Chinese banks sail into uncharted waters as they expand globally
Chinese banks are sailing into uncharted waters as they follow their wealthy corporate and retail clients abroad, though obstacles brought about by compliance investigations are unlikely to slow the momentum as mainland lenders buck the trend that has seen their foreign counterparts trim global operations, market observers said.
Some banks have already hit choppy waters.In September, Agricultural Bank of China was ordered by the US Federal Reserve to overhaul its protections against money laundering to address “significant deficiencies”, the US central bank said in a statement on Thursday.
The lender, one of China’s biggest banks, will have to come up with a written plan within 60 days to fix the shortcomings in managing risk in its New York branch and to maintain better control over suspicious activity, the Fed said. However, the order didn’t carry a monetary penalty.
The slap on the wrist comes as domestic Chinese banks are poised to accelerate their overseas expansion over the next five years as they follow their clients abroad.
“In the early stage of domestic banks’ opening up in the past, it was more about embracing foreign players in the home market,” Liu Xinyi, president of Shanghai Pudong Development Bank, told the Lujiazui Forum in Shanghai in June. “But we have seen a growing trend in the past five years where more domestic lenders are making a foray into overseas markets.
“China is transferring from capital inflow to outflow and financial institutions should move in tandem with those corporate clients to go abroad,” Liu said.
Overseas business, including offshore services, accounted for less than 5 per cent of Shanghai Pudong Development Bank’s total assets – which analysts say is far from enough considering the need to follow the trend of more and more Chinese companies going abroad.
It has been common to see Chinese companies flex their muscles in overseas markets with rising outbound direct investment (ODI) in recent years.
According to data from the Ministry of Commerce, China’s ODI rose to a record high of US$145.67 billion in 2015, up 18.3 per cent from the year before, the second largest in the world after the United States. China’s total accumulated ODI by the end of 2015 amounted to US$1.1 trillion, the world’s eighth largest. It has risen for 13 straight years, with an annual average growth of 35.9 per cent. In the five years to the end of 2015, total ODI was 2.4 times that of the previous five year period.
Domestic banks are attempting to ride the wave by following their clients that are expanding abroad. By the end of 2015, more than 20 Chinese banks had set up nearly 1,300 outlets in 59 countries and regions overseas, according to a Bank of China research note.
Ren Zhiyi, partner at domestic law firm Fangda Partners, said it is interesting to see Chinese banks accelerate their overseas expansion at a time when the traditional global players are scaling back their global footprint, especially cutting their retail business which involves heavy investment but contributes relatively lower income.
“Chinese banks can learn from the experience of those global banks when expanding abroad, and avoid the same mishaps,” Ren said.
Global players are restructuring their business operations in the post-financial crisis era. New York-based Citigroup, which had a global retail empire spanning 50 countries a decade ago – from Tokyo to Tegucigalpa (Honduras) – has since sold or shut retail operations in more than half of those countries, including Guatemala, Egypt and Japan, Bloomberg reported in July.
The transformation of Citigroup, and similar changes at HSBC Holdings and other global banks, isn’t just about cutting expenses. It is also about looking for greater returns by focusing on the richest customers – high-net-worth individuals, large corporations and institutional investors.
Alfred Shang, a partner at consultancy Bain & Co, said Chinese banks’ overseas expansion initially focused on corporate banking, trade finance and transactional banking as these mainly served corporate clients with global strategies. “In recent years, we see them follow another type of wealthy clients – the high net worth individuals who look for opportunities to invest globally, especially against local capital market volatility,” he added.
By far, the big-five state-owned Chinese banks are the main force behind the “go-abroad” trend while smaller banks are still playing catch up.
“Not all banks have the enthusiasm and matching capability to go global,” said Shang. “The top 15 banks make up the majority of the ‘go-abroad’ group.”
Bank of China is leading its peers in terms of doing international business mainly through organic growth, partly thanks to its legacy as China’s largest foreign currency bank. Industrial and Commercial Bank of China (ICBC) took a shortcut to rapid expansion by acquiring overseas banking assets. For example, ICBC bought 92.8 per cent of Turkey’s Tekstilbank and acquired a 60 per cent stake in South Africa’s Standard Bank.
China Construction Bank is also aiming high when it comes to international business, targeting foreign currency and overseas assets to account for 15 per cent of its total assets by 2020. Pre-tax profits from overseas businesses are projected to account for 7 per cent of the group’s total by then.
Bank of Communications has also targeted international expansion as a key priority. The Shanghai-based bank has set up about 50 outlets in 15 overseas countries and regions and also acquired an 80 per cent stake in the Brazilian bank BBM.
However, BoCom chairman Niu Ximing sees another expansion path besides opening branches and acquiring assets – setting up new lines of business. The bank set up a centre for financial market and transactional banking in Hong Kong, with the new business earning profits within the first year of operation.
Hong Kong has been a natural target for mainland domestic banks wanting to expand overseas thanks to the city’s unique gateway position as a mature, open market with free flow of goods, capital and talent. One example of this approach was the takeover of Wing Lung Bank in Hong Kong by China Merchants Bank, the nation’s six largest lender.
Mainland banks are also ratcheting up their overseas expansion amid China’s One Belt and One Road initiative that aims to revive historical trading routes by shifting part of China’s industrial overcapacity to developing markets along the routes.
By the end of last year, nine lenders had set up 56 outlets in 24 countries involving in the One Belt and One Road initiative, according to BOC’s research.
But it hasn’t been all smooth sailing overseas. Chinese banks have been dragged into money laundering investigations conducted by overseas regulators.
The US Federal Reserve last year instructed both Bank of China and China Construction Bank Corp to improve their anti-money laundering (AML) procedures.
Six ICBC employees in its Madrid branch were arrested in February on suspicion of facilitating money laundering and fraud. ICBC issued a statement saying it has operated strictly within the law.
Separately, Italian prosecutors sought to indict 297 individuals and Bank of China as part of a massive money laundering investigation, Associated Press reported in 2015. The bank has denied any wrongdoing.
In April, a LexisNexis Risk Solutions survey showed that respondents in China emphasised the commercial aims of international expansion when asked about drivers for AML initiatives.
“Interestingly, respondents in China listed regulatory compliance as the lowest of their priorities by a wide margin,” LexisNexis said.
The survey targeted AML, compliance and risk professionals in the financial services industry in six markets in Asia – China, Hong Kong, Indonesia, Malaysia, Singapore and Thailand. The survey focused heavily on the banking industry, which accounted for 50 per cent of survey responses.
Among the six markets, China had the highest average AML operational costs of US$12.4 million, mainly due to the greater number of large banks in China responding to the survey, the report said.
China is also experiencing the sharpest increase in compliance spending, with nearly three quarters of respondents stating that overall AML compliance costs increased 20 to 39 per cent in the past 24 months, and half the respondents expecting overall costs to increase 20 to 39 per cent in 2016.
However, respondents in China also acknowledged that the rising AML burden also does some good for their businesses.
“Implementing an AML compliance programme revealed deficiencies in many of our processes, enabling us to correct these issues and improve as a firm,” the report quoted an AML officer at a leading Chinese bank as saying.
Annabella Fu van Bijnen, a partner with UK law firm Linklaters, said Chinese banks confront a combination of hurdles when going abroad, including understanding cultural differences and local regulations.
However, “I don’t think Chinese banks will slow down their overseas expansion because of the recent bout of anti-money-laundering probes,” she said. “Chinese banks will learn from the lessons and gain experience.”
The China Banking Regulatory Commission, the country’s top banking watchdog, issued a notice in late March requiring banks to take measures to guard against risks when going abroad. These included
strengthening management of overseas branches and strictly complying with overseas regulations on banking supervision, tax and AML.
At its half-year meeting on July 14, the CBRC prioritised four major risk areas that it will pay more attention to during the second half, including overseas compliance.
Zhang Xingrong, head of banking research at BOC Institute of International Finance, said lenders will be more cautious and prudent and introduce tighter safeguard measures to adhere to the regulatory call.
Looking forward, Shang of Bain & Co said Chinese banks need to do more strategic planning before they go abroad, and become more international in their management.
“Unlike their industrial counterparts, Chinese banks have not really globalised their management team as much as frontrunners such as Huawei and Lenovo,” he said. “Banks still prefer sending bankers from China to the overseas market though they are leveraging senior bankers from Hong Kong and Taiwan, while actively exploring partnership opportunities with foreign banks.”