Should Chinese banks buy banks abroad?
The recent news that China Development Bank is considering buying Germany's Dresdner Bank has sent a frisson of thrill among investment bankers around the world. If this signals the beginning of a major acquisition spree by cash-rich Chinese banks with their high stock market valuations, it will mean a surge of business for investment bankers.
And it's not just investment bankers who will benefit. Shareholders of foreign banks will celebrate the advent of a new group of large, determined buyers. Large Chinese corporations will also benefit as their local banks develop the skills and expertise to operate in global markets. Chinese banking regulators will no doubt welcome the diversification of risk that will accompany foreign expansion, and even ordinary Chinese will experience a nationalistic thrill as once-mighty foreign names are gobbled up by newly emerging Chinese giants.
But one group will not benefit from an acquisition spree, no matter how well managed. Current shareholders of large Chinese banks will almost certainly see the value of their holdings drop if the banks they own make major purchases abroad.
At first this might seem paradoxical. There are many benefits to a foreign acquisition. The most obvious is that Chinese banks, by buying assets abroad, will sharply reduce their excess exposure to the very volatile Chinese economy. The diversification will affect both their mix of assets and their income streams.
They will acquire valuable management skills that can raise their profitability and improve the services they offer domestically. They will also be able to enhance their relationships with their most important Chinese clients by acquiring expertise and facilities abroad. All of these should improve future profitability and reduce risk.
Yet, ironically, it is precisely because a large foreign acquisition significantly reduces risk that shareholders will suffer. Chinese bank shares trade at a high multiples not because their assets are valuable relative to their liabilities. On the contrary, their loan quality is questionable and there is a legitimate concern that many of the largest banks would barely be solvent if their portfolios were correctly valued.