Identifier
Created
Classification
Origin
06GUANGZHOU10672
2006-04-07 08:03:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Consulate Guangzhou
Cable title:  

Getting a Piece of the Action: Foreign Banks Try To

Tags:  ECON WTRO EFIN EINV CH 
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UNCLAS SECTION 01 OF 03 GUANGZHOU 010672 

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USDOC FOR 4420/ITA/MAC/MCQUEEN
TREASURY FOR OASIA/INA-CRANE
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E.O. 12958: N/A
TAGS: ECON WTRO EFIN EINV CH
SUBJECT: Getting a Piece of the Action: Foreign Banks Try To
Get Their Foot in the Door of Chinese Banking

REF: A) Shanghai 1354
B) Guangzhou 5379
C) Beijing 3454

UNCLAS SECTION 01 OF 03 GUANGZHOU 010672

SIPDIS

SENSITIVE
SIPDIS

USDOC FOR 4420/ITA/MAC/MCQUEEN
TREASURY FOR OASIA/INA-CRANE
STATE ALSO PASS USTR/STRATFORD
STATE ALSO PASS FEDERAL RESERVE

E.O. 12958: N/A
TAGS: ECON WTRO EFIN EINV CH
SUBJECT: Getting a Piece of the Action: Foreign Banks Try To
Get Their Foot in the Door of Chinese Banking

REF: A) Shanghai 1354
B) Guangzhou 5379
C) Beijing 3454


1. (U) Summary: Under a five-year transition period in its
WTO accession agreement which ends December 11, 2006, the
Chinese Government is gradually becoming more liberal in
allowing foreign investment to enter China's banking
industry. With the Chinese Government opening its RMB
currency market later this year, how do foreign banks get
into the market? The quick way is for foreign banks to
invest in local Chinese banks to access the latter's usually
extensive system of bank branches and customer networks.
Such strategic investment can also effectively help foreign
banks to circumvent the Chinese Government's barriers to
slow the growth of the foreign banking sector through
licensing procedures as well as the difficulties most
foreign banks face in accumulating RMB deposits with their
few branches. End Summary.


2. (U) Economic Minister Counselor Robert Luke and
Congenoff met with Milton Lau, General Manger of Citigroup's
Guangzhou Branch, and Professor Lu Jun, Dean of the Finance
Department of Lingnan College of Dr. Sun Yat Sen University
in late February. Interlocutors discussed their opinions on
China's opening of the banking industry.

Restricting Trade: Control through Indirect Means
-------------- --------------


3. Administrative barriers govern foreign bank expansion at
present. According to Citigroup's Lau, RMB business is
currently restricted. Foreign banks, with only a two
percent share of the banking sector, are eager to get a
larger share. Even if there were an RMB license available,
only 20 cities in China are approved for foreign banks to
offer RMB transactions. Currently, RMB services by foreign
banks are only allowed for foreign customers. According to
Lau, whenever a foreign bank wants to open a new bank branch
or launch a new product, it will face delays due to lengthy
application and permit procedures. Lau mentioned another
foreign bank that was delayed for six-nine months in opening

a branch office. And approval is not an approval. After
leasing an office, installing IT systems, and providing
training, the local China Banking Regulatory Commission
(CBRC) office then does an on-site inspection. Only then is
a final license issued. Large capitalization requirements
are also required as per CBRC requirements, depending on the
level of services provided. For each additional sub-branch
an additional RMB 10 million (USD 1.25 million) is required.
To provide foreign currency trading, RMB 100 million (USD
12.5 million) is required. To provide RMB banking business
services to individuals, a foreign bank needs to have RMB
200 million (approximately USD 25 million) in operating
capital. For comprehensive RMB services for businesses, RMB
300 million (USD 38 million) is required. Lu Jun also noted
that even if a bank obtained approval for opening a new
branch, it may still face zoning restrictions, limiting the
number of banks that can be allowed within a certain
geographic area. Starting December 11, at the end of
China's WTO transition period, the Chinese Government will
fully open its banking industry and lift all current
geographical and product restrictions on foreign banks.

Domestic Banks are the Most Efficient Choice For Expansion
-------------- --------------


4. (U) To work locally, foreign banks need access to local
currency, i.e., RMB. RMB most commonly comes from local
depositors. Without access to local depositors, banks could
use interbank lending to get access to RMB but would be at a
competitive disadvantage from the start due to the higher
acquisition costs. Ready access to RMB would also allow
foreign banks to offer loan services to a sector that had
defaulted on them earlier. Though many foreign banks,
including Citigroup, had earlier suffered from bad loans to
some of China's large state-owned enterprises (SOEs),in
recent years, according to Lau, foreign banks have found
that large reformed SOEs to have become good customers.
Since domestic banks have a long tradition of providing the
majority of their loans to SOEs, these banks have very

GUANGZHOU 00010672 002 OF 003


close, long-term relations with the big SOEs. Additionally,
domestic banks holding full business licenses already
maintain a far-flung branch network with ready access to
local depositors. China is already well known as a country
with a savings rate as high as 40-50 percent with banks
awash in cash. Lu noted that management, not finance, is
the problem with domestic banks. Buying into domestic banks
can provide foreign banks with the fastest access to the
local market, especially in getting RMB deposits after
November 1. The current average three percent gap between
the deposit and loan interests also make the RMB currency
market very attractive to foreign banks. Investing in a
domestic bank with its built-in advantages is the most
efficient and cost-effective way for foreign banks to expand
in China.

But No Free Lunch: Citigroup Plays Catch-up To Rivals
-------------- --------------


5. (U) All of this opportunity comes with costs and
limitations. Some domestic banks carry a high percentage of
non-performing loans, so acquiring a share of a domestic
bank often means acquiring a net negative value, though it
obviously is not entirely without value. In theory, each
foreign bank is only allowed to invest in two domestic
banks. Citigroup is trying to catch up with rivals in China
such as HSBC Holdings, which already has a bigger stake in
China's financial sector. Citigroup has already invested in
Shanghai Pudong Development Bank with a 4.6 percent share,
is in negotiations for an increased share, and is currently
bidding for a significant share of Guangdong Development
Bank (GDB). Lu's understanding is that GDB's capitalization
rate is already negative seven percent but still described
Citigroup's bid as "good risk management." Despite this
negative worth, GDB already has a built-in infrastructure
that will save Citigroup much money and time it would need
for its own expansion with the purchase. The success of
Citigroup's bid depends on whether the Chinese regulators
make an exception in the ownership cap of 20 percent set for
a single foreign firm and 25 percent for collective
ownership. As reported on ref A, Citigroup hopes to acquire
a 40 percent stake in GDB. Citigroup believes the
Government might still approve the purchase because of the
seriousness of GDB's current situation.

Citigroup's Strategy
--------------


6. (SBU) Lau outlined several steps that Citigroup would
take to expand its business. Beginning with its current
multinational corporate clients, Citigroup would expand its
services to Guangdong's top tier of SOEs and to Taiwan-
invested businesses, building on its strong business in
Taiwan. Later, Citigroup would develop services
specifically for small and medium enterprises (SMEs) and
commercial banks; groups Lau said were often ignored by
local banks. Lau noted that Citibank Hong Kong already has
a well-established SME banking business begun in 2005. This
sector has just opened to foreign banks. Citigroup China
has promoted the former Guangzhou Citigroup director to be
the head of all China commercial banking in an effort to
begin planning. Taking a long-term view of the China
market, Lau said that both Citigroup and HSBC would expand
into consumer banking, an area he suggested few foreign
banks would penetrate, preferring to stick with corporate
banking.

Encouraging a Foreign Lifeline
--------------


7. (U) Lu also pointed out the Chinese Government and
domestic banks acknowledge the value of attracting foreign
investment. The Chinese Government, which formerly held
that the banking industry was a strategic sector of the
economy and therefore no portion of it could be sold to
foreign interests, has seen that keeping domestic banks
fully state-owned is not the best way of keeping them

GUANGZHOU 00010672 003 OF 003


healthy, particularly given their previous track record.
Foreign banks offer strategic investment, financial
expertise, advanced management, and experience in a
competitive global world, all of which domestic banks will
need to survive in a more open post-WTO transition period.
Starting from January 1, 2007, three weeks after the
transition period ends, all domestic banks will be required
to meet an eight percent capitalization rate before they can
provide new business products, critical for their survival.
Foreign banks could provide much of this capital.

Comment: Possible Breakthrough for Mutual Benefit?
-------------- --------------


8. (SBU) The Chinese Government is protecting its domestic
banks by using intangible administrative measures to push up
the expansion costs for foreign competitors. Foreign banks'
investment in domestic banks will have a win-win effect of
providing a fast and comparatively low-cost expansion for
foreign banks while bailing out and encouraging the
comprehensive upgrading of domestic banks. A successful
Citigroup bid for Guangdong Development Bank may open the
door to more rapid access to this sector by foreign banks.
End Comment.

DONG