ICBC recapitalization due
By Zhao Renfeng (Business Weekly)
Updated: 2004-12-27 10:08

People expect it, and the government has confirmed it. The major question regarding the recapitalization of the Industrial and Commercial Bank of China (ICBC), the nation's largest lender, is when and how it will take place.

Lou Jiwei, vice-minister of finance, said in early December that his ministry will definitely help recapitalize the ICBC, sparking anticipation that the plan for the bank is already on the cards.

According to a source close to the bank, the proposal has already been submitted to the authorities, pending final approval.

Given the bank's huge size and its high bad loan ratio of about 20 per cent, one thing is almost certain -- the amount of the capital infusion would be equally phenomenal.

"I would expect the ICBC needs 300-400 billion yuan (US$36.14-US$48.19 billion) in capital infusion," Zhong Wei, director of International Finance Research Centre at Beijing Normal University, said, last Thursday.

Zhong said this estimate was based on an analysis of the bank's 2003 annual report, which stated that its total asset was 5.27 trillion yuan (US$634.9 billion) and its capital adequacy ratio -- capital divided by risk weighted assets -- was only 5.52 per cent, below the 8 per cent requirement by the government.

Dennis Gartman, Virginia, US-based editor/publisher of The Gartman Letter, an influential publication on the world's financial markets, said that he is not at all surprised to hear that prior to its going public, the new capital ICBC needs from the government will reach up to US$50 billion.

ICBC: When, how to inject capital?

"Although this may be on the higher side of the guesstimates by most China capital market watchers, the figure does not surprise me in the slightest," he said.

"Certainly there will be many who find this number stunning ... even perhaps objectionable ... and perhaps suggestive of the possibility that the problems we all understand to exist in the banking system are even larger than feared. That is the one great fear that such a large number will engender."

He said the government was sending a signal that it is prepared to deal with the situation forthrightly and that it understands how real the problems are to be dealt with and that it is doing so.

Market analysts and industry experts have suggested a few options for the ICBC recapitalization, many ruling out the same plan that the government picked up to inject US$45 billion of its foreign exchange reserves into the Bank of China (BOC) and China Construction Bank (CCB) about one year ago.

"As foreign exchange reserves are denominated in foreign currencies, this option may not work well with the ICBC because most of the bank's business is conducted in renminbi," Wei Yen, Moody's managing director in Asia-Pacific, said last week.

And the government financial injection into BOC and CCB has not delivered the expected results.

"I think they are still facing big challenges to meet the 5-per-cent investment return target the government set for them," Zhong said.

In addition, he said, utilizing foreign reserve cannot help much in solving the problem of the ICBC's mounting non-performing assets.

Experts agree that the Ministry of Finance is likely to undertake this huge infusion project.

"Given the sufficient fiscal income this year, I think the government has enough evidence to inject capital into the ICBC," Gao Huiqing, a senior analyst with the State Information Centre, said.

According to a report prepared by the National Bureau of Statistics (NBS), China's fiscal income is expected to realize a stunning year-on-year growth of 21 per cent by the end of this year, reaching 2.62 trillion yuan (US$315.6 billion).

According to Zhong, there would be a few options available to the government.

The Ministry of Finance can issue Treasury bonds and then infuse the capital and the ICBC can also issue additional bonds itself.

Experts said it is also possible to supplement the capital with foreign exchange reserves, which already scaled a new record of more than US$540 billion by the end of October. But the amount would not be large.

Then there will be another question -- who will take care of the newly-injected capital?

"Personally, I would think it is better to let the Central Huijin Investment Co manage the capital," Zhong said. Huijin was established last year to manage the capital into the BOC and CCB.

Zhong said he expected the government would announce the infusion plan between the end of the second quarter and the early part of the third quarter in 2005.

And the estimate of the timing was mainly out of three reasons.

"Firstly, the government need to see the result of auditing on the ICBC, which is still going on," he said.

"Then, the huge amount of capital expenditure has to be decided based on the outlook of next year's fiscal budget."

China will likely see a continual momentum of the increase of fiscal income in the new year, but the growth rate will likely slow down with new tax policies.

The growth rate for new year will drop to 14 per cent, according to a report by the NBS.

Finally, the government needs to fathom the general performance of macro-economy in early next year before they take any steps, Zhong said.

In routine procedure, as the fiscal incomes will be utilized, he said, the infusion plan will have to be approved by the National People's Congress, which holds its annual meeting in March.

Experts said the ICBC is already approaching a critical moment to recapitalize itself as foreign competition already exists in the market.

By the end of 2006, China will give foreign banks unfettered access to its domestic market. For the ICBC, the potential rivalry is huge.

One current example is that the ICBC is probably the most well-known bank in China, but many people are now hesitant to go to the bank's branches, which are always filled with long queues.

The ICBC may currently enjoy the largest customer base, but it risks losing its most valuable clients.

"Foreign players have been targetting the most profitable customer community now. They may only win 20 per cent of the market share, but they can gain 80 per cent of the market's profits," Gao said.

"It already comes to a high time to help the bank get rid of bad loans and shore up its competitive edge."

Gao said the government's recapitalization will greatly increase public confidence in the ICBC.

Experts said the government has learned the lessons that Japan's banks took so long to learn: that the market abhors opaqueness and applauds transparency.

According to Gartman, the Japanese banks refused to admit that they had enormous lending problems even as the market understood those problems to exist. Thus the market worked relentlessly to mark down the prices of bank shares to force the banks into accepting responsibility for their past errors. Some finally did not, and liquidation was the final and eventual outcome.

"From my perspective, it appears that China has learned from Japan's mistakes," he said.

It is worth remembering, according to him, that the US banks found themselves in rather the same sort of situation in the late 1970s and early 1980s.

At that time, several major New York banks were technically insolvent as their real estate loans were defaulting ... or should have.

Those that were not in default were out simply because the examiners were unwilling to force the banks into accepting new levels of asset prices that they really should have mandated.

The banks understood the necessity of new capitalization, and of writing off their bad loans ... a process that enabled them not to spend their time and knowledge upon loans that were never going to be made good again any longer, and allowed them to focus upon new business that could generate profits and reconstitute the banks' balance sheets.

"This is where China is presently at. We all understand that China's banks have erred badly in the past. The main questions are 'How badly did they err... and how much new money shall be needed in the form of capital to make the bank's healthy again?"'

Experts said capital infusion would be only the first step for China's State-owned banks.

"Then, the question will become, 'How will the China's State banks use this new capital, and has management learned its lessons?' If not, then new management shall have to be instituted along with this new capital," he said.

Experts said foreign investors would remain cautious even after the recapitalization of the big banks.

"The State banks are too big. Without a sizable stake in them, foreign investors can hardly effect change," said Moody's Yen.

"If you look the world's bank list, you may find only a few are strong enough to take considerable stakes."

Zhong said the ICBC will see a long way off before getting listed.

"I expect the earliest listing time would be in 2007."

"In the world of business and banking, the character names change from one decade to another, but the plot lines always remain the same," said Gartman.

"In this instance, the watchword shall be 'transparency.' If the ICBC is open ... very, very open... about the problems it has had and what it has done thus far to alleviate those problems, and what it shall do in the future to insure utter and complete transparency, then the bank can be properly re-capitalized, brought public and be made to prosper," he added.

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