Transcript China’s Financial Development, Reforms and Challenges Chun Chang Professor of Finance China Europe International Business School.

China’s Financial Development,
Reforms and Challenges
Chun Chang
Professor of Finance
China Europe International Business School
 China’s Latest Financial
Reforms and Development
China’s Financial System
Financial Regulatory Structure
The State
Council
CBRC
CSRC
Commercial
Banks
Securities
Firms
Credit
Cooperatives
Exchanges
Trust &
Investment
Fund
Management
Source: CICC Research
CIRC
Insurance
Companies
China’s Financial System
Heavy Reliance on Bank Financing (2006)
Source: CEIC; CICC Research
China’s Financial System
• Japan-Germany-like Financial Structure
– Financial assets concentrated in the banking
system
– No stock markets before 1991
– In 2006, more than 80% of financing is still
through banks
– insurance industry is growing fast but still
underdeveloped
– legal framework for private equity financing is
just starting
China’s Financial System
The State’s Dominance of the Banking Industry (Assets, 2006)
Urban Credit
Union
0.5%
Rural Credit
Union
9.5%
Foreign Banks
2.1%
City
Com m ercial
Banks
6.9%
Joint Stock
Banks
18.8%
Source: The Statistics Quarterly PBOC
State-owned
Banks
62.2%
Banks in China
• State-owned banks: ICBC, CCB, BOC, CAB
• Joint stock banks: Bank of Communication, China
Merchants Bank, Guangdong Development Bank,
Minsheng Bank
• City banks and credit unions: Bank of Shanghai,
Bank of Nanjing, Ningbo Commercial Bank
• Foreign banks: HSBC, Citibank, Standard
Chartered,
China’s Financial System
• Progress in Banking Reform
– Recapitalization of state banks
• 4 asset management companies set up in year 2000 to take
over US$1,600 billion of non-performing loans
• US$1108 billion NPLs disposed up to March 2006,
cash recovery rate 20.8%
• US$45 billion capital injection in 2004 for BOC and CCB
• US$15 billion capital injection in 2005 for ICBC
– CCB listed in Hong Kong in 2005, BOC and ICBC in
2006
– Reorganization and recapitalization of China
Agricultural Bank and Postal Savings Bank for listing
China’s Financial System
• Progress in Banking Reform (2)
– Brought in foreign strategic investors before IPO
– Foreign strategic investors introduced
• CCB: Bank of America, Asian Financial Holdings (AFH),
holding 14.4%
• BOC: Royal Bank of Scotland, AFH, UBS, Asian Development
Bank, holding 16%
• ICBC: Goldman Sachs, Allianz et. al. 17%
– Foreign investment in banks raised to 25%
– Invited private entrepreneurs to take minority stake
China’s Financial System
Comparison of Chinese and Foreign Banks 2002
(US$ mn, 2002)
BNP Paribas
Citigroup
Bank of America
HSBC Holdings
Bank of Tokyo-Mitsubishi
ICBC
BOC
CCB
Total Assets
710,319
1,097,190
660,458
795,246
807,111
571,768
350,931
372,367
Net Profit Profit per Staff
3,295
37,571
15,276
61,104
9,249
na
6,239
33,833
42
na
746
1,841
1,141
5,927
520
1,694
Source: Banks’ Annual Reports, CICC Research
ROA
0.52
1.48
1.23
0.90
0.01
0.14
0.34
0.15
ROE Fee Income NPL Ratio
16.74
35.50
6.45
20.01
49.00
2.34
16.40
35.00
1.47
13.69
29.40
2.90
0.22
32.90 na
3.35
5.71 25.69
4.31
33.99 22.50
4.01
4.93 15.17
China’s Financial System
Comparison of Chinese and Foreign Banks 2005
(US$ mn, 2005)
BNP Paribas
Citigroup
Bank of America
HSBC Holdings
Bank of Tokyo-Mitsubishi
ICBC
BOC
CCB
Total Assets
1,560,018
1,494,037
1,269,892
1,501,970
863,021
788,047
481,568
559,920
Net Profit Profit per Staff
7,256
66,096
24,589
82,237
16,465
na
15,873
55,891
2,676
na
4,115
10,829
3,357
16,014
4,792
15,958
Source: Banks’ Annual Reports, CICC Research
ROA
0.67
1.66
1.30
1.06
0.30
0.59
0.67
0.92
ROE Fee Income NPL Ratio
20.20
20.81
3.47
22.30
36.82
2.01
16.51
36.13
0.85
16.80
32.24
2.37
10.13
40.15
na
13.30
6.41
4.69
11.45
7.97
4.90
17.99
6.57
3.84
ROA & ROE of Listed Chinese Banks 2006, 2007
ROA
ROE
Year 2006
First half year of 2007
Year 2006
First half year of 2007
China Merchants Bank
0.81%
1.20%
16.70%
21.40%
Bank of China
0.85%
1.06%
12.81%
14.09%
ICBC
0.71%
1.05%
13.60%
19.90%
Industrial Bank
0.70%
1.02%
26.20%
29.90%
Bank of Communications
0.78%
0.93%
14.10%
17.47%
China CITIC Bank
0.60%
0.82%
14.10%
11.70%
Shenzhen Development Bank
0.54%
0.78%
22.40%
31.50%
China MinSheng Bank
0.61%
0.73%
22.10%
19.00%
Shanghai Pudong Development Bank
0.53%
0.70%
16.50%
23.70%
HuaXia Bank
0.36%
0.44%
13.10%
17.80%
Nonperforming Loans of Chinese Banks
21000
15
18000
12
15000
12000
9
9000
6
6000
3
3000
0
Year 2004
Year 2005
Year 2006
Year 2007 1st Qtr
Balance (hundred million)
17176
13114
12549.2
12455.7
Percentage(%)
13.21
8.61
7.09
6.63
Balance (hundred million)
Percentage(%)
0
China’s Financial System
• Chinese Capital Markets
– 1540 publicly listed companies on domestic
exchanges, 143 on overseas (Feb 2007)
– Equity market capitalization of around US$3
trillion (2007)
• State Shares 33.1%, (non-tradable until 2005)
• Legal person shares 16.7% (non-tradable until 2005)
• Tradable individual shares 50.2%
– Government bond market cap US$ 364 billion
– Corporate bond market cap US$35 billion
Progress of Chinese Stock Market Reform
• Before 2005, state-owned and legal person-owned
shares could not be traded on stock exchanges.
Large shareholders paid little attention to the
prices of tradable shares held by the public.
• In 2005, the government initiated reforms that
made non-tradable shares tradable.
• This aligned the interests of large shareholders
with that of outside shareholders
Dec-07
Dec-06
Dec-05
Dec-04
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
Dec-95
Dec-94
7000
Dec-93
Dec-92
Dec-91
Dec-90
Financial Reforms
Shanghai Stock Exchange Index
(1990/12/19--2008/01/04)
6000
5000
4000
3000
2000
1000
0
China’s Financial System
• Great Leap Forward in Equity Market
– An average of US$9 billion raised per year from
1991 to 2006
– In 2007, $50 billion new A-shares were issued,
taking the first place in the world (the second
place US equity markets raised less than $40
billion in 2007)
– Shanghai Stock index increased by almost
100% in 2007
China’s Financial System
Over-Valuation? (P/E)
80
70
60
50
40
30
20
10
A Share- Shanghai
Source: CEIC
A Share- Shenzhen
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
0
H Share
China’s Financial System
QFII and QDII
• Raised QFII quota to US$ 30 billion at the end of
2007
• QDII launched in July 2006
– 5 domestic banks: BOC, CCIB, CCB, BOCOM, CMB; 3
foreign banks (Bank of east Asia, HSBC, Citibank); &
Huaan Fund Management chosen for experiment
– 19 institutions approved, US$14.5 billion investment
quota granted
• QDII quota reached US$42.17 billion by the end of
the third quarter in 2007
• Local markets (Shanghai & Shenzhen) have 120
million investor accounts in Sept. 2007.
China’s Financial System
• Private Equity
– Size estimated around 620 billion RMB in 2007,
much of it comes from abroad.
– Limited Partnership were authorized in Chinese
law in June of 2007
• Enormous Potential
– Great demand in a vibrant economy for private
equity
– High risk and cost due to poor legal and
financial infrastructure
China’s Financial System
• Financial Regulations
– Entry regulation
• Geographic and business restrictions for foreign banks
and insurance companies
• Foreign stake in commercial banks capped at 25%
• Foreign partners can take up to 33% in JV brokerage
firms and fund management companies
• Approval required for branches & offices
• License required for domestic institutions
• Private individuals can only have a minority position
China’s Financial System
• Financial Regulations (2)
– Interest rate regulation
• Both lending and deposit benchmark rates are set by
the central bank (one year lending rate is now 7.47%
and deposit rate is 4.14%)
• Lending rate has no upper limit and the lower bound
is 90% of the benchmark rate. the rates for mortgage
loan can be 85%.
• Deposit rate has the benchmark rate as the upper
limit and is allowed to float downward.
• Interbank rate SHIBOR was introduced on Dec. 1,
2006 and determined by market forces
China’s Financial System
• Financial Regulations (3)
– Regulation of international accounts
• Current account deregulated
• Closed Capital/Financial account with a few exceptions
– Managed floating exchange rate regime
• The RMB pegged to USD at RMB 8.27/USD from mid1990s to 2005
• It is supposed to be pegged to a basket of currencies
since July 21, 2005
• The RMB/US$ exchange rate allowed to float no more
than 0.5% of the previous day’s closing, 1.5% against
other currencies
• No timetable for full convertibility
China’s Financial System
Strong RMB Backed by Foreign Reserves
1200
8.8
8.6
8.4
8.2
8
7.8
7.6
7.4
7.2
1000
800
600
400
200
0
Apr- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan94 95 96 97 98 99 00 01 02 03 04 05 06 07
Foreign Reserve (billion US$)
Source: CEIC
Exchange Rate (Yuan/dollar)
China’s Financial System
• The Value of RMB
– The upward pressure on RMB is driven by the
twin surplus (current account and financial
account) and is balanced by holding surplus
foreign currencies as reserves
– To balance the twin surplus and reduce foreign
currency reserves, RMB needs to be revalued
– The speculation that RMB will be revalued
eventually has caused hot money flowing into
China and excess liquidity and asset inflation
Factors Against Appreciation:
• Worries about adverse effect on exports and employment
• Unwillingness to be seen as yielding to foreign pressure
• Factors in Favor of Appreciation:
• Domestic inflationary pressure and asset bubbles
• Interest rate differentials and inflow of hot money
• Ability to raise interest rate in order to cool down economy
• Responsibility for the loss of value of foreign currency
reserves
Challenges Ahead
Exchange Rate Issues
• How much and how fast should RMB rise?
• Free floating, Pegging and pegging to what?
• When and how to make RMB fully
convertible?
Banking Issues
• How and when to eliminate interest rate regulation
and introduce real competition?
• How to compensate party-appointed bank officials?
• How to introduce universal banking?
• How to establish government deposit insurance?
Capital Market Issues
• Need to develop a more mature market and
less government intervention
• Institutional investors need to play a more
important role
• Need to develop corporate bond market,
learn how to price credit risk
• Information disclosure and insider trading
Other More Important Issues
• The following issues will have a bearing on
how fast China’s financial reforms will be
carried out:
• Income inequality
• Political stability and reforms
• Environmental Issues