China's Banking Industry: Flawed But Unstoppable

Reports from the World Economic Forum in Davos, Switzerland cast somewhat of a cloud over China's banking industry, with economists saying more reform needs to be done before the country can achieve its predicted growth: The country's banks carry the burden of transferring the population's sky-high savings into industry and investment, and they haven't been doing such a terrific job, according to reports from the forum on Marketwatch.

"The banks have poured huge amounts of money into wasteful and often grandiose infrastructure projects and kept afloat struggling state-owned enterprises," reports Marketwatch, citing McKinsey & Company. "Most of China's banks are also technically insolvent, carrying twice as much value in non-performing loans as they have in equity."

Jack Ribeiro, global managing partner of Deloitte's Financial Services Industries practice agrees that banks need to increase their efforts, but he also lauds the progress made. "For the 9% growth [expected in China's economy, banking growth] needs to be around 15%," Ribeiro told InstitutionalInvestor.com. The big four banks — Bank of China, Industrial and Commercial Bank of China, China Construction Bank and the Agricultural Bank of China – have made progress, albeit some would argue not enough. For instance the current lending culture needs to be changed for the banks to be able to accommodate the growing middle class

"The way to really illustrate this is that [economists] are anticipating an additional middle class of 40 million per year," Riberio said. "That's the size of most countries needing autos, houses and [engaged] in consumer spending."

The decision by the World Trade Organization to allow foreign banks to enter in to the Chinese market has had a significant impact, particularly in terms of improving standards, monitoring [non performing loans], implementing new risk policies and ensuring transparencies, Ribeiro said. Foreign banks can operate independently in China beginning in 2007, but most of the largest global institutions have bought into the "big four" to learn the market prior to the transition: RBS and UBS have invested roughly $7 billion in the Bank of China; Goldman Sachs, Allianz Group and American Express have invested $3.78 billion for a share of Industrial and Commercial Bank of China, pending approval by the China Banking Regulatory Commission; Bank of America has invested in China Construction Bank, and the list goes on.

Ribeiro, who is bullish on China's economy, says the momentum is "unstoppable" and extends beyond the banking industry to the insurance sector. "In 2006, [expect] premiums to double what they were in 2005," he said. "The property and casualty market is completely underserved; fifteen years ago, 5% of the population in China had insurance. That's completely changing."