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Goldman Sachs vs. Chinese Banks

What does it take for China's big banks to become world-class players in this industry?

Ann Lee

Financial analysts who claim that China’s big banks will soon catch up with their Western counterparts in the league tables demonstrate a lack of understanding about what it takes to be a world-class player in this industry. Goldman, Sachs & Co. became a powerhouse by developing its culture, talent pool and infrastructure over the past century under the right mix of regulation and opportunity. For Chinese banks to reach the same competitive plane would likewise take decades, if they could manage it at all.

First and foremost among the issues Chinese banks face is compensation. Wall Street, with its extraordinarily large compensation packages, is able to lure the best talent in the U.S. A 23-year-old who can earn $3 million a year speculating in the markets has little incentive to go into other industries. In China the government owns large equity stakes in the banks, which it views not as profit centers but as tools to carry out certain mandates. As a result, these banks would be hardpressed to offer the type of compensation that would attract and retain the best talent.

A second obstacle is the wild card of government intervention, as seen in the Rio Tinto scandal. Potential clients may well conclude that doing business with purely private enterprises is a safer, smoother route.

A third stumbling block is the relative lack of financial sophistication in China. The country has no derivatives market and an extremely small bond market, does not allow shorting and has virtually no consumer credit outside of mortgages. Financial services in China look like those in the U.S. in the 1970s. Building an industry with the necessary risk management and intellectual capital to rival New York or London will take decades.

Last, the cultural gap between U.S. and Chinese financial firms is enormous. Goldman Sachs and other large Western firms originated as partnerships, an ownership structure that instills a culture of care and commitment in employees. Many Chinese banks, especially the largest ones, have evolved under state ownership. Their employees, therefore, do not feel the same loyalty as their counterparts at Western investment banks and have less incentive to be innovative and competitive.

If the Chinese government wants to build the country’s financial sector, it will have to liberalize the currency, establish consumer credit and allow much freer capital markets. It must permit more generous compensation packages to attract top talent from Western firms and among Chinese graduates, and it will have to reduce its involvement in the industry, giving employees a greater ownership stake in the firms. Doing all of this is a tall order, and after witnessing the credit crisis topple some Western firms, the Chinese are in no hurry to follow in their footsteps.

That said, now that large Western banks such as Goldman Sachs have become public companies, abandoning the partnership model together with other elements of the culture that made them successful, some argue that the playing field may begin to level. If so, Chinese banks may eventually be able to catch up and develop formidable franchises. To do this they must develop greater trust between management and employees, rewarding the latter for their efforts, giving them greater autonomy to take calculated risks to benefit the firm and encouraging them to believe that they belong to an exclusive club that deserves their loyalty.

Unfortunately, creating such a culture is easier said than done, especially in a country where parents learned to mistrust their own children only a few short decades ago during the Cultural Revolution. However, only when this challenge is overcome can Chinese banks successfully retain the necessary intellectual capital and talent to compete against the best deal makers in the world.

Ann Lee is an adjunct professor at New York University, a former visiting professor at Peking University, an investment banker and a fixed-income trader.

See related article, "China Wants to Reshape the International Financial System."

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