Time for China’s banks to think local
When foreign strategic investors were invited to take stakes in Chinese banks, the word “strategic” had a clear meaning for their hosts.
The banks were supposed to stay in for the long term, and that’s why they had the chance to buy big stakes at bargain prices. Yet many have behaved like “foreign speculative investors”, as they are now called in China — they took the cheap deal and then flipped the shares for a fast profit.
Chinese banks looked to the West for access to capital, risk management and exposure to fast growing and sexy new products. But now China no longer needs as much foreign investment.
Meanwhile some of the fancy new financial products China once craved have turned out to be toxic, and the risk management skills of the so-called teachers from the West look tarnished in the wake of the credit crunch.
The recent exodus by cash-strapped Western banks such as RBS, BofA, and UBS, all of whom sold out of Chinese banks for fat profits, has left behind a sour taste.
LAST OF THE BIG 5
Beijing should reflect on this as it prepares the last of the big 5 state-owned lenders to go public. Does the Bank of Agriculture really need strategic investors at all?
And if so, should it exclude local strategic investors, as the other Chinese banks did, in the name of attracting foreign capital and expertise?
There are strong arguments for changing tack. If foreign banks haven’t really delivered the goods, there is little point in bending over backwards to secure their involvement, especially when only a handful of Western banks can afford a substantial investment in AgBank.
With assets of 7 trillion yuan ($1 trillion) it is the second largest bank in China. It would therefore make sense to open the door for domestic companies to bid for Agbank’s shares.
There would be no shortage of interest. Chinese financial institutions have some of the strongest balance sheets in the world and are eager to find new investment targets.
Domestic commercial banks are unlikely to get a stake at AgBank for competition reasons, but China Investment Corp. (CIC), the Social Security Fund and China Life could be interested.
CIC already owns half of AgBank through Central Huijin, its wholly-owned subsidiary. While it would not necessarily bring AgBank much in terms of banking technology or risk management, an investment would allow China to use its reserves to fund domestic investment.
China Life, on the other hand, could be an partner as well as an investor. Chinese banks have become a vital distributor of insurance policies. AgBank can help China Life tap into a market of 700 million farmers, equal to twice the U.S. population.
Chinese financial firms all have ambitions to become financial conglomerates, and a strategic investment will help China Life, and probably AgBank too, get closer to that goal.
Of course, just because you stop favoring foreign investors doesn’t mean you should start favoring the locals. The right answer is to favor no-one.
That would allow real price competition for the shares, meaning that the most likely winners would be those institutions that most valued the relationship. Moreover, a proper competition would not leave too much money on the table and would be fair for future common investors.
That said, the powers that be still seem to be hung up on old thinking. Despite the credit crunch, Western banks are still regarded as superior by many in China. Xiang Junbo, the chairman of AgBank, said in a recent interview with Asian Banker that he still believed foreign strategic investors would bring “advanced concepts, risk management models and microfinance experiences.”
Yet it is far from clear that sophisticated Western institutions have that much to teach AgBank, which is dealing with a large, relatively poor clientele. For instance, if AgBank really wants to learn about microfinance, it would probably do better to engage microfinance pioneer and Nobel laureate Muhammad Yunus as a consultant rather than, say, to bring in the French bank, Credit Agricole, as a shareholder.
To use a Chinese idiom — Chinese banks and their foreign strategic investors have been sleeping in the same bed but dreaming differently. The Chinese hoped to learn from the Westerners but never fully trusted them, while the Westerners planned to use the partnership to build their own franchise in China. The credit crunch has merely laid bare these differences.
TIGHTER SELECTION CRITERIA
Facing the backlash against foreign investors, Xiang said he would tighten the selection criteria applied to foreign investors, probably extending the lock-up period from three to six years. Foreign bidders for a stake in AgBank must be financially strong, and be experienced in agriculture, rural area business and microfinance loan extension, he said.
This has effectively weeded out almost all Western interest, leaving China with limited negotiating power — surely another argument for widening the net to domestic bidders.
AgBank does not need a foreign sugar daddy to get its IPO away. True, it has traditionally been the weakest among the big five state-owned banks for a good reason: AgBank shoulders a social responsibility to lend to the largest disadvantaged group in the world. But as the success of microfinance in Bangladesh has demonstrated, lending to the rural poor can be a lucrative business if it is done well.
AgBank reckons that the profit of lending 1 billion yuan in rural areas is equal to lending 1.6 billion in urban areas, because it can command a higher interest rate.
China is focusing on boosting rural demand, and AgBank can benefit from this process. The land reform will give the rural population more rights over the land.
As this happens they will be able to borrow more money using land as a collateral — something that should boost lending. That is a good story to tell public investors. Gone are the days that Chinese lenders need a foreign label to help sell shares. The AgBank IPO is a chance to drive home this point.