Big banks a lousy bet despite bailout
China has thrown billions of yuan at its key lenders but still foreign investors find them unpalatable, writes Tom Holland
It is hard to think of US$15 billion as just a drop in the ocean.
But given the enormity of the black hole in China's banking system, the US$15 billion injected this week into the Industrial and Commercial Bank of China (ICBC) amounts to little more than that.
Even coming on top of the 270 billion yuan 1998 finance ministry bailout of China's Big Four state-owned banks, the 1999 transfer of 1.4 trillion yuan in bad loans off the banks' books, and the injection of US$45 billion into Bank of China (BOC) and China Construction Bank (CCB) in 2003, the latest move still leaves China's banks years away from sound financial health.
That will not deter Beijing from attempting to recruit foreign banks as strategic investors for the Big Four. But it really ought to stop foreign bankers from sinking billions of dollars of their shareholders' funds into such hazardous investments.
Consider ICBC. Following this week's capital boost, some reports boldly declared that China's biggest lender is now preparing for a US$10 billion stock market flotation as early as next year.
Fat chance. ICBC is a vast, chaotic behemoth sprawled across China. It has more than 20,000 branches, nearly 400,000 staff and around 100 million customers. In comparison, McDonald's Corp only serves 50 million people a day worldwide.
ICBC's banking assets are estimated at about six trillion yuan. But 19 per cent of those, or 1.14 trillion yuan, are officially classed as non-performing.
In other words, the bank has lent more than a trillion yuan to borrowers who are not likely to pay it back.
According to Fitch Ratings, it would take US$50 billion, not US$15 billion, to recapitalise ICBC. Other analysts have put the amount needed as high as US$70 billion.
Even that figure may understate the true magnitude of the problem. To flatter their figures, bank branch managers commonly avoid classing loans as non-performing by rewriting payment schedules, or by simply lending new money to borrowers so they can service their old loans.
Aware of these problems, Beijing is leaning hard on the banks to clean up their acts, strengthen management supervision and introduce strict credit controls.
Rather than a one-off payment, it is likely last week's US$15 billion capital injection was intended as an incentive to ICBC's bosses to meet new targets for returns on assets and profitability. If they do, the bank will get more cash in the future. But this is a process that will take years, not months.
CCB and BOC are in better shape than ICBC, on paper at least. By the middle of last year, CCB's official non-performing loan ratio had been pared to just 3 per cent, while BOC's was about 5.5 per cent.
With their capital bases reinforced by last year's injections, both banks are actively courting foreign strategic investors before planned initial public offerings on international stock markets.
Their problems remain huge, however. As a recent spate of scandals has shown, corruption and fraud are endemic in the mainland's banking system, and they reach all the way to the top.
Zhang Enzhao, chief executive of CCB, was forced to step down last month after allegedly accepting a US$1 million bribe from a US software supplier. He was installed at CCB in 2002 as a safe pair of hands, after his predecessor was imprisoned for accepting bribes.
Although China's banks have introduced sophisticated risk management and credit systems, they face enormous obstacles to implementing their use at branch level across the country.
Provincial managers, who are often important communist party officials, deeply resent the infringement on their fiefdoms and in many cases continue to lend to inefficient state-owned companies at the direction of local party bosses, in defiance of the new procedures.
Now analysts fear that loans made during a wild lending spree in 2003, which saw outstanding loans grow by about 20 per cent, will begin to turn bad, once again pumping up the ratio of non-performing assets.
If recent press reports are to be credited, none of this has deterred potential investors in BOC and CCB.
In the past few weeks international banks including HSBC, JP Morgan, UBS, Deutsche Bank and Royal Bank of Scotland, have all been named as negotiating to take stakes in either CCB or BOC.
Some of this is crazy talk.
Last year, having bought a 20 per cent stake in a smaller bank, Bank of Communications, HSBC has denied any interest in the Big Four. And late last year JP Morgan Chase International president Andrew Crockett said that a stake in one of the Big Four state banks was 'not a highly attractive proposition'.
He had a point. To buy the maximum permitted stake of 20 per cent in CCB, for example, a foreign bank would have to commit about US$7.5 billion of its shareholders funds - an enormous sum. That would probably get the investor a seat on the board, but little effective management control, except possibly over specialist subsidiaries like the credit card or asset management unit.
That is one reason why foreign investments so far have been concentrated in China's second-tier banks: investing in one of the Big Four is a lousy bet.