Risks cloud BAC's first-mover edge in China bank deal

PUBLISHED : Saturday, 18 June, 2005, 12:00am
UPDATED : Saturday, 18 June, 2005, 12:00am

Selling a US$3 billion strategic stake to Bank of America Corp (BAC) is a good move for China Construction Bank (CCB). Whether the deal turns out to be a success for the United States bank depends largely on how much management influence it can exert on its mainland partner.

For CCB, the advantages are clear. It can pick the best in international management practices, risk management techniques and information technology to help it upgrade its internal operations.

It also gets valuable assistance in marketing its financial services from an investor that has cut its teeth in the most sophisticated and fiercely competitive market of all.

Equally importantly, CCB gets a vital seal of approval from a reputable strategic investor as it heads towards its initial public offering. Just how advantageous such an endorsement can be has been demonstrated this week by Bank of Communications (Bocom), whose initial offering has been a big hit largely because investors were reassured by HSBC Holdings' 20 per cent stake, acquired last year after months of rigorous due diligence.

But CCB is all together a more daunting proposition than Bocom, and BAC is taking a far bigger risk than HSBC did. With 136 million depositors across 14,500 branches, CCB dwarfs Bocom. Its three trillion yuan in customer deposits at the end of 2003 and 2.1 trillion yuan of outstanding loans look impressive, but there are concerns over the quality of CCB's loan book.

Officially, the bank's bad loan ratio stood at a touch under 4 per cent at the end of last year, down from 11 per cent a year earlier. Some independent analysts, however, believe the true figure to be far higher, approaching 15 per cent.

In 2003, CCB expanded its loan book by a massive 20 per cent. Many of those loans went to loss-making state companies and property developers punting in China's overheated property market.

Worse, analysts say the loans were approved with little or no attempt to assess credit-worthiness. As Beijing moves to rein in overinvestment and cool the property sector, many are expected to default.

Introducing a prudential credit culture is the biggest challenge facing CCB's senior executives. Historically, branch managers have owed more loyalty to local party and industry bosses than they have to the bank's headquarters.

CCB has started to revamp its operations, but sceptics say the changes are cosmetic and do not extend beyond the head office. In some cases, they barely get that far. In March, CCB's last chief executive, Zhang Enzhao, was forced to step down after allegedly accepting a US$1 million bribe from a US software supplier.

How effectively BAC will be able to advance internal reform at CCB is questionable. Although its investment buys it one seat on CCB's board and the right to place 50 advisers inside the Chinese bank, the US bank will not get anything like the management influence that HSBC has at Bocom.

As one of the Big Four state-owned commercial banks, CCB has deeply entrenched relationships stretching back decades with state enterprises, and it remains woven into the fabric of the Communist Party's economic power structure.

Foreigners may be allowed to own small stakes, but they will not be permitted to exercise much control. That may not trouble BAC's bosses. If investing US$3 billion buys them the right to establish and run joint ventures with CCB in potentially lucrative sectors like credit cards and asset management, they may yet be on to a good thing.

But BAC has little experience in China and other potential investors with far more have shied away from buying into the Big Four, doubtful whether management would ever surrender control of profitable businesses.

With China's financial system in such disarray, some of BAC's international competitors wonder whether there is any real first-mover advantage in buying into a big Chinese bank now.

They argue that, in five years' time, the competitive environment will have evolved so much that they will be better off waiting and entering the market then without partnering a local bank.