China's new banking regulator Liu Mingkang has confirmed the government plans to lift the ceiling on foreign bank ownership of local banks to 25% from 15% at present in a bid to bolster the performance of mid-sized institutions.

In comments published Tuesday in the International Financial News, Liu said China should encourage foreign banks to become strategic investors in the country's mid-ranked banks.

"A single shareholder can increase the holding to 20%, but total foreign investment shouldn't exceed 25%," Liu told a recent meeting of foreign bankers in Shanghai, the report said.

"Acquiring stakes in a local bank brings many benefits to foreign banks as they won't necessarily have to wait for a year to receive a branch license and they also won't have to wait until the end of 2006 to begin yuan and other business."

No timetable was given.

Citigroup's Citibank is expected to be the first bank to benefit from the relaxed investment rules, with the banking regulator tipped to approve a gradual increase in its stake in Shanghai Pudong Development Bank Co. to 24.9% by 2008 from the current 4.6% at present.

Canada's Bank of Nova Scotia and the World Bank's investment arm, International Finance Corp., are waiting for central bank approval to take a stake in Xian City Commercial Bank with an option to increase their combined holding to 25% once the investment cap is lifted.

Big Four Still Dominate

However, China's banking system is still dominated by the four major state-run banks, Industrial & Commercial Bank of China, Bank of China (Q.BCH), China Construction Bank (Q.CCB) and Agricultural Bank of China (Q.AGB). There are a further 112 commercial banks operating in urban areas across the country.

While China's regulators have approved 37 foreign bank branches to offer limited local-currency services to corporate clients since the country's entry into the World Trade Organization, retail business in local currency remains off limits until the end of 2006.

To skirt these restrictions, as well as onerous regulations on expanding their branch networks, foreign banks have looked to mid-sized local banks, many controlled by municipalities and provinces, for strategic partnerships.

Currently, foreign banks are allowed to offer yuan services only in the cities of Shanghai, Shenzhen, Tianjin, Dalian, Guangzhou and Qingdao.

Liu said by December China will add the cities of Jinan, Fuzhou, Chengdu and Chongqing to the list of areas open to foreign banks.

As of the end of July, foreign banks had collectively opened 151 branches in China, he said. A further 211 representative offices, which aren't allowed to directly conduct business, have also been approved, Liu said in the speech, which was posted on the commission's Web site.

Without a license to conduct business in yuan, foreign banks in China are restricted to the much smaller market for foreign-currency financial services.

Separately, Liu said most city commercial banks have poor asset quality, imperfect internal control systems and deficiencies in their risk management.

Liu's statements about underline the challenge that the bank regulator faces as the financial system struggles to make a transition to the realities of an emerging market economy.

The success of that transition is vital ahead of China's World Trade Organization-agreement mandated opening of its bank sector to foreign competition in 2006.

Liu's comments suggest that the regulator is preparing to expand its emphasis on improving governance and tackling bad debt ratios in China's first tier, large state-owned commercial banks to the third tier city commercial bank sector.

China's second tier banks consist of shareholding banks.

China's city commercial banks at the end of June had total assets of 1.3 trillion yuan (US$1=CNY8.28). Total deposits were valued at CNY985 billion, while outstanding loan portfolios totaled CNY652.4 billion.

The banks recorded an average nonperforming loan ratio of 16.53% at the end of June, he said.

He said the China Banking Regulatory Commission will continue to support city commercial banks to improve their risk control measures, attract domestic and foreign investors and prepare for possible public listings.

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