China's entry into WTO brings new challenges to the nation's financial sector, particularly the struggling banking system. But it is unlikely to give foreign competitors a major boost in market share in the short-term, as China will ensure this is a gradual rather than a 'Big Bang' reform process. 'Chinese banks have been relatively slow in developing a commercial culture,' says Nicholas Lardy, a senior fellow at the Brookings Institution and expert on the mainland's financial system. Banking is probably the most open segment of the mainland's financial sector, far more so than securities or insurance. There were 190 foreign banks on the mainland operating 158 branches and 217 representative offices at the end of September, according to the People's Bank of China, the central bank. Of these, 32 have been granted licences to conduct local currency business in and around Shanghai and Shenzhen. But foreign banks still only have about 1.5 per cent of the banking market in terms of assets, and their share is unlikely to grow quickly. Domestic banks are big but so are their problems. They are hindered by their former role under decades of central planning as the cashier for needy state enterprises. Many of these borrowers proved unable or unwilling to repay, leaving the mainland's banks with a mountain of bad debt. The big four state banks - the Industrial and Commercial Bank of China, the China Construction Bank, the Bank of China and the Agricultural Bank of China - are technically insolvent, according to Western standards. They remain weak despite efforts to boost their capital base and shift many of their non-performing loans to asset management companies, set up along the lines of the Resolution Trust Corporation of the United States. The central government has also tried to enforce lending discipline on the state banks, making management more accountable for its mistakes. And to a certain extent, this is working. 'The quality of their new loans is much better,' says Cheng Dinghua, an analyst at Everbright Securities. Domestic banks have also been encouraged to close branches, trim their overgrown payrolls and boost profitability. And Beijing has given the nod to many smaller banks to list their shares on the domestic stock markets. So far, only three banks - Shenzhen Development, Pudong Development and the Minsheng Bank - have gone public, but others are queueing up, and could expect a warm welcome from investors. But the government has been reluctant to take one controversial step: introducing privately-owned banks. Beijing has quietly set aside its plans, fearing banks will collapse without the benefit of a deposit insurance system as a safety net. It would also prefer to compete with foreign banks by putting additional financial muscle into existing banks rather than creating new ones. 'The government has been very low-key on this issue,' says a consultant for a local firm which had its eye on setting up a private bank. 'They don't want to create new banks from scratch.' Beijing need not worry too much about foreign competition for some time, however. Under the WTO accord, foreign banks will have to wait five years for full national treatment, and to compete for individual customers without geographic restrictions. They will also only be able to take local currency deposits and make local currency loans to domestic companies after two years. Beijing is likely to restrict lending by foreign banks through capital adequacy provisions - a move that could be applied equally to domestic and foreign banks and therefore comply with WTO rules. Moreover, most foreign banks will not be chasing every potential depositor in this country of 1.3 billion people. They will probably focus on the big cities instead, which means that in many areas, foreign financial institutions will be co-operating with domestic banks. 'Domestic banks have a lot of branches and customers. The foreign banks will want to rely on them,' says Mr Cheng. Already, there is evidence of this form of co-operation. Standard Chartered and HSBC have turned to big local banks for jumbo yuan financing to beef up their local currency sources. Most major foreign banks have also formed payment alliances with domestic counterparts and more such co-operation is on the cards. The same type of partnering is apparent in the securities sector where foreign companies will have to take a back seat for the medium-term. Under the WTO accord, China has agreed to allow foreign securities houses up to 33 per cent stakes in securities joint ventures immediately on accession, and up to 49 per cent after three years. China will also be able to maintain its two-tier stock market which shields the mainland from the full force of foreign investors. The A share market is reserved exclusively for domestic investors while the foreign currency B share market is open to domestic and foreigner investors. The action, however, is in A shares, where market capitalisation totals 4.23 trillion yuan (HK$4 trillion) against 117.37 billion yuan in the B share market. Foreign securities houses are looking to tap the A share market, however, and fund management partnerships appear to be the answer. 'There will be lots of partnerships in this area,' says Yang Xingjun, an analyst at Shanghai GT Securities Research Institute. Foreign securities houses are preparing to team up with local securities firms to set up fund management joint ventures which would be able to invest in A shares. J P Morgan Chase is trying to turn its co-operation accord with Hua An Fund, which has already unveiled the first open-ended fund on the mainland, into a joint venture management company. Other firms like Franklin Templeton, BNP Paribas and ING Management are throwing their hats in the ring. China is studying a qualified foreign institutional investor programme, modelled on the formula used successfully by Taiwan, to bring foreign investors into the A share market in a controlled fashion. One problem is that A shares are considered to be overvalued. Even after a steep market decline, the average price-to-earnings ratio is over 40 on both the Shanghai and Shenzhen markets. And just for good measure, Beijing is telling its securities firms to boost their capital base and giving them access to the stock market. In the insurance sector, the outlook is strikingly similar. Local insurers are also heading towards the stock market for a last minute boost, and foreign companies are focusing on partnerships and a gradual expansion of market share.