Analysts suggest foreign investors are likely to remain cautious about investing in China's Big Four State-owned commercial banks, even though regulatory approval allowing such deals looms following a bold move by the government to infuse US$45 billion of its foreign exchange reserves into two of the banks.

The vast size of the four financial institutions, the analysts said, will cause investors to pay close attention to how they pool their money, even though the banks' sprawling networks would seem to be appealing.

"Foreign investors can be very interested in the government message ... but they will remain very cautious," Fred Hu, managing director of Goldman Sachs (Asia), told China Business Weekly last Thursday.

"The State banks are huge. Without a sizable stake in them, foreign investors can hardly effect change."

It will be very difficult, given the cost, to take a stake in any of the Big Four banks, experts said.

"If an investor wants to take a 10-per-cent stake (in any of the four banks) ... that could be very expensive," Richard Duncan, author of the "Dollar Crisis: Causes, Consequences and Cures," told China Business Weekly.

Some analysts question whether foreign investments in the Big Four banks will be worthwhile, as foreign players will be allowed unfettered access to China's market by the end of 2006, in accordance with China's commitments to the World Trade Organization.

"They will be able to conduct business on their own at that time, so why invest?" asked Gao Huiqing, a senior researcher with the State Information Centre.

The Big Four banks, burdened by mountains of bad loans - a legacy of decades of government-directed lending to State-owned enterprises - are widely considered by analysts as one of the weakest links in China's booming economy.

Reforming these banks - the Industrial and Commercial Bank of China (ICBC), Bank of China (BOC), China Construction Bank (CCB) and the Agricultural Bank of China (ABC) - is crucial if China is going to sustain its roaring economic growth.

The State Council, China's cabinet, announced last Tuesday it had launched a pilot programme to recapitalize its State banks.

The government pumped US$45 billion of its foreign exchange reserves into the BOC and CCB, which are preparing initial public offerings, which are expected to be as early as next year.

Liu Mingkang, chairman of the China Banking Regulatory Commission, said on the following day the regulator will give foreign investors the go-ahead once the banks have been restructured into stockholding companies.

The next step, analysts said, will be introducing strategic investors from around the world to the Big Four banks.

Participation by strategic foreign investors in the four banks will enhance their fiscal strength and improve their capital structures and corporate governance, Liu said.

Right direction

The fresh fund infusion, experts suggested, is a step in the right direction, given the current economic situation.

Analysts suggested the move could kill two birds with one stone - it could rejuvenate the ailing State banks, and it could reduce China's foreign exchange reserves.

Those reserves have grown rapidly. They reached US$403.3 billion by the end of last year, up US$116.8 billion from a year earlier.

The fast-rising foreign exchange reserves, which have contributed to surging credit growth in China, have placed additional pressure on the government to revalue the nation's currency, the renminbi.

The fund infusion "is a necessary step to reform the banks," Hu said.

The move will boost the banks' capital adequacy ratio and help the banks write off their bad loans, he added.

The capital amount, which is one-10th of China's foreign exchange reserves, will not affect either the forex system or the yuan's stability, he said.

Gao told China Business Weekly the step is a must for the banks as they continue their shareholding reforms.

However, the capital infusion is clearly not a cure-all for the country's ailing banking industry, he added.

"It (the move) will act like an anesthetic. It might not cure the disease, but it has to be done before the surgery," he said.

The State banks are on the verge of failure, and the fund infusion is critical to pave the way for continued reforms in the banking sector, Gao said.

Whether it is successful, he added, depends on how well the Big Four restructure themselves.

Government officials said they will step up reforms in the creaky banking sector after the fund infusion.

Zhou Xiaochuan, governor of the People's Bank of China, the nation's central bank, told the Financial News last Friday, "The significance (of the injection) lies not only in replenishing capital, it has given out an important signal that China's commercial bank reforms will enter a period of acceleration.

"There will be a series of strong reform measures to push forward internal reforms at commercial banks, and to help them establish corporate governance structures."

Emmanuel Daniel, founder and managing director of The Asian Banker, the Singapore-based intelligence company for the financial services community, told China Business Weekly the capital infusion implies the Chinese Government is trying to better capitalize the banks rather than write down non-performing loans (NPLs).

"But the real benefit of taking this approach will only become evident in the manner the banks themselves utilize the funds to increase lending and take advantage of greater liberalization in the future and a strong economy," he said.

"We hope reducing non-performing loans while building confidence through increasing operating income and managing a better, but growing, loan book is a better guarantee to resolving NPLs in a long-term, sustainable manner, rather than merely increasing capital," Daniel said.

Ratings firms' view

Standard & Poor's last Wednesday upgraded its outlook on both the BOC and CCB to "positive," from "stable."

Moody's a day later reaffirmed its "stable" outlook for both banks.

Fitch highlighted the Chinese Government's decision to help only two of the Big Four state banks.

Fitch said it reflected a new "carrot-and-stick" approach that will penalize banks that lag in their efforts to reform.

Although the ratings firms described the move as a positive step towards reforming China's ailing banking sector, they questioned whether the amount will be sufficient to restore the solvency of the financial system.

"Although these injections are significant, Moody's believes, given the vast sizes of these institutions and the fairly rapid asset growth in recent years, these banks will require additional capital in order to fully restore their economic solvencies," Moody's said last Thursday in a statement.

"Neither the BOC nor CCB have demonstrated a track record of sustainable profitability underlined by their respective franchises, and supported by a commercial culture capable of withstanding intensifying competition when the market becomes fully liberalized in 2007."

Duncan said significant challenges continue to face China's banking industry, as the country's loan growth continues to expand rapidly and there are signs of overheating in some industries.

In need of cash

ICBC, the nation's biggest lender, said last Wednesday it is seeking approval to recapitalize by issuing subordinated bonds.

ICBC was not included in the pilot project.

Experts said capital will still have to be infused into ICBC and ABC if the government aims to push the two banks onto the stock markets.

"Since the foreign exchange reserves are huge, I think the government can infuse US$100 billion into the banks," Gao said.

Some media outlets have reported ICBC is next in line for an infusion of capital, but the amount and timing of that injection has not been determined

Analysts said the timing is right for the State banks to seek listings, since shares of China's firms continue to rise and some new initial public offerings (IPOs) are being overbooked in overseas markets.

"Liquidity is not a problem in the global stock market, and China plays are particularly hot," Frank Han, an analyst with the Centergate Securities, told China Business Weekly.

"The recent successful IPO of China Life might spark hope for China's banking industry."

Still, experts believe a lot must be done before the banks will have sustainable commercial banking systems.

And time, they added, is running short.

"Although it appears the Chinese Government has put in place numerous checks to ensure the moral hazard of taking this route can be minimized, the experiences in Japan and South Korea show it is difficult to guarantee the banks will be better run in the long term," Daniel said.

"The jury is still out regarding the actual impact on CCB and BOC."

BOC had 3.593 trillion yuan (US$434 billion) worth of assets at the end of 2002, while CCB had 3.083 trillion (US$373 billion) in assets.

(Business Weekly 01/13/2004 page4)