New Foreign Banking Regulations: Foreign Bankers are

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TAGS: EFIN WTRO ECON EINV CH
SUBJECT: New Foreign Banking Regulations: Foreign Bankers are
Optimistic, Chinese Banks are Wary

REFERENCE: Guangzhou 30413

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accordingly.


1. (SBU) SUMMARY: Following the November 15 release of banking
regulations that permit wholly foreign-owned banks in China,
Guangzhou-based representatives of foreign banks believe they can
now operate on a level playing field with domestic banks. Citibank
and Deutsche Bank branch managers said their banks plan to
incorporate locally in order to participate in full RMB business and
issue credit cards. Their optimism was tempered, however, by a
belief that a slow-moving approval process will limit their ability
to gain market share. Chinese commentators expect a fierce battle
between foreign and domestic banks and were critical of foreign
banks' continued tax benefits. END SUMMARY.

New Banking Regulations: A Level Playing Field on Paper
--------------


2. (SBU) Guangzhou branch managers for Bank of America, Citibank,
and Deutsche Bank told Econoff that the foreign banking regulations
issued on November 15, 2006, are generally the same as the draft
regulations released earlier this year. The regulations, which take
effect December 11, 2006, allow foreign banks for the first time to
create wholly foreign-owned enterprises (WFOEs) within China. WFOEs
will be permitted to engage in a full range of RMB business with
local customers. Foreign banks that do not incorporate locally will
continue to be restricted geographically and limited to servicing
bank accounts with deposits of RMB 1 million (USD 127,000) or more.



3. (SBU) The new regulations also allow WFOE banks to issue their
own credit cards, a service previously off-limits to foreign banks.
The Bank of America, Deutsche Bank, and Citibank representatives all
said this is a major opportunity for foreign banks to generate new
profits and cited it as a primary incentive to incorporate locally.
Bank of America's Yu said she expects to see new regulations
governing the credit card market in the near future. She also
expects that China will soon establish a national system of deposit
insurance, under which WFOEs (but not foreign branches) will be
covered.

Areas of Concern: Credit Ratings, Liquidity Ratios, Capital
Requirements
--------------


4. (SBU) Foreign banking representatives noted that a negative
consequence of incorporating locally is the likelihood of a lower
credit rating. Deutsche Bank's Myron Shi said banks that handle
derivatives will find this a serious concern. However, none of the
representatives considered this issue a major impediment, and
Citibank's Milson Lau expects that the parent company's credit
rating will be given primary consideration.


5. (SBU) Bank of America's Julia Yu said the new regulations do not
permit foreign banks to buy or sell government securities, which
domestic banks can do. She also noted that the liquidity ratio of
25 percent that China is likely to impose leads to burdensome
borrowing costs. Deutsche Bank's Shi noted that foreign banks that
choose not to incorporate will see an increase in their capital
requirements from RMB 100 million (USD 12.7 million) to RMB 200
million (USD 25.4 million).

Implementation Will Be a Barrier
--------------


6. (SBU) Though the representatives said the new regulations level
the playing field on paper, they all expect that long procedural
delays by Chinese authorities will slow their ability to expand as
quickly as they would like. (NOTE: this is similar to what happened
with the opening of China's insurance market. End note.) In
addition, they are waiting for officials to clarify whether WFOEs
would need two years of profit prior to opening new branches.
Citibank's Lau said foreign banks are severely handicapped for local
representation, particularly for residential banking in China,
because of the extensive retail networks that domestic banks have
already established. (Septel addresses the Citibank-led deal with
Guangdong Development Bank.)

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Details Still to Come
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7. (SBU) Banking representatives expect China's Banking and
Regulatory Commission (CBRC) to issue detailed rules by December 11,
when the five-year post-WTO accession transition period ends. Areas
that need to be addressed include the formulas for calculating
asset/liability and liquidity ratios and the RMB/foreign currency
ratio for branch capital requirements. Deutsche Bank's Shi said he
was pleased to see that the regulations do not include a 1 percent
general provision requirement on loans, and is waiting to see
whether it will be added in the CBRC rules. The representatives are
also hoping that CBRC does not impose limitations on the number of
branches or sub-branches a WFOE may open.

Who Plans to Incorporate?
--------------


8. (SBU) Though many banks will decide to incorporate locally, those
that concentrate on corporate banking may decide not to change,
according to the representatives. The media has reported that
Citibank, Standard Chartered, HSBC, Hang Seng, and Bank of East Asia
intend to incorporate. Deutsche Bank's Shi did not say whether his
bank has made a decision, but said he believes that incorporating is
the best strategy moving forward. Julia Yu from Bank of America
said incorporating makes good long-term sense from a business
perspective, but acknowledged that Bank of America is limited in its
options. (Bank of America agreed not to engage in retail business
for three years as part of its deal to purchase a nine-percent stake
in China Construction Bank in 2005.)

The Chinese Perspective: Giving Away Too Much
--------------


9. (SBU) In an interview with the Southern Weekend weekly newspaper,
a manager with China Merchants Bank complained that foreign banks
enjoy preferential treatment. He said WFOE banks will continue to
enjoy a 15 percent tax while domestic banks pay 33 percent. Foreign
banks are given a two-year maturity period for interbank lending,
compared with only four months for Chinese banks. In addition,
foreign banks' headquarters can offer a broader range of services
than those of Chinese banks. The article echoes a complaint by some
Chinese banks that China is opening its banking industry faster than
other countries. It noted that China is a base of operations for 71
banks from 21 countries, but Canada has only a dozen foreign banks.



10. (SBU) In an article in the influential Southern Metropolis
Daily, commentator Chen Jialin argues that, despite the new
regulations, the high costs in setting up branch networks will lead
many foreign banks to buy stakes in local banks instead. He writes
that in the short term foreign banks will target high-end customers
with wealth management and credit card services. He believes
competition between foreign and local banks will become particularly
fierce in late 2007 and early 2008 as foreign banks expand their
networks.

A Chinese Banker: Foreign Banks are Competitive
--------------


11. (SBU) Yu Xiaoping, General Manager of the Shenzhen Branch of the
China Development Bank (a policy bank under the State Council),said
foreign banks could find considerable success in China in small
loans and community banking, trade financing, and credit cards.
Calling the new regulations a true leveling of the playing field,
she criticized Chinese banks as being too focused on large projects
and too hesitant to offer loans to small enterprises and
individuals. According to her, most Chinese consumers, if given the
option, would choose to put their money in a foreign bank.

ROCK