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The 2006 year has been branded the 'Year of the Bank'. Indeed, on the fifth anniversary of China's accession to the World Trade Organisation (WTO), the Chinese banking sector is expected to undergo a revolutionary transformation. As part of China's WTO commitments, the financial services sector is expected to open up fully to foreign players by 11 December this year. Of all those set to get a slice of the WTO cake, foreign banks will take home the largest slice.
On 11 December all geographical and customer restrictions on renminbi business will be removed. This means foreign financial institutions will be allowed to offer renminbi services to individual and corporate clients in any part of China.
Currently foreign financial institutions can only provide renminbi services to corporate clients and non-Chinese nationals in a limited number of cities. In theory, the full liberalisation of the banking sector will afford national treatment to foreign financial institutions - that is, they will be treated in the same manner as domestic banks. But does this, from a practical perspective, place foreign banks on the same competitive platform as domestic banks?
To provide services to customers in China, a foreign bank must operate through a foreign financial institution, such as a branch of a foreign bank in China or a wholly foreign-owned or joint venture bank or finance company established in China. Recently, there have been suggestions of the need to incorporate branches and sub-branches of foreign banks. This is likely to raise the entry threshold to a higher level. To establish a foreign financial institution, a foreign bank must satisfy certain additional requirements that do not apply to their domestic counterparts and that will remain in place even after 11 December.
This means that, while the criteria for provision of a particular renminbi service applies equally to foreign financial institutions and domestic banks, foreign banks will still be subject to a distinct layer of regulation on the expansion of their networks, the only limitation of which is that the criteria must be "solely prudential and contain no economic needs tests or quantitative limits on licences". These barriers to entry are expected to restrict, at least in the short term, the depth and breadth of activities in China for a foreign bank without an existing branch network.
Meeting the criteria
An extensive customer network is vital to achieving success on the consumer banking battlefield. To catch up to the infrastructure already built by domestic banks over a substantial period of time, foreign banks not only face challenges typically faced by new market entrants, but more so the formidable hurdles which only foreign banks have to cross.
Under the current legal framework, foreign banks must meet additional criteria for establishing branches, including: having total assets of no less than $20bn (£10.99bn); having a capital adequacy ratio of no less than 8 per cent; and having no less than Rmb100m-Rmb300m (£6.87m-£20.6m) of working capital allocated to each branch, depending on the type of business.
It is critical to note that, behind the banner of 'full market access', the opening of every branch is subject to regulatory approval, and even in an environment that offers complete transparency and accountability, discretion plays a significant role in the decision-making process. It cannot be ruled out that the approval process may be delayed, or made more difficult, to control the pace of foreign banks' expansion, and investment in certain locations may be favoured over that in other, more well-established, cities.
For those foreign banks yet to enter the Chinese market, they may discover that 'national treatment' is not 'national' in every sense of the word. For example, the minimum registered capital for a wholly foreign-owned bank or a Sino-foreign joint venture bank is Rmb300m (£20.6m) - this is Rmb200m (£13.73m) more than the minimum requirement for urban commercial banks and Rmb250m (£17.16m) more than rural commercial banks. Furthermore, the total assets of a foreign bank in the year immediately preceding its application may not be lower than $10bn (£5.49bn).
It must be emphasised that 11 December does not entail liberalisation of every form of banking activity. Activities that are currently restricted and do not fall within the schedule of specific liberalisation will only be opened up to foreign banks on a case-by-case basis, the timetable of which one can only speculate about. For example, the permitted business scope of foreign banks does not expressly contain certain business that appears in that of domestic banks, such as the issue of financial bonds, the issue and underwriting of treasury bonds and bancassurance, none of which are subject to specific liberalisation under the WTO commitments. This means that, even after 11 December, there will be certain discrete areas of business that will continue to remain off-limits to foreign financial institutions unless specific liberalisation is made in those areas.
In order to conduct renminbi business, foreign banks must have operated a business in China for more than three years and made profits in three consecutive years of the three years prior to its application. Adding that to the two-year representative office requirement prior to the opening of a wholly foreign-owned bank or a foreign bank branch, it effectively means that one needs to have had a presence in China for at least five years before any application can be made.
Finding a way in
Tough prudential controls and uncertainty of regulatory approval, combined with domestic banks' established branch networks and longstanding relationships with local clients and government officials, mean that the competitive edge enjoyed by domestic banks cannot be easily displaced. As such, we have witnessed a wave of foreign banks buying strategic minority stakes in domestic banks in an attempt to gain greater access to the Chinese market; and such a wave is likely to continue given the limitations on foreign banks' expansion. In fact, three of the chinese big four - China Construction Bank, Bank of China and ICBC - have all welcomed capital injections by foreign investors. Bohai Bank, the first domestic bank to be established with strategic foreign investment, opened for business early this year.
It is important to note that the implementation of the WTO commitments does not lift the current shareholding restriction imposed on foreign investors in domestic banks. Government officials have reportedly made it clear that the current cap of 20 per cent for a single foreign investor and 25 per cent for foreign investors collectively will stay in place, and it is a current policy rule that a foreign investor may not invest in more than two domestic banks. In addition, draft regulations in respect of Sino-foreign credit card joint ventures suggest that foreign participation is likely to be capped at a level below 50 per cent. Although experience shows that the price of securing a minority stake in a domestic bank is high and there exists structural problems, particularly in the areas of corporate governance and risk management, it must be weighed carefully against the cost and speed of organic growth. The utilisation of each party's comparative advantage in a Sino-foreign alliance has been one of the key drivers of foreign investors owning stakes in domestic banks.
Indeed, implementation of the WTO commitments will redefine the competitive landscape as foreign banks are granted the opportunity to access China's booming market for financial services. As one of the most anticipated commitments to date, the opening up of the Chinese banking sector will hopefully result in consumers being the ultimate beneficiaries as local players improve their competitiveness in the wake of foreign competition.
Although much of the legal infrastructure is now in place, it is unlikely that there will be a level playing field for foreign banks starting from day one. China has taken an important first step in recognising the need for an open market. The next step is critical.
Zili Shao is managing partner of greater China and Min-Jie Lou is an associate, both at Linklaters
especially the banks. But do too many restrictions remain? Zili Shao and Min-Jie Lou report