The mainland is rethinking its view of the American banking system
Jane Cai 20 October 2008
A popular story on the mainland in the early 1990s shows the huge gap that then existed between the attitudes of Chinese and American consumers.
A Chinese grandmother saved a lifetime to buy a new flat. She moved in with great excitement but died only a few years later. Her domestic bliss was short-lived. An American grandmother, on the other hand, took out a loan when she was relatively young and enjoyed her home for decades.
That was when credit cards were still a novelty for Chinese banks and consumption was just becoming an admirable lifestyle rather than a shameful act. Buying on credit has since become widely accepted, mainly by the mainland’s younger generation. But with the deepening US-led financial meltdown triggered by the overexpansion of credit, there are serious doubts about whether continuing to follow the American consumerist style is wise.
Such reflection is taking place not only in internet chat rooms and among ordinary consumers. Mainland officials, bankers and academics are now rethinking their views of a system that has led to a long period of low interest rates in the US but sown the seeds of the financial crisis. Depending on their US dollar asset holdings, countries around the world including China have been dragged into the crisis.
The US financial system, once the epitome of modern economic thinking and an example to emulate, has suddenly imploded. Without a banking equivalent of the North Star to navigate by, coupled with the bleak global economic outlook, where should mainland banks turn to for direction?
More than a decade ago, when it was liberalising its economy, the mainland saw the devastating result of overzealous capitalism - the Asian financial crisis. That crisis showed Beijing that market liberalisation and free capital flows into developing countries could be destructive.
Now, 11 years later, a similar dire situation is unfolding. Mainland officials, think-tanks, bankers and experts have yet to draw any specific conclusions about this crisis, but the essence of the future direction is obvious - regulators will strike a more cautious note in banking supervision and be more meticulous about financial innovations. Banks, on the other hand, will be more risk-averse in making acquisitions as they continue to expand overseas.
At a forum last month, China Banking Regulatory Commission chairman Liu Mingkang, comparing the mainland’s supervision of the banking sector with the US, lauded the effects of his country’s long-time, tight surveillance.
“China’s property prices surged in previous years. Housing prices declined this year and the stock market slumped more than 60 per cent. What happened? Non-performing loans in our banks did not rise,” Mr Liu said.
“We will be very cautious. China has been opening up for 30 years. We realised many times that our teacher [the US] was not always right.”
Nonetheless, others have questioned the cautious approach. Is it the right path for a country that has an underdeveloped banking system?
Former central bank vice-governor Wu Xiaoling last month said the mainland’s problems were excessive supervision and insufficient financial innovation - issues totally different from those in the US. She warned that tightening the already stringent grip on banks’ businesses could backfire.
Unlike the US, the mainland has no subprime credit, securitised subprime credit products or a securities market for housing assets. Nor has the mainland financial sector the 30 to 40 times leverage that US investment banks and securities firms had. Any new financially innovative product requires the approval of regulators. Institutions also have to report their investment status to supervisory bodies regularly, according to Galaxy Securities economist Teng Tai.
“It is not China but the US that should learn a lesson from the meltdown. We should be wary against excessive caution in opening up the financial sector, for which we have a precedent,” Mr Teng said.
The precedent came after the 1997 Asian crisis, when the mainland upheld its foreign exchange system under which exporters could only exchange their foreign currencies for yuan. The aim was to build up the country’s foreign reserves. Though academics argued that US$300 billion in foreign reserves was enough as early as a decade ago, Beijing followed a conservative approach. As a result, the reserves reached US$1.8 trillion at the end of June.
Of the reserves, at least US$922 billion has been invested in bonds issued by Washington and government-sponsored enterprises. Mainland academics blame this overreliance on US assets to Beijing’s overreaction to the 1997 crisis. It has inevitably made itself a victim of the current turmoil.
The crisis also pressured authorities to be more cautious in liberalising the financial market in the areas of “supervising commercial banks’ activities, among other things”, said Guo Tianyong, a director of the Banking Industry Research Centre at the Central University of Finance and Economics.
“The leaders believe that excessive caution and insufficient innovation are better than vice versa. At least it will not incur serious mistakes,” Mr Guo said.
“Innovation will still be encouraged, but it should be in line with risk management ability.”
He advocated a better co-ordinated supervision system to streamline the practice of banking, insurance and securities regulators as well as the central bank issuing separate and inconsistent decrees.
“If the [subprime] crisis took place in China, the effect would be more disastrous. Each regulator only governs its own field and there is no effective co-ordination. If something goes wrong, no prompt action will be taken and no one will take responsibility,” Mr Guo said. “The supervision system is in urgent need of change.”
Mainland banks should be thankful for their relatively limited holdings of products related to the credit crunch. That exposure amounts to several billion US dollars, a small fraction of their assets.
With the meltdown, bankers are becoming more rational and moderating the drive to expand overseas.
“So far, overseas acquisitions by mainland financial institutions have proved to be failures. They should not buy because of low prices. They should consider buying only if the target business is in line with their strategy,” said Holger Michaelis, a partner and managing director of the Boston Consulting Group.
The US$3 billion investment last year by China Investment Corp in Blackstone’s initial public offering left the mainland’s US$200 billion sovereign wealth fund with a floating loss of more than US$1 billion as the US buyout firm’s share price plunged.
In its maiden overseas acquisition, mainland insurer Ping An Insurance (Group), paid US$2.7 billion for a 4.2 per cent stake in European financial group Fortis in November last year and boosted the stake to 4.99 per cent in March. But Ping An said this month it would book an impairment charge of 15.7 billion yuan (HK$17.8 billion) in the third quarter, after the governments of Belgium, the Netherlands and Luxembourg were forced to rescue Fortis. These lessons appear to have hit home.
The head of Industrial and Commercial Bank of China has indicated the bank was unlikely to take stakes in ailing US financial institutions just because prices were low.
“We will tighten our purse strings and spend every penny carefully,” chairman Jiang Jianqing said.
“As a commercial bank, we don’t favour bargain hunting. We will still focus on strategic investments rather than financial investments. The US financial meltdown has not yet bottomed. The crisis has made mainland banks more wary about investing in the US market.”
Instead, ICBC is interested in increasing its presence in emerging markets, notably the Middle East. A bank official said it would open branches this month in Dubai and Doha.
A source in another large lender said the bank was not interested in acquiring US financial institutions at the moment to avoid getting “into troubled water”.
Bank of China, the nation’s largest foreign exchange lender, is eyeing overseas businesses with models and products that could raise the bank’s earnings in its intermediary businesses.
“We are open. From a business point of view, we are looking at all possible deals everywhere,” Bank of China vice-president Zhu Min said. “We are more interested in unique and profitable business models and financial products rather than in seemingly undervalued financial assets.”
But a looming economic slowdown at home is also compelling many mainland banks to shelve ambitious expansion plans. After five consecutive years of rapid growth and an extraordinary first half in which 14 listed banks posted an average 67 per cent year-on-year increase in net profit, the winter is approaching.
Analysts said bank earnings peaked in the first half of this year and net interest margins could shrink. Economists expect lending rate cuts of up to 108 basis points in coming months until the end of next year.
In addition, an ailing property market, beleaguered exporters, and small and medium-sized companies are fuelling worries about rising non-performing loans, while the stock market downturn would weigh on banks’ fee and commission businesses, they said.
With the first big mainland economic slowdown in 10 years looming, a key risk to watch for is possible policy overreaction if a downturn is sharper than expected, says Standard & Poor’s analyst Tan Kim Eng.
Should growth slow sharply, throwing large numbers of people out of work, policymakers may react strongly with heavy-handed administrative controls. This could exacerbate pressures that banks face in a cyclical downturn and require some institutions to turn to the government for financial support, he said.
“Another important risk is that lending practices at the major banks may not have improved as much as generally believed. If a significant economic slowdown occurs, it would be a major test of the risk assessment and management capabilities of the large Chinese banks,” Mr Tan said.
“Should they prove to be less robust than expected, a greater proportion of their loans will likely turn bad. This, too, could require the government to step in to support the banks.”
While it is certain the US banking sector has fallen from its peak of prosperity, there is still no firm word on the prospects for mainland banks. How they weather the coming storm will play a key part in the country’ economic reforms in the future.
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Search for Lessons from Financial Crash
The mainland is rethinking its view of the American banking system
Jane Cai
20 October 2008
A popular story on the mainland in the early 1990s shows the huge gap that then existed between the attitudes of Chinese and American consumers.
A Chinese grandmother saved a lifetime to buy a new flat. She moved in with great excitement but died only a few years later. Her domestic bliss was short-lived. An American grandmother, on the other hand, took out a loan when she was relatively young and enjoyed her home for decades.
That was when credit cards were still a novelty for Chinese banks and consumption was just becoming an admirable lifestyle rather than a shameful act. Buying on credit has since become widely accepted, mainly by the mainland’s younger generation. But with the deepening US-led financial meltdown triggered by the overexpansion of credit, there are serious doubts about whether continuing to follow the American consumerist style is wise.
Such reflection is taking place not only in internet chat rooms and among ordinary consumers. Mainland officials, bankers and academics are now rethinking their views of a system that has led to a long period of low interest rates in the US but sown the seeds of the financial crisis. Depending on their US dollar asset holdings, countries around the world including China have been dragged into the crisis.
The US financial system, once the epitome of modern economic thinking and an example to emulate, has suddenly imploded. Without a banking equivalent of the North Star to navigate by, coupled with the bleak global economic outlook, where should mainland banks turn to for direction?
More than a decade ago, when it was liberalising its economy, the mainland saw the devastating result of overzealous capitalism - the Asian financial crisis. That crisis showed Beijing that market liberalisation and free capital flows into developing countries could be destructive.
Now, 11 years later, a similar dire situation is unfolding. Mainland officials, think-tanks, bankers and experts have yet to draw any specific conclusions about this crisis, but the essence of the future direction is obvious - regulators will strike a more cautious note in banking supervision and be more meticulous about financial innovations. Banks, on the other hand, will be more risk-averse in making acquisitions as they continue to expand overseas.
At a forum last month, China Banking Regulatory Commission chairman Liu Mingkang, comparing the mainland’s supervision of the banking sector with the US, lauded the effects of his country’s long-time, tight surveillance.
“China’s property prices surged in previous years. Housing prices declined this year and the stock market slumped more than 60 per cent. What happened? Non-performing loans in our banks did not rise,” Mr Liu said.
“We will be very cautious. China has been opening up for 30 years. We realised many times that our teacher [the US] was not always right.”
Nonetheless, others have questioned the cautious approach. Is it the right path for a country that has an underdeveloped banking system?
Former central bank vice-governor Wu Xiaoling last month said the mainland’s problems were excessive supervision and insufficient financial innovation - issues totally different from those in the US. She warned that tightening the already stringent grip on banks’ businesses could backfire.
Unlike the US, the mainland has no subprime credit, securitised subprime credit products or a securities market for housing assets. Nor has the mainland financial sector the 30 to 40 times leverage that US investment banks and securities firms had. Any new financially innovative product requires the approval of regulators. Institutions also have to report their investment status to supervisory bodies regularly, according to Galaxy Securities economist Teng Tai.
“It is not China but the US that should learn a lesson from the meltdown. We should be wary against excessive caution in opening up the financial sector, for which we have a precedent,” Mr Teng said.
The precedent came after the 1997 Asian crisis, when the mainland upheld its foreign exchange system under which exporters could only exchange their foreign currencies for yuan. The aim was to build up the country’s foreign reserves. Though academics argued that US$300 billion in foreign reserves was enough as early as a decade ago, Beijing followed a conservative approach. As a result, the reserves reached US$1.8 trillion at the end of June.
Of the reserves, at least US$922 billion has been invested in bonds issued by Washington and government-sponsored enterprises. Mainland academics blame this overreliance on US assets to Beijing’s overreaction to the 1997 crisis. It has inevitably made itself a victim of the current turmoil.
The crisis also pressured authorities to be more cautious in liberalising the financial market in the areas of “supervising commercial banks’ activities, among other things”, said Guo Tianyong, a director of the Banking Industry Research Centre at the Central University of Finance and Economics.
“The leaders believe that excessive caution and insufficient innovation are better than vice versa. At least it will not incur serious mistakes,” Mr Guo said.
“Innovation will still be encouraged, but it should be in line with risk management ability.”
He advocated a better co-ordinated supervision system to streamline the practice of banking, insurance and securities regulators as well as the central bank issuing separate and inconsistent decrees.
“If the [subprime] crisis took place in China, the effect would be more disastrous. Each regulator only governs its own field and there is no effective co-ordination. If something goes wrong, no prompt action will be taken and no one will take responsibility,” Mr Guo said. “The supervision system is in urgent need of change.”
Mainland banks should be thankful for their relatively limited holdings of products related to the credit crunch. That exposure amounts to several billion US dollars, a small fraction of their assets.
With the meltdown, bankers are becoming more rational and moderating the drive to expand overseas.
“So far, overseas acquisitions by mainland financial institutions have proved to be failures. They should not buy because of low prices. They should consider buying only if the target business is in line with their strategy,” said Holger Michaelis, a partner and managing director of the Boston Consulting Group.
The US$3 billion investment last year by China Investment Corp in Blackstone’s initial public offering left the mainland’s US$200 billion sovereign wealth fund with a floating loss of more than US$1 billion as the US buyout firm’s share price plunged.
In its maiden overseas acquisition, mainland insurer Ping An Insurance (Group), paid US$2.7 billion for a 4.2 per cent stake in European financial group Fortis in November last year and boosted the stake to 4.99 per cent in March. But Ping An said this month it would book an impairment charge of 15.7 billion yuan (HK$17.8 billion) in the third quarter, after the governments of Belgium, the Netherlands and Luxembourg were forced to rescue Fortis. These lessons appear to have hit home.
The head of Industrial and Commercial Bank of China has indicated the bank was unlikely to take stakes in ailing US financial institutions just because prices were low.
“We will tighten our purse strings and spend every penny carefully,” chairman Jiang Jianqing said.
“As a commercial bank, we don’t favour bargain hunting. We will still focus on strategic investments rather than financial investments. The US financial meltdown has not yet bottomed. The crisis has made mainland banks more wary about investing in the US market.”
Instead, ICBC is interested in increasing its presence in emerging markets, notably the Middle East. A bank official said it would open branches this month in Dubai and Doha.
A source in another large lender said the bank was not interested in acquiring US financial institutions at the moment to avoid getting “into troubled water”.
Bank of China, the nation’s largest foreign exchange lender, is eyeing overseas businesses with models and products that could raise the bank’s earnings in its intermediary businesses.
“We are open. From a business point of view, we are looking at all possible deals everywhere,” Bank of China vice-president Zhu Min said. “We are more interested in unique and profitable business models and financial products rather than in seemingly undervalued financial assets.”
But a looming economic slowdown at home is also compelling many mainland banks to shelve ambitious expansion plans. After five consecutive years of rapid growth and an extraordinary first half in which 14 listed banks posted an average 67 per cent year-on-year increase in net profit, the winter is approaching.
Analysts said bank earnings peaked in the first half of this year and net interest margins could shrink. Economists expect lending rate cuts of up to 108 basis points in coming months until the end of next year.
In addition, an ailing property market, beleaguered exporters, and small and medium-sized companies are fuelling worries about rising non-performing loans, while the stock market downturn would weigh on banks’ fee and commission businesses, they said.
With the first big mainland economic slowdown in 10 years looming, a key risk to watch for is possible policy overreaction if a downturn is sharper than expected, says Standard & Poor’s analyst Tan Kim Eng.
Should growth slow sharply, throwing large numbers of people out of work, policymakers may react strongly with heavy-handed administrative controls. This could exacerbate pressures that banks face in a cyclical downturn and require some institutions to turn to the government for financial support, he said.
“Another important risk is that lending practices at the major banks may not have improved as much as generally believed. If a significant economic slowdown occurs, it would be a major test of the risk assessment and management capabilities of the large Chinese banks,” Mr Tan said.
“Should they prove to be less robust than expected, a greater proportion of their loans will likely turn bad. This, too, could require the government to step in to support the banks.”
While it is certain the US banking sector has fallen from its peak of prosperity, there is still no firm word on the prospects for mainland banks. How they weather the coming storm will play a key part in the country’ economic reforms in the future.
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