Identifier
Created
Classification
Origin
06SHANGHAI7112
2006-12-08 03:51:00
CONFIDENTIAL
Consulate Shanghai
Cable title:  

CITI'S RICHARD STANLEY ON GDB AND BANKING IN CHINA

Tags:  EFIN ECON PREL PGOV PINR CH 
pdf how-to read a cable
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FM AMCONSUL SHANGHAI
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INFO RUEHBJ/AMEMBASSY BEIJING 0681
RUEHHK/AMCONSUL HONG KONG 0451
RUEHSH/AMCONSUL SHENYANG 0362
RUEHGZ/AMCONSUL GUANGZHOU 0341
RUEHMT/AMCONSUL MONTREAL 0006
RUEHOT/AMEMBASSY OTTAWA 0013
RUEHGP/AMEMBASSY SINGAPORE 0029
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/US DEPARTMENT OF COMMERCE HQ WASHINGTON DC
RHEHNSC/WHITE HOUSE NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHCN/AMCONSUL CHENGDU 0357
RUEHGH/AMCONSUL SHANGHAI 5668
C O N F I D E N T I A L SECTION 01 OF 05 SHANGHAI 007112 

SIPDIS

E.O. 12958: DECL: 11/30/2031
TAGS: EFIN ECON PREL PGOV PINR CH
SUBJECT: CITI'S RICHARD STANLEY ON GDB AND BANKING IN CHINA

REF: A. SHANGHAI 5625 B. SHANGHAI 1354

CLASSIFIED BY: Mary Tarnowka, Political/Economic Chief, U.S.
Consulate Shanghai, State Department.
REASON: 1.4 (b),(d)



C O N F I D E N T I A L SECTION 01 OF 05 SHANGHAI 007112

SIPDIS

E.O. 12958: DECL: 11/30/2031
TAGS: EFIN ECON PREL PGOV PINR CH
SUBJECT: CITI'S RICHARD STANLEY ON GDB AND BANKING IN CHINA

REF: A. SHANGHAI 5625 B. SHANGHAI 1354

CLASSIFIED BY: Mary Tarnowka, Political/Economic Chief, U.S.
Consulate Shanghai, State Department.
REASON: 1.4 (b),(d)




1. (C) Summary: On December 1, Citibank China CEO Richard
Stanley updated a visiting Federal Reserve Bank (FRB) delegation
led by Governor Kevin Warsh on the status of Citi's efforts to
purchase a minority stake with management control in the
Guangdong Development Bank (GDB). According to Stanley, the
deal, signed on November 16, needed to be finalized no later
than December 18, and could potentially be part of the
deliverables for the December 14-15 Strategic Economic Dialogue
(SED) meetings in Beijing. To meet this deadline, Guangdong
Province, responsible for removal of about USD 7 billion in bad
loans, would need to sell its stake in Southern Grid and deposit
the cash in GDB by December 10. Stanley also described Citi's
China business strategy and, with his usual candor, outlined
Citi's views on some of the challenges facing foreign banks in
China, including the new banking regulations. He encouraged USG
officials participating in the SED to take a "publicly
accommodating, privately tough" stance in convincing China to
continue to open up it is market to the world. End summary.


2. (SBU) As part of a recent visit to Shanghai to assess
macroeconomic and financial sector development, FRB Governor
Kevin Warsh, San Francisco FRB President Janet Yellen, and VPs
Rueven Glick and Teresa Curran, accompanied by P/E Chief and
Econoff, met with Citibank China CEO Richard Stanley and VP
Christie Ho on December 1.

--------------
Citi's Three-Pronged Strategy for China
--------------


3. (SBU) Stanley outlined Citi's three-pronged strategy for
continued growth in China. He identified these as: 1) Citi's
own organic growth; 2) its relationship with the Shanghai Pudong
Development Bank (SPDB); and 3) its efforts to acquire a
minority stake with management control in GDB.

-------------- --
Citi's Organic Growth as the American-flag Bank

-------------- --


4. (SBU) Stanley said that Citi's top priority would be to
continue to enlarge its organic (independent Citibank) growth,
and take advantage of its 104-year history in China using its
well-known brand, which in Chinese meant "American-flag Bank"
(Huaqi yinhang). According to Stanley, Citi had 3,000 employees
located in six cities across China. He expressed continued
frustration with the obstacles Citi had encountered opening up
new branches, noting that other countries' foreign banks seemed
to be allowed to expand more rapidly, and said that the approval
of "a branch or two" of a Chinese bank in the U.S. would help
Citi's approval process here in China. Warsh and Yellen smiled,
noting that had heard similar suggestions in their meetings with
People's Bank of China (PBOC) and China Banking Regulatory
Commission (CBRC) in Beijing.

--------------
Citi's Stake in SPDB
--------------


5. (C) Stanley said Citi's second priority was to develop its
"synthetic joint venture investment" in SPDB. Stanley explained
that Citi's initial 4.9 percent stake, acquired in 2002, had
been reduced to a 3.2 percent stake, due to non-tradable share
reform. The main business of the investment was a joint credit
card operation, which had 700,000 cardholders. Stanley
explained that the business was doing well now, but had been
delayed at the outset. Apparently former CBRC Chairman (now
Tianjin Mayor) Dai Xianglong had approved the credit card JV,
but Liu Minkang tried to stop the deal, resulting in the
business not being launched until 2004. Stanley said that while
he sat on the board of directors and Citi had employees seconded
to the SPDB as advisors, the day-to-day management was done by
SPDB. Stanley noted SPDB was already listed on the Shanghai
Stock Exchange and planned another listing, and said Citi had
the option to increase its stake to 19.9 percent, and would do
so likely when the price dropped.

--------------
Citi's Efforts to Acquire a Stake in GDB
--------------


6. (C) Stanley was most excited by the third part of Citi's
growth strategy, the contract to acquire a 20 percent stake in
GDB, signed on November 16. According to Stanley, the deal
would give Citi an option to purchase up to a 65 percent stake,
exercisable "the minute the law changes." Stanley said,
although the Central Government clearly wanted to retain a
majority stake in the Big Four or Big Five Banks at least for
the medium-term, it had expressed an intent to raise the
ownership caps on foreign ownership in other Chinese banks.
Stanley's conversations with National Development and Reform
Commission staff led him to believe that 3-5 years out, the cap
still might be around 49 percent, but that eventually majority
foreign ownership would be allowed. Once Citi had more than a
50 percent stake, it would merge GDB into Citibank China, and
possibly list it, as it had done with similar acquisitions in
other counties. Under a worst case scenario, it would just list
and take its money out. From Stanley's perspective, however,
GDB was "a long term investment" in building Citi's penetration
into China's market. According to news reports, GDB had 500
branches, 12,000 employees and USD 48 billion in assets.
Stanley said GDB had about USD 100 billion in loans and about
USD 40 billion on its balance sheet.

--------------
Citi and GDB: Anatomy of the Deal
--------------


7. (C) Expressing thanks for continued strong USG support, from
Treasury Secretaries Paulson and Snow, Commerce Secretary
Gutierrez and Ambassador Randt, Stanley said that Citi and GDB
signed the take-over contract on November 16 and were scheduled
to close the deal by December 18. He said there had been some
discussion of including the signing in the SED meetings and he
was certainly supportive. He recollected spending the prior
Christmas holiday in negotiations and said he did not want to
repeat that experience. He commented that someday, he and
Christie Ho, would write a book about their negotiating
experience, a la "Beijing Jeep." He noted that Citi, unlike its
two competitors for the GDB deal, continued to be a tough
negotiator. Societe General was ready to sign whatever was
offered and Ping An had offered an additional USD 800,000 after
bids were closed. Stanley said he thought China's financial
leaders were willing to accept Citi's terms because 1) they
wanted to do something for the United States, and 2) they wanted
a capable partner who could turn the bank around as a showcase.


8. (C) Stanley explained that Citi, and its consortium partners,
agreed to purchase 85.6 percent of GDB for about USD 3.1
billion. Citi would own 20 percent and International Business
Machine (IBM) would own 4.7 percent. Stanley commented that
CBRC had raised some concerns about Citi's financing of a
portion of IBM's stake, but he didn't think they were serious
since Citi had always been very transparent about this and IBM
was also obtaining some financing from unrelated parties.
According to reports in Caijing, an influential Chinese business
periodical, Citi's other partners include China Life Insurance
Company (20 percent share),National Electricity Net (20 percent
share),Puhua Investment Company (8 percent share),and
Cititrust (12.8 percent share).


9. (C) The deal was scheduled to close by December 18 after GDB
resolved the issue of 58 billion RMB (about USD 7 billion) in
nonperforming loans (NPLs),what Stanley referred to as "the
core cancer." The adjusting entry to handle the write-off was
supposed to occur by December 10 to allow GDB's auditor, KPMG,
time to review the financial statements. Stanley said that Citi
already had a 100-person transition team in Guangzhou working
with GDB. He said that business had basically been frozen this
year but that the transition team now had the opportunity to
review any new big loans before they were issued.


10. (C) Stanley also indicated that, what he had once termed
"the worst Bank in China" (ref B) was actually in better
condition than he had expected. He said although there were
"legacy problems" in Guangdong, the branches in Shanghai,
Hangzhou and Nanjing were relatively well-run. KPMG had been
auditing GDB for three years and was ready to give it a clean
opinion -- provided the cash came in to write-off the NPLs.
Stanley told Warsh that Citi had actually been hoping for a more
conservative classification. Nonetheless, he said that after
KPMG and Citi had gone through GDB's books, there were only "a
few hundred million RMB" in loans that they could not agree on.
He said this was "really amazing" given GDB's reputation.


11. (C) Under the terms of the agreement, GDB's board would
elect Citi's Michael Zink, currently Citi Korea Senior Executive
VP for Corporate and Investment Banking, as President later that
afternoon. There would be 17 total directors -- 14 executive
and three independent. Citi could nominate six directors, five
executive and one independent. The three executive directors
would include Zink, a tough-talking Citi risk management expert
from North Carolina, and a consumer banking expert from Citi's
Singapore operations. One of the independent directors Citi
would bring on was Y.S. Wong, who had retired after 35 years of
experience with Citi as a risk management expert. Stanley said
Chinese officials openly admitted that Citi would have
management control. The President would have the ability to
appoint a new management team, and hire and fire staff. While
Citi could nominate the bank's chairman, it currently planned to
retain GDB's chairman for the next one and half years to see
through the transition process.


12. (C) Stanley said that at the working level, GDB employees
were "welcoming Citi like the arrival of the Savior." He
estimated that it would take Citi one year to implement basic
compliance and anti-money laundering policies and a more-robust
audit process. Stanley observed that the biggest challenge was
human resources. He said that all of GDB's branch managers
located in Guangdong were "political appointees," many of whom
were responsible for the bad loans. Stanley said the Guangdong
Deputy Party Secretary had advised Citi to "go in and fire two
branch managers on the first day to show who is boss."

-------------- --
Guangdong Province Has to Clean Up its Own Mess
-------------- --


13. (C) According to Stanley, GDB, the PBOC and the CBRC agreed
that 58 billion RMB worth of NPLs would be resolved in a
"pre-closing adjustment" prior to Citi's final signature.
Stanley said these loans were too politically sensitive to ever
see the light of day since he understood they were largely
channeled to Guangdong's current and former leaders and their
friends. In the end, the question came down to who would pay.
Guangdong Government had tried to place the responsibility on
the PBOC, but Chairman Zhou Xiaochuan had made clear that PBOC
would only take care of the Big Four banks. CBRC acknowledged
that the NPLs needed to be removed to make the sale, but had no
money of its own. Eventually, PBOC told Guangdong's political
leaders that they needed to clean up their own mess. The
current plan was that Guangdong Province would sell its stake in
Southern Grid and parts of the Guangdong Electricity Group to a
State Grid and China Life consortium. The sale of these
provincial assets was due to bring in roughly 50 billion RMB.
The Citi-lead consortium would be responsible for the other 8
billion RMB.

--------------
Stanley Never Sleeps, Wen is Weak; Hu is Sick
--------------


14. (C) An obviously exhausted Stanley described the hectic pace
he had maintained over the past several months conducting his
own brand of shuttle diplomacy in order to resolve the business
and regulatory issues surrounding the GDB acquisition. He said
he tried to start and end each week at the office in Shanghai,
and traveled to Guangzhou and Beijing for meetings from Tuesday
to Thursday. Part of the problem he encountered was that "PBOC
and CBRC don't like each other" and kept asking Citi to relay
messages and information back and forth.


15. (C) Stanley said that in his discussions in Beijing, he had
heard that Huang Ju was sick with cancer and resided in
Shanghai; Huang was "technically retired" and would probably be
officially retired in March 2007. He also had heard that Hu
Jintao was also "not healthy" and that the Party had begun the
process of looking for the next generation of leaders. Stanley
added that, compared to Zhu Rongji, Wen Jiabao was "a weak
premier" and not effective in leadership circles.


16. (C) Stanley said that he had seen "radical political change
in the last eight months" and a "general backlash against
foreign investment." He mentioned that Huijin Investment
Company CEO Xie Ping had come under a lot of criticism for
pricing the China Construction Bank (CCB) sale of stock to Bank
of America too cheaply (after BofA made large paper profits from
the CCB listing on the Hong Kong exchange) and many other
Chinese officials began to question why they should be so open
to investment after the failure of the CNOOC and Dubai Port
deals. Stanley said "hard line communists" now had more say in
the governing process and the media had become "increasingly
vocal in opposing foreign encroachment" in China's economy. He
said China's leadership, to its credit, had taken a more
populist tack in addressing issues such as the wealth gap, and
environmental degradation. However, in the process, it had
dismantled the more business-oriented polices of the previous
government and tried to address these economic problems by
"pouring money into fixed asset investment" through the hands of
local party bosses.

--------------
China's Financial Services Advisory Committee
--------------


17. (C) Stanley said that with Huang's sickness and Wen's weakness, all decisions about China's exchange rate, monetary policy, and interest rates were made by a twelve-person Financial Service Committee headed by State Councilor Hua Jianmin. He said that Hua was "a very mysterious guy" who Citi executives had never met, despite having previously employed his daughter, Hua Qin. PBOC Zhou Xiaoquan and CBRC Liu Minkang also sat on this committee. Stanley added that Zhou was quite open about the constraints on his power, sometimes stating, "If I was an independent Central Bank Chairman..."

--------------
The Dribbling Pace of Banking Reforms
--------------


18. (C) Stanley said the November 28 regulations requiring
foreign banks to incorporate locally to carry out RMB business
were "not bad" and that Citi had undertaken local incorporation
in other markets around the world. Citi looked forward to being
able to conduct RMB business with Chinese citizens. The
"dribbling out" process of releasing the regulations had caused
lots of heartburn, but there had been many opportunities for
Citi and others to provide comment. He noted that the new
banking rules benefited banks, such as Citi, that were already
established in China with capital. If a new bank wanted to open
up in China, he said, it would be "virtually impossible to get
in." "How could a bank be profitable for three sequential years
if it couldn't do RMB business?" he added.


19. (C) Stanley said China was engaged in an ongoing process of
de-politicizing its banks, but still had a long way to go. The
FRB participants were delighted to hear Stanley note the
increased teeth CBRC had gotten in requiring Chinese banks to
reclassify loans, a process he had observed at SPDB. While
generally optimistic on the reform path Chinese banks had taken,
Stanley said that the "Big Four" Chinese banks would never
entirely get out of the business of making "political" loans.
He discussed the difficulty that Small and Medium Enterprises
(SMEs) had in securing loans, despite CBRC policy support,
quipping: "A bad loan to an SOE is patriotic -- a bad loan to an
SME is idiotic." Banks, he said, have no incentive to make
loans to SMEs and no real experience in making the
forward-looking valuations necessary to effectively
differentiate between good and bad companies.

--------------
Less Progress on Capital Market Reforms
--------------


20. (C) Stanley said the security market was "still totally
closed" except for investment banks profiting from cross-border
listings in Hong Kong. He said the current stock market boom
was "ridiculous." He observed that the high domestic stock and
real estate prices merely reflected the excess liquidity caused
by the failure of monetary policy and the limited types of
assets available to soak it up, noting that bond market yields
were zero.

-------------- ---
SED: Be Soft on the Outside, Tough on the Inside
-------------- ---


21. (C) In response to a question by Governor Warsh, Stanley
advised that U.S. officials coming to participate in December's
SED adopt a posture that is "publicly accommodating, but hard
behind the scenes." In his experience, he had found that it was
never useful to "publicly beat them up," but that the USG should
be "tough" on such issues as market access. He said it was in
China's own interest to adjust its currency policy to manage its
excess liquidity. Market access was the real problem, and if
China didn't open up, its unchecked enormous trade surplus would
increase the potential for U.S. or EU trade retaliation.
Stanley said it was important that SED participants made clear
that "We, in the Cabinet, are your friends, but we are getting
fed up as well." He believed that Chinese officials "had the
feeling that they need to be friendly to Americans," and would
be receptive to such tough talk so long as it was presented
privately and couched in terms of steps taken being in the
mutual interests of both China and the United States.


22. (U) The FRB delegation did not have an opportunity to clear
on this cable.
JARRETT