By Chen Daofu, Research Institute of Finance of DRC

Research Report No.255, 2006

Since its accession to the WTO, China has made impressive progress in further opening its financial industry to the outside world. By the end of June 2006, 71 foreign-funded banks had established a total of 214 commercial service outlets in China and had been permitted to offer RMB services to enterprises in 25 cities; 36 overseas financial institutions became shareholders of 18 Chinese banks, with a combined investment of US$17.9 billion; 23 sino-foreign fund management joint ventures and eight sino-foreign securities joint ventures had been established; 42 overseas institutional investors had been granted QFII licenses. In addition to fulfilling WTO commitments, China has taken the initiative to promote RMB convertibility under capital account by opening the markets for QFII custody, bonds underwriting, insurance agency, use of insurance funds abroad and custody of insurers' equity assets, in consideration of the development needs of its economic and financial reform. So far, the opening-up of China's financial industry's has even surpassed the scope of the country's WTO commitments in some fields.

As the transitional period set by the WTO is about to expireby the end of 2006, China's financial industry will be fully opened. This, on one hand, will increase the depth and scope of China's financial market, promote competition and improve efficiency. The country's domestic financial market will gradually integrate with the world financial market. On the other hand, this will impose new challenges upon financial market supervision and monetary adjustment in China. Moreover, whether foreign investment helps to sharpen the competitive edge of joint venture financial institutions is still subject to the test of time.

I. Present Situation of China's Banking Sector sinceOpening-up and its Impact on the Market

In terms of equity investment, 25 overseas financial institutions have become shareholders of 18 Chinese banks with a combined investment of US$17.9 billion. Among the investors, Bank of America Corporation and Temasek Holdings invested US$5.466 billion in China Construction Bank, the Royal Bank of Scotland, UBS AG and Asia Development Bank invested US$3.675 billion in Bank of China, and Asia Development Bank, CitiGroup, HSBC and other banks invested a total of US$2.6 billion in Bank of Communications, China Everbright Bank, China Minsheng Banking Corporation, Industrial Bank, Shanghai Pudong Development Bank, Shenzhen Development Bank and Bohai Bank. Except for Agricultural Bank of China, the big four state-owned Chinese banks have introduced strategic investors. All national joint-stock banks have also introduced strategic investors, except Guangdong Development Bank (who is negotiating with possible investors), CITIC Industrial Bank and China Merchants Bank. Major city-level commercial banks with relatively large scale and good asset quality have started the process as well. In general, the introduction of strategic investors shows the following characteristics:

Table 1　The Investment of Foreign Banks in Chinese Banks

1. Chinese banks differ in their purpose of introducing strategic investors

Chinese banks introduce strategic investors either actively or passively.

For the active group, large state-owned banks introduce strategic investors mainly for promoting the reform of their corporate governance structure, pushing ahead the transformation of internal systems and regimes, and improving the quality of management. Some joint-stock commercial banks do so largely for the purpose of improving management and competence, by learning from strategic investors' business development mode and success experiences. For those banks in financial difficulties, they introduce strategic investors mostly for lowering cost, driving comprehensive reform, rapidly reversing the financial status from deficit to surplus, preventing risks and maintaining stability.

The passive group's chief purpose of introducing strategic investors is to satisfy the strict requirement of the 8% capital adequacy ratio set by the China Banking Regulatory Commission (CBRC). Since financing on the domestic capital market is still restricted at present, and the laws and regulations on private placement are yet to be established, strategic investors have become a reasonable choice for domestic banks. On top of that, after introducing foreign investment has become popular in the banking sector, those who fail to do so would seem to be unfashionable.

2. Foreign investors sought for control right in the process of equity participation

The percentage of shares held by many foreign financial institutions in domestic banks have reached the upper limit set by the Chinese regulatory authority. For example, HSBC, ING Group, Commonwealth Bank of Australia, and Standard Chartered Bank invested in Bank of Communications, Bank of Beijing, Hangzhou City Commercial Bank and Bohai Bank, respectively, all with a 19.9% percentage of shares. Although some foreign financial institutions haven't become the largest shareholder, they have all negotiated a contract clause in the equity participation agreements allowing for future expansion of their shares. In some domestic banks, such as Industrial Bank and Bank of Beijing, the total percentage of foreign shareholding reaches the upper limit of 25% set by the Chinese regulatory authorities.

3. Some foreign-funded financial institutions invested in more than one Chinese bank

For instance, HSBC held a 19.9% stake in Bank of Communications, an 8% stake in Bank of Shanghai, a 19.9% stake in Ping An Insurance and an indirect stake in Ping An Bank controlled by Ping An Insurance. Commonwealth Bank of Australia is a shareholder of both Jinan City Commercial Bank and Hangzhou City Commercial Bank. Other financial institutions such as International Finance Corporation and Temasek Holdings held stakes in several banks. On the one hand, this is because China's relevant policy is not very clear and foreign-funded financial institutions that are positive about the development of China's financial market have to get prepared in several fields in order to confront this uncertainty and to avoid missing development opportunities. On the other hand, this might be related with the business strategy of foreign-funded financial institutions, especially of those who have set up branch offices in China. Investing in more than one Chinese banks may enable them to make use of their mixed operation advantages. They might also be seeking the possibility of checking the development of Chinese local banks and finally eliminating rivals.

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