CITIBANK'S LOCAL INCORPORATION PROBLEMS

UNCLAS SECTION 01 OF 03 SHANGHAI 000504

SIPDIS

SENSITIVE
SIPDIS

STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/ALTBACH/READE
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN
FRANCISCO FRB FOR CURRAN; NEW YORK FRB FOR CLARK/CRYSTAL/MOSELEY
CEA FOR BLOCK
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN
TREASURY FOR OASIA - DOHNER/BAKER/CUSHMAN
TREASURY FOR WRIGHT AND AMB HOLMER
NSC FOR WILDER AND TONG

E.O. 12958: N/A
TAGS: ECON EFIN EINV CH
SUBJECT: CITIBANK'S LOCAL INCORPORATION PROBLEMS

REF: A) SHANGHAI 478; B) SHANGHAI 161; C) GUANGZHOU 850

(U) This cable is sensitive but unclassified and for official
use only. Not for distribution outside of USG channels or via
the internet.


1. (SBU) Summary: In a meeting with Federal Deposit Insurance
Chairman (FDIC) Sheila Bair on July 26, Citibank (China) Chief
Executive Officer Richard Stanley opined that the China Banking
Regulatory Commission was "making it up as they went along" with
regard to the treatment of newly locally-incorporated foreign
banks such as Citibank. Citibank was facing unprecedented level
of intrusiveness and forced change on the bank. Citi was still
not permitted to issue a debit card to its RMB customers and was
experiencing management problems with its partners at the
Guangdong Development Bank. According to American businessmen
who participated in a roundtable with Bair, China faced
enormous challenges overcoming the risks associated with
corruption in designing and implementing a banking deposit
insurance program. End Summary.


2. (SBU) Federal Deposit Insurance Corporation (FDIC) Chairman
Sheila Bair met with Citibank (China) Chief Executive Officer
Richard Stanley and Citibank Director of Government
Affairs-China Vice President Jie Huang on July 26. Also, on
July 26, Chairman Bair attended an Amcham-hosted business
roundtable. Chairman Bair was joined during her July 26-27
visit to Shanghai by FDIC Vice Chairman Martin Gruenberg, FDIC
Director of International Affairs Fred Carns and FDIC Chief of
Staff Jesse Villarreal. Chairman Bair's July 27 meeting at the
Shanghai Stock Exchange was reported Ref A; other FDIC
delegation meetings will be reported septel.

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Citibank Not Pleased With Local Incorporation
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3. (SBU) Citibank's Stanley said that Citi was "not pleased"
with having been required to incorporate locally as a Chinese
bank due to the "challenging complexities" this change had
created. Stanley was optimistic, however, that Citibank could
work through these complications. He reiterated to Chairman
Bair his previously reported (Ref B and previous) view that any
bank not already in China would find it prohibitively costly to
set up business here due to Chinese regulations.


4. (SBU) Stanley said that in terms of how to treat the newly
locally-incorporated foreign banks, the China Banking Regulatory
Commission (CBRC) was "making it up as it went along." He said
that while the CBRC had initially approved the names submitted
to act as Citibank's independent board in China, Citibank
recently was told that the board needed to include "a Mainland
person," and that the CBRC was again reviewing Citi's board
membership.


5. (SBU) "The CBRC is pushing a level of intrusiveness and
forced changes on Citibank" that Stanley had not expected.
Citibank was being forced to adopt Chinese banking practices
"immediately." Stanley said that Citibank was also facing
interference from non-CBRC officials as well. He said, for
example, that the local police had inspected a Citibank branch
in a second-tier city and informed Citibank that they needed to
construct a different style vault for "security reasons."


6. (SBU) Despite being forced to act as a local Chinese bank,
Stanley said that Citibank was still not able to issue debit
cards to its RMB deposit customers. Stanley said that despite
the facts they were locally incorporated and therefore a
"Chinese bank" and should be able to issue debit cards like
every other Chinese bank, but the regulators "wanted to slow
Citi's growth and restrict capital inflows." The excuse given
by the CBRC to deny Citibank's issuance of the cards was that

SHANGHAI 00000504 002 OF 003


the People's Bank of China (PBOC) had some unspecified
"certification test" that Citi needed to pass. No one at either
the CBRC or the PBOC, however, "knew what the test was." While
he expected this issue to be resolved soon, he said it was clear
that the CBRC was using stalling tactics to enable Chinese banks
to "get there before the foreign competition."


7. (SBU) Nevertheless, Stanley said, "the good news is that the
market is hot and we are making money."

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Problems With Guangdong Development Bank
--------------


8. (SBU) Stanley said that Citibank's investment in the
Guangdong Development Bank (GDB) had not gone as smoothly as he
had hoped. Citibank had "management influence" at GDB, "but not
control." "There have been some issues with our consortium
partners and resistance to change," he said. There had been
problems with GDB's Communist Party Committee as well. (Note:
See Ref C. End note.)


9. (SBU) Eight of the top 13 people at GDB are seconded-Citibank
employees; this gives Citibank "blocking rights, but not
outright control." GDB was now capitalized to 6+ percent and
had an non-performing loans (NPL) book of only 5 percent.
Stanley expected that GDB would be capitalized to 7.2 percent by
the end of 2007. Since Citibank and its partners took it over,
GDB has earned $300 million in profits and was in the process of
raising more capital.

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Recapitalizing Rural Cooperatives
--------------


10. (SBU) Responding to a query from Chairman Bair, Stanley said
that there was "tremendous interest" by foreign capital to enter
China's financial sector. Given the difficulties and barriers
that banks not already present in China would face entering the
market, Stanley believed that there would be banks interested in
recapitalizing and consolidating China's ailing rural
cooperatives. This would be the "best way for the next wave of
foreign banks to get a piece of China's banking sector. But
this would be very hard to do organically," he said.


11. (SBU) Citibank had already brought some if its India-based
employees to China to discuss their success with similar
programs in India. However, the challenges, such as management
controls, accountability, and finding appropriately-trained
staff to live and work in these areas would be immense.
Furthermore, Stanley doubted that regional governments would be
willing to sever their controlling ties over the local banks.
"Not in this generation; it is not going to happen," he said.

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Implementing Deposit Insurance Would Be Difficult
-------------- --------------


12. (SBU) Chairman Bair discussed China's business climate and
China's need for a deposit insurance system with U.S. businesses
at a roundtable hosted by the American Chamber of Commerce
(Amcham) on July 26. Also attending was KPMG Assistant Manager
Paul Watson, Javelin Investments Chairman Kim Woodard, ChinaVest
Senior Vice President Erik Bethel, Huangpu Enterprise
Development Corp. CEO Eugene I-Chun Wang, AIU Insurance Shanghai
Branch Assistant Vice President Eric Zhang, and Bank of America
Senior Vice President Leehun M. Lee.


13. (SBU) Chinavest's Bethel said that the Chinese government
had undergone a "tectonic shift" from ownership of the means of
production to a regulator over independent companies. Every

SHANGHAI 00000504 003 OF 003


bank wanted to follow the success of the Industrial and
Commercial Bank of China (ICBC) and list on the market. Banks
therefore need to "clean themselves up" and deal with their
nonperforming loans and other structural problems. The stock
market was a catalyst promoting banking sector reform. A
deposit insurance system for banks in China would be a
beneficial step for both banks and the government, he said.


14. (SBU) Javelin Investment's Woodard agreed, but noted the
"serious risk of corruption in the system." He outlined as one
of China's endemic problems the fact that there was a serious
disconnect between rules and regulations and actual behavior.
Strong and independent regulatory oversight of the bank deposit
insurance program would be one solution to this problem, "but it
was difficult to envisage how this would be executed," he said.


15. (SBU) Huangpu Enterprise Development Corp.'s Wang noted that
under the current system, bank customers assumed that the
government would guarantee their savings even if the bank lost
money due to corruption and embezzlement. This was one reason
why Chinese continued to put money into savings accounts despite
the zero percent real interest rate they earned on these
deposits.
SCHUCHAT