Chinas Financial Development, Reforms and Challenges Chun Chang Professor of Finance China Europe International Business School

China’s Financial Development, China’s Financial Development, Reforms and ChallengesReforms and Challenges

Chun Chang

Professor of Finance

China Europe International Business School

China’s Latest Financial China’s Latest Financial

Reforms and DevelopmentReforms and Development

Source: CICC Research

The State

Council

CBRC CSRC

Commercial Banks

Credit Cooperatives

CIRC

Trust & Investment

Securities Firms

Exchanges

Fund Management

Insurance Companies

Financial Regulatory Structure

China’s Financial SystemChina’s Financial System

Heavy Reliance on Bank Financing (2006)

Source: CEIC; CICC Research


• 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


State-ownedBanks62.2%

Rural CreditUnion9.5%

Urban CreditUnion0.5%

Foreign Banks2.1%

Joint StockBanks18.8%

CityCommercial

Banks6.9%

The State’s Dominance of the Banking Industry (Assets, 2006)

Source: The Statistics Quarterly PBOC


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,

• 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


• 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


(US$ mn, 2002) Total Assets Net Profit Profit per Staff ROA ROE Fee Income NPL Ratio

BNP Paribas 710, 319 3, 295 37,571 0. 52 16. 74 35. 50 6. 45Citigroup 1, 097, 190 15, 276 61, 104 1. 48 20. 01 49. 00 2. 34Bank of America 660, 458 9, 249 na 1. 23 16. 40 35. 00 1. 47HSBC Holdings 795, 246 6, 239 33, 833 0. 90 13. 69 29. 40 2. 90Bank of Tokyo-Mitsubishi 807, 111 42 na 0. 01 0. 22 32. 90 naICBC 571, 768 746 1, 841 0. 14 3. 35 5. 71 25. 69BOC 350, 931 1, 141 5, 927 0. 34 4. 31 33. 99 22. 50CCB 372, 367 520 1, 694 0. 15 4. 01 4. 93 15. 17


Comparison of Chinese and Foreign Banks 2002

Source: Banks’ Annual Reports, CICC Research

(US$ mn, 2005) Total Assets Net Profit Profit per Staff ROA ROE Fee Income NPL Ratio

BNP Paribas 1, 560, 018 7, 256 66,096 0. 67 20. 20 20. 81 3. 47Citigroup 1, 494, 037 24, 589 82, 237 1. 66 22. 30 36. 82 2. 01Bank of America 1, 269, 892 16, 465 na 1. 30 16. 51 36. 13 0. 85HSBC Holdings 1, 501, 970 15, 873 55, 891 1. 06 16. 80 32. 24 2. 37Bank of Tokyo-Mitsubishi 863, 021 2, 676 na 0. 30 10. 13 40. 15 naICBC 788, 047 4, 115 10, 829 0. 59 13. 30 6. 41 4. 69BOC 481, 568 3, 357 16, 014 0. 67 11. 45 7. 97 4. 90CCB 559, 920 4, 792 15, 958 0. 92 17. 99 6. 57 3. 84


Comparison of Chinese and Foreign Banks 2005

Source: Banks’ Annual Reports, CICC Research

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

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Balance　(hundred　million) Percentage(%)

Balance　(hundred　million) 17176 13114 12549.2 12455.7

Percentage(%) 13.21 8.61 7.09 6.63

Year　2004 Year　2005 Year　2006 Year　2007　1st　Qtr

• 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

Financial ReformsFinancial Reforms

Shanghai Stock Exchange Index(1990/12/19--2008/01/04)

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• 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


Over-Valuation? (P/E)

Source: CEIC


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A Share- Shanghai A Share- Shenzhen H Share

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.


• 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


• 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



• 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


• 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 mid-

1990s 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

Strong RMB Backed by Foreign Reserves

Source: CEIC


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Foreign　Reserve　(billion　US$) Exchange　Rate　(Yuan/dollar)

• 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 AheadChallenges 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

Documents

Chinas Financial Development, Reforms and Challenges Chun Chang Professor of Finance China Europe International Business School