending
policies, it had to first "staunch the bleeding." To do
this, he said the bank headquarters withdrew all credit
authority from the local levels. In his view, it is
necessary to separate the credit and marketing functions.

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Stent noted that there has been some debate about this
issue. When he was at the Bank of Asia in Thailand, credit
authority was taken away from the branches and the branch
managers became sales managers instead. This, of course,
required a very responsive credit function at the head
office, which would not be true in Chinese banks.


6. (SBU) All three directors agreed that building a credit
culture is a slow process. Stent noted that it takes a
great deal of training at all levels, with a total
commitment from the senior management. To assist in this
effort, Ipson pointed out that the IFC is helping the
People's Bank of China develop a credit information bureau.
Even a state-owned entity like this is a step forward,
although it will take a long time to sort out the legal
system to support it. He noted that China has more of a
"rule of judges" rather than "rule of law." Hawke pointed
out that one major legal problem for banks is that a bank
legally cannot foreclose on a borrower's primary residence.

Foreign Director Effect
--------------


6. (SBU) The directors all agreed that they are having a
positive influence in the way their bank boards operate.
Hawke said he had succeeded in ratcheting back Everbright's
lending targets for 2006. Despite Everbright's negative
capital position, Hawke said his bank originally aimed at
growing its loan portfolio by 12 percent in 2006. Hawke
countered with an 8 percent proposal, and eventually
persuaded the bank to adopt a lower target. He noted that
Chinese bank boards will usually put off a vote if it
appears there will be a dissenting vote because dissenting
votes have to be reported to the China Banking Regulatory
Commission (CBRC). Stent pointed out that the standard is
even higher for listed banks like Minsheng: dissenting
votes have to be made public. In his bank, if an issue
will not receive unanimous support, it will be pulled. He
commented to Hawke that it was impressive that Everbright's
board discussed the loan growth issue so openly. Hawke
suggested that despite Everbright's bad loan problem, it
actually has a reputation for better-than-average
management. Perhaps this is because the ADB, the first
foreign investor to take a stake in a Chinese bank, has
been working with Everbright since 1997. The three
directors agreed that Everbright and China Merchants at
least had the best reputations for customer service. Ipson
commented that the banks still need to develop more income
options because thus far over 90 percent of bank income is
generated from interest on loans. Stent commented that the
banks are not yet using their ability to charge higher
interest for higher risk.


7. (SBU) Although foreign investors are helping to reform
the banking system, Stent commented that there has been a
backlash against foreign investment in the banks. As a
result, he suggested the senior leadership may slow the
reform process. Ipson argued that China's leadership still
expects foreign participation in the banking sector will
make a major difference. Hawke agreed, noting that the
Chinese Government is very concerned that the continued
misallocation of capital will eventually affect growth.
China is looking to foreign investors to help it improve
the overall management of the banking sector.


8. (U) Report was cleared by the New York FRB delegation.

RANDT