Everbright cleans up governance ... now for the balance sheet
At first glance, all things are not well at China Everbright Bank, the banking flagship of one of the mainland's less than a handful of financial holdings companies.
The 13-year-old bank's capital adequacy ratio dwindled to 4.65 per cent - just more than half of the regulatory minimum of 8 per cent - at the end of 2003, the last year an annual report was published.
Instead of a management target of pretax profit of one billion yuan, the bank booked losses of 4.58 billion yuan last year, weighed down by deteriorating asset quality and a sharp increase in loan-loss provisions to meet a regulatory deadline on reserves levels. Non-performing loans rose to 26 billion yuan, or 9.9 per cent of its loan portfolio, up from the previous year's 9.34 per cent.
Responding to a plea by the bank - which has an history of dabbling in lending to companies connected to China Everbright Group, a conglomerate controlled by the State Council, and being asked by the government to take over troubled firms such as China Investment Bank - the government is working inject capital into the lender.
That has delayed for almost a year a company plan to bolster its capitalisation through a nine billion yuan share placement to domestic and possibly international investors, which may include the sale of a 15 per cent stake to British bank Standard Chartered.
However, with the expected full opening of the mainland banking sector to lean and mean foreign competitors at the end of last year and regulatory urgings, no mainland bank can afford to sit around.
Changes are already quietly taking place to tighten credit approvals, improve risk management and diversify revenue sources, according to Chen Yuansheng, the lender's board secretary and one of its executive vice-presidents.
Last year, a unified risk management department took control of credit and market risk as well as the internal compliance functions that seek to curb operational risks such as internal corruption - roles previously carried out by different departments.
The new department presents progress reports and risk management outlook assessments at each board meeting. A risk advance-warning committee, led by the risk management department, also has come into being.
Earlier this year, real-time risk-monitoring software devised by BearingPoint, formerly known as KPMG Consulting, was initiated throughout the bank.
Second and third phases of the programme are being planned to expand computer risk monitoring to market and operational risk.
Like other mainland lenders, Everbright Bank's provincial loan officers were traditionally accountable to local branch chiefs, resulting in uneven lending practices, heavily influenced by local government interests, and lax risk control.
Mainland banks, prodded along by the regulators, have now embarked on reforms to centralise approval, tightening controls over loan approval.
In Everbright Bank's case, except for very low-risk lending such as well-secured small loans, authority for other credit approval now rests with regional credit centres in Beijing, Shanghai and Guangzhou, which report directly to the head office. The largest loans also must be approved by headquarters officials.
In the new structure, the primary functions of the local branches are reduced to sales and marketing, with their performance judged on the ability to recommend credit-worthy borrowers and projects.
'The entire bank now gets to apply unified credit standards,' Mr Chen said.
Although domestic banks are still being asked to support government macroeconomic policies - evidenced by the curtailment of lending to the overheated cement, steel, car and property sectors last year - at least credit controls now can be executed with more precision, channelling loans to the more needy industry sectors and geographic areas.
'Actual lending used to frequently stray away from [sector and geographical] credit guidelines,' Mr Chen said. 'Loans now can be more quickly redirected to regions where lending should be increased ... and high credit-rating borrowers have risen.'
Everbright Bank's network of 370 branches is dwarfed by the Big Four state giants, and the set-up has already raised efficiency issues at a time when credit-worthy borrowers are fiercely vied for by domestic lenders relying on net interest income for more than 85 per cent of their revenue and now facing the dual pressure to improve their asset quality and profitability. Over-centralisation at the bank also ignores the peculiarities of local markets.
In response, the bank has set up credit sub-centres in its major loan markets, such as Nanjing, Suzhou and Ningbo, according to Mr Chen.
The arrangement is likely to be a transition to a new system - to be tried out in 10 branches initially - under which the head office will appoint 'independent credit approval officers' to large branches with authority to clear small loans of up to tens of millions of yuan.
'They are independent in the sense that they are not accountable to the local branch chiefs,' Mr Chen said. 'They report to and are paid by the head office.'
Similar changes are being made to the internal audit functions. While lower-level internal audit staff used to report to local branch management, leading to many irregularities being covered up, they are now accountable to the head office and the board.
During the bank's reshaping, some loan officers had been reassigned to risk management while internal auditors were put on three-year rotations outside home branches to avoid conflicts of interests, Mr Chen revealed.
Further organisational and staffing reforms were being devised by international consulting firm Hewitt Associates and scheduled for implementation next year to create a structure of 'big head office, small branches', he added.
Domestic banks have been asked to classify their outstanding loans into five tiers - normal, special mention, sub-standard, doubtful and loss - with the last three categories being grouped into non-performing loans.
In addition to general provisions at 1 per cent of outstanding loans, sufficient specific loss provisions must be made by the end of this year, according to a regulatory guideline that spells out provision levels for different categories of loans - a daunting task for many mainland lenders without state help and burdened with low profitability.
Meanwhile, a sweeping review of the classification of the nearly 268 billion yuan loan book according to the domestic five-tier system is expected once the government gives Everbright Bank approval for the financial restructuring. Only then can a reserve coverage ratio be meaningfully calculated.
Under capital constraints, Everbright Bank plans to adjust its business to focus on products and clients with lower risk.
By 2010, the bank envisions low-risk retail banking to make up between 30 per cent and 40 per cent of its business mix. It will also extend small and medium-sized enterprises working capital loans of up to five million yuan secured against fixed assets such as shops and property.
Parallel to that, it aims to raise the weighting of private savings in its deposit base from last year's 14 per cent to between 30 per cent and 40 per cent in five years.
Everbright Bank further plans to raise revenue contributions from non-interest income from last year's 3.2 per cent to between 10 per cent and 15 per cent by 2010.
To that purpose, the lender's board has voted to invest in a fund-management joint venture with Prudential Financial, which will be about 50 per cent owned by Everbright Bank and 20 per cent to 30 per cent by the United States giant.
The lender's domestic and foreign-currency wealth-management business was already a domestic leader, with yuan business commanding nearly one-third of the nascent domestic market last year, Mr Chen said.
Earlier this year, the bank won licences as custodian and manager of voluntary corporate pension funds.
Its investment banking arm now commands a 50 per cent share of the new market to underwrite short-term corporate notes. It helped five domestic giants sell 12 billion yuan of the notes earlier this year and has built up a pipeline of more than 20 billion yuan of such offerings.
By the end of this year, Mr Chen estimated earnings from underwriting such deals would increase to 500 million yuan from 100 million yuan.
Where Everbright Bank was falling short on the balance sheet, it was trying to make up through corporate governance, Mr Chen said.
Before 2003, Everbright Bank often drew regulatory reproach for poor corporate governance mechanisms. Of late, however, the China Banking Regulatory Commission has held it up as a positive example of corporate governance reform for other mainland banks to follow.