FROM HIS OFFICE ON THE 36TH FLOOR OF THE HSBC TOWER IN Pudong, Richard Yorke looks out over Shanghai's teeming financial district and outlines growth plans that are every bit as lofty as the skyline around him. With China lifting restrictions on foreign banks, HSBC Holdings plans to open as many as 30 branches a year nationwide beginning in 2007, a breakneck expansion of its existing 26-branch network. The bank hired 1,000 employees in 2006, bringing its China head count to 2,700, and will add another 1,000 this year. It recently introduced two capital-protected investment products that allow Chinese investors to gain exposure to international currencies and Hong Kong stocks; the bank plans to roll out a full suite of products, including yuan deposits, mortgages and personal loans, just as soon as the authorities permit.
The aim is to use the brand of the world's second-largest bank to gain a significant share of the market in China's big eastern cities. "This is where the wealth is concentrated," says Yorke, HSBC's China chief.
"The opportunities that can be created by doing business with local citizens are huge," says Peter Wong, Hong Kongbased head of Greater China at HSBC. "China has a savings rate of 45 percent, and foreign banks with good products and services can now tap into this vast area."
The British bank has a head start, but it is hardly alone in its ambitions. International banks are gearing up for a major assault on the Chinese market, hoping to take advantage of the December 2006 liberalization of retail banking that was mandated as part of the country's November 2001 entry into the World Trade Organization. These banks, which had been restricted to offering foreign currency accounts to Chinese consumers, will now be able to take deposits and make loans in yuan.
To exploit that opportunity, foreign banks have aggressive plans to open new branches. Although their presence is tiny compared with China's banking behemoths, the foreigners believe their powerful brands, marketing and product expertise, technology and global reach will appeal to Chinese consumers, particularly the urban elite that controls the country's wealth.
"Everybody is anticipating full deregulation so foreign banks will be able to offer services to this huge market," says Linda Wong, head of ABN Amro Bank in China, which has ten branches and focuses on individuals with assets of at least $100,000. "It would only be banks that have absolutely no international strategy that would not be thinking about China."
Yet for all their enthusiasm, expertise and deep pockets, foreign banks face daunting challenges here.
The vast branch networks, long-standing customer relationships and deep knowledge of local consumer tastes that Chinese banks enjoy are crucial advantages in the coming battle with global players. Moreover, many of the biggest local banks have strengthened their competitive positions by raising billions of dollars through initial public offerings and selling minority stakes to foreign banks, giving them access to outside management and product innovation. The primitive state of China's financial markets, furthermore, will blunt foreigners' edge in innovation because there are few derivatives products on which to base newfangled structured products.
"In an incomplete financial market, sometimes those with international experience do not have an advantage," says Zhang Xuyang, head of wealth management at Beijing-based China Everbright Bank, the country's tenth-largest bank. "We have time to catch up with our foreign competitors."
Foreign banks also have plenty of regulatory hurdles to clear. Although the WTO agreement required China to open its market to foreign banks as of December 11, those institutions still need to obtain approval from the China Banking Regulatory Commission to open new branches or introduce new products. Most leading foreign banks are betting that they will be allowed to expand into perhaps three new cities a year and open as many as 20 to 30 branches in cities where they already operate, but the regulator's stance is far from clear. And even if foreign banks get a green light, expansion won't come cheap. The regulator requires banks to put up 100 million yuan ($12.8 million) of working capital for each new branch.
China, in short, is anything but a slam dunk for foreign banks. That's quite a change from a few years ago, when Chinese banks were mired in bad debts and offered little in the way of modern consumer products. "Winning is not a foregone conclusion, even when a market is growing at breathtaking speed and on a grand scale," says Tang Tjun, head of Boston Consulting Group's financial services practice in Beijing.
The experience of Western automakers offers a hint of the difficulties facing foreign banks, says Tang. Foreign manufacturers began investing in China in 1985, but only a handful of the 20 firms that entered -- including General Motors Corp., Honda Motor Co., Toyota Motor Corp. and Volkswagen -- have captured significant market shares.
Banks face an even steeper uphill struggle, says Lee Ah Boon, head of Chinese consumer banking at Citigroup. "When the auto manufacturers moved here, there was no local auto industry," he notes. "When we move into consumer banking, there are already well-established local banks that have a dominant role in the consumer market and $1.7 trillion in deposits."
Notwithstanding the challenges, foreign bankers are eager to take their gloves off, and for good reason. The potential of China's banking market is mouthwatering. Boston Consulting Group forecasts that between 2004 and 2010 the country's banking revenues will more than double, to $240 billion from $110 billion. The $130 billion increase will represent 28 percent of the expected rise in global banking revenues during the period, significantly more than the $110 billion increase projected for the U.S. and more than twice the $60 billion that Europe's top five banking markets -- France, Germany, Italy, Spain and the U.K. -- are expected to contribute.
Already, foreign banks have gone on a buying spree in a bid to access China's market. Since 2001 roughly 30 have spent more than $21 billion to obtain minority stakes in Chinese banks -- $17.6 billion of that in 2005 alone. Among the more prominent investments, HSBC spent a total of $3.5 billion for an 11 percent stake in Bank of Shanghai and 20 percent of Bank of Communications; Bank of America Corp. plunked down $3 billion for 9 percent of China Construction Bank; Royal Bank of Scotland led a consortium that included Merrill Lynch & Co. to buy 10 percent of Bank of China for $3.1 billion; Goldman, Sachs & Co. teamed up with American Express Co. and Germany's Allianz to buy an 8.9 percent stake in Industrial and Commercial Bank of China for $3.8 billion; Citigroup bought 5 percent of Shanghai Pudong Development Bank for $72 million. In November, Citi led a consortium including IBM Corp. and four local companies that agreed to buy 85.6 percent of Guangdong Development Bank for $3.1 billion.
Citigroup says it will gain operational control of Guangdong, but it is far from clear whether other foreign banks will be able to exercise real management influence with their stakes or be allowed to bid for control. As a result, most foreign institutions with serious designs on China's retail banking market are planning to build up their own fledgling branch networks.
The newcomers start with one massive disadvantage. China's big four -- Agricultural Bank of China, Bank of China, China Construction Bank and ICBC -- have 73,000 branches. The 73 foreign banks with operations in the country have a grand total of 252 branches. HSBC's 26 branches put it at the front of the pack, followed by London-based Standard Chartered Bank with 22, Hong Kong's Bank of East Asia with 16, Hang Seng Bank (HSBC's Hong Kongbased subsidiary) with 15, Citigroup with 12 and ABN Amro with ten. Foreign banks have a combined $105.1 billion in local and foreign currency assets, representing just 1.9 percent of the banking industry's total assets, according to the CBRC. They have a total of $33.4 billion in deposits and $54.9 billion in loans.
Size isn't everything, though. China's banks have historically focused on channeling capital to state-owned enterprises; they get only about 11 percent of their revenues from retail banking, on average. By contrast, in the first three quarters of 2006, Citigroup generated 55 percent of its revenues from consumer banking and a further 11 percent from wealth management.
The concentration of China's wealth also should make it easier for foreigners to penetrate the market. Boston Consulting Group estimates that a mere 0.4 percent of China's households -- some 1.6 million -- hold more than 60 percent of the country's wealth, controlling roughly $820 billion in assets. Merrill Lynch estimates that there are 300,000 Chinese with liquid assets, excluding property, of more than $1 million. Those numbers make China the largest market for wealth management in Asia, excluding Japan. And the majority of that wealth is in just six of China's 31 provincial regions: Beijing, Guangdong, Jiangsu, Shandong, Shanghai and Zhejiang.
"Institutions seeking to establish a presence in China can reasonably pursue their goals by focusing on a few key targets," says Boston Consulting's Tang.
Foreign banks are doing just that. HSBC is centering its expansion efforts on the cities of Beijing, Guangzhou, Shanghai and Shenzhen, which have a combined population of 55 million. Citigroup, which declined to disclose its expansion plans but says it will open as many branches as regulations allow, plans to concentrate on those cities as well as on Chengdu, in south-central China, and on Tianjin, near Beijing. "The biggest competition is on the eastern seaboard," says Citigroup's Lee.
Other contenders plan to open branches as fast as they can. Standard Chartered says it will double its branch network, to 44, within 18 months. Hang Seng plans to invest $128 million over the next two years to double its Chinese branch network, to 30. Hang Seng generated 5 percent of its $1.7 billion in pretax profit in 2005 from China and aims to raise that share to 10 percent by 2010. In 2005, HSBC's China profits surged 181 percent to $63 million, Standard Chartered's rose 80 percent to $33 million, and Bank of East Asia's gained 74 percent to $37 million, estimates Morgan Stanley analyst William Wong.
In coming months regulators are expected to announce the types of products and services that foreign banks will be allowed to offer local consumers. Draft regulations require foreign banks to incorporate locally and have minimum registered capital of 1 billion yuan, or $128 million, before serving domestic customers. After incorporating, which is expected to take three to six months, foreign bankers believe they will be allowed to take deposits; offer mortgages, personal and auto loans; provide credit cards; and sell yuan-denominated structured products. In the meantime, regulators are allowing applicants to accept time deposits of at least 1 million yuan. HSBC began offering such deposits in nine cities in mid-December.
So far 11 banks have applied to incorporate their operations: ABN Amro, Bank of East Asia, Bank of TokyoMitsubishi UFJ, Citigroup, Singapore's DBS Group Holdings, Deutsche Bank, Hang Seng, HSBC, ING Group, Japan's Mizuho Corporate Bank and Standard Chartered.
Foreign banks are targeting the cream of the Chinese retail market. HSBC and Citigroup, for example, are aiming to lure customers with disposable assets of more than $50,000. China's big banks, by contrast, define their wealthy customer base as those with deposits of more than 100,000 yuan, or $12,760.
Naturally enough, wealth management is a key area in which foreign banks believe they have an edge on their domestic rivals. Foreign investment products -- everything from stocks and bonds to currency plays -- can be sold to consumers under China's Qualified Domestic Institutional Investor program. Citigroup and HSBC have each been awarded rights to sell $500 million of QDII products, and Hang Seng and Bank of East Asia have the right to sell $300 million each.
In August, HSBC introduced a principal-guaranteed structured note linked to a basket of currencies. The note, which requires a minimum investment of $10,000, offers a return of up to 18 percent over 18 months, depending on the value of the euro, South Korean won and Indian rupee against the dollar.
Citigroup Private Bank, which targets customers with a net worth of more than $10 million, opened a Shanghai office in March and plans to set up in Beijing and Shenzhen in 2007. The private bank aims to help Chinese entrepreneurs grow their businesses and to connect them with international clients eager to invest in China, says Kaven Leung, the bank's Hong Kongbased head for North Asia. "Everybody wants to be in China and have a piece of the action," he says.
China Everbright's Zhang acknowledges that the brand cachet and experience of foreign banks are formidable strengths. But he is undaunted by the prospect of competition. With the yuan widely expected to appreciate against the dollar in coming years, he believes Chinese investors will hesitate to buy foreign currency assets. In any event, he says, China Everbright could easily find foreigners to help it provide QDII products of its own and has already begun talking with potential partners. Indeed, the big Chinese banks enjoy by far the largest QDII concessions, led by Bank of China ($2.5 billion), China Construction Bank and ICBC ($2 billion each) and Bank of Communications ($1.5 billion).
Major Chinese banks have been striving to improve the services they offer wealthy clients -- mainly, credit cards, mortgages and personal loans, as well as some structured investment products -- to keep them from defecting to foreign rivals.
ICBC has created 3,000 wealth management centers at its 18,870 branches, catering to its 16 million customers who maintain deposit balances of more than 50,000 yuan. Bank of China claimed to have 334,800 customers with deposits of more than 500,000 yuan and 3.3 million with more than 100,000 yuan at the end of 2005, the latest period for which it discloses figures; at that time, it boasted 200 wealth management centers with 2,000 advisers. China Construction Bank claimed to have 860,000 wealth management customers as of mid-2005; it employs 11,300 wealth managers.
The numbers are impressive, but bankers and analysts say the services that Chinese banks offer to high-end retail customers are still rudimentary. China Construction Bank's chief financial officer, Pang Xiu-sheng, acknowledges as much. "Although we are not so ready for the competition, we have over the past few years always been making preparations," he tells Institutional Investor. The bank's major initiative has been to bring Bank of America on board as a strategic shareholder. "We will rely on help from Bank of America to improve customer service," says Pang. Cooperation between the two banks, including training courses BofA is providing for senior CCB executives, has so far focused mostly on the mass retail market, but that training is applicable to wealth management, says Helen Eggers, the senior vice president in charge of the relationship at the Charlotte, North Carolinabased bank.
Foreign bankers say there is scant evidence that the big state-owned Chinese banks can match the products or services offered by their global rivals. Says HSBC's Wong, "I don't think they understand the concept of service."
A handful of partly private commercial banks -- including China Everbright, Beijing-based China Minsheng Banking Corp., Fuzhou-based Industrial Bank Co., Shanghai Pudong Development Bank and Shenzhen-based China Merchants Bank -- are doing a better job of serving wealthy customers, foreign bankers say. China Merchants offers one-on-one financial consulting to the 120,000 customers of its Sunflower wealth management service, provided at 102 offices. Customers with balances of more than 500,000 yuan accounted for 35.5 percent of the bank's 287 billion yuan in retail deposits at the end of June, by far the highest percentage of any Chinese bank.
"If you have a fixed-term certificate of deposit, at CMB you can transfer interest into another account on maturity," says Zhao Xinge, associate professor of finance at the China Europe International Business School in Shanghai. "When I tried to do that using my Bank of America account, there was no way I could do it. CMB leads in terms of service and innovation."
Fortunately for the locals, global banks will be too preoccupied with constraints of their own to fully capitalize on their opponents' weaknesses.
A lack of knowledge of the local market is the biggest obstacle foreigners face, bankers say. "Without a customer database, it is hard to do good lending," says HSBC's Wong. "We cannot say, 'Here is a big opportunity' and go like gangbusters. The opportunity is out there, but we need to take it one step at a time and build experience." The bank will focus its initial yuan-denominated lending efforts at existing customers, Wong adds.
The plummeting value of automobiles and legal difficulties in repossessing cars after defaults have curbed banks' appetites for auto loans, putting a damper on a potential growth area. China Merchants Bank slashed its auto-loan book to 1 billion yuan, or 1.3 percent of retail lending, at the end of March 2006, compared with 3.1 billion yuan, or 9 percent, in 2003.
Although the car-loan market is tempting, considering that 5 million cars were sold in China in 2006, Citigroup's Lee says his bank has no plans to offer them.
Foreign banks also must get to know local consumers better. "In China consumers don't understand risk," says HSBC's Wong. "When they invest they must win. So we have to be extremely careful with the types of products we offer. If they lose money, they will come back and say, 'You misrepresented the investment,' and ask for their money back."
Pricing pressures will make it difficult for foreign entrants to win market share. The Shanghai-based head of one foreign bank notes that competition from local fund managers drove mutual fund front-end fees down to 1 percent shortly after China opened the market six years ago, compared with more than 5 percent in Singapore and 3 to 5 percent in Hong Kong. Chinese banks are likely to use pricing to defend their market share in lending and other areas, this banker contends.
"When the market opens up, don't expect the foreign banks to do very well," this banker says. "Don't forget that local banks don't have to go for profits and can undercut you on price."
A shortage of experienced staff is another obstacle. This bottleneck is a key reason HSBC is keeping its expansion tightly focused. "In our four main cities, our ability to open new branches is not constrained by regulations," says China chief Yorke. "It's constrained by our ability to find the right location and to staff it with the right people in order to provide the consistent level of service that people expect from HSBC."
So how much headway can foreign banks make? Yorke says they still have some arrows in their quivers. HSBC's foreign currency business with consumers has grown since 2004 to represent more than half of its volume in China -- and is its fastest-growing segment. "One could argue that the range of services we can offer at the moment is relatively limited, yet at the same time, the growth is coming from local customers," says Yorke. "So what is it that they are choosing HSBC for? I think service, trusted advice, internationalism, the brand and integrity are the key differentiators."
The global reach of foreign banks is something that locals cannot match, explains Citigroup's Lee. "The moment government allows me, I can issue an ATM card and my customer can go to any city in the world to withdraw money," he says. "And there's a 24-hour Citiphone service available anywhere in the world. These are some things we can ride on and get people excited about."
Foreign banks have some key advantages and no shortage of ambition. But no one is expecting any easy, or fast, breakthroughs. As the Shanghai-based foreign banker puts it: "We're saying, 'Let's get the branches open, the staff trained. Even though we don't have many products to sell, this is an investment for the long term.'"