Moving into the Lead
This article was first published in Quantum magazine.
September 2009 was a good month for China—and for its reputation as a global leader.
At the United Nations Energy Summit in New York, President Hu Jintao told delegates that China will increase its efforts to improve energy efficiency and to curb the rise in CO2 emissions. He pledged to ensure that the increase in emissions would be less than the increase in economic growth and that China would “vigorously develop” renewable and nuclear energy.
On the same day it was announced that China’s foreign exchange reserves had risen to a staggering US$1,950 billion, ranking it first in the world and confirming the country’s role as the United States’, if not the world’s, banker.
Addressing the 64th session of the UN General Assembly, the Chinese president linked his country’s future progress with greater world prosperity. Hu told world leaders that “a more developed China will make a greater contribution to the world and bring more opportunities to the world.” He said that the security of all countries was interconnected and that they must cooperate to combat terrorism. President Hu also urged the world to oppose the temptation to protect domestic industries from outside competition.
At the same time, the six-monthly Global Financial Centres Index report was published by the City of London Corporation and the Z/Yen Group. This showed the continuing rise of the Asian financial centres, with Hong Kong back in third position after London and New York. In China, Shanghai is up from 35th to 10th position and Beijing is up a staggering 135 points from 51st to 22nd in the global index. By comparison, Frankfurt is down four places from 16th to 12th and Amsterdam is down seven to 31st position.
Astonishingly, Shenzen—30 years ago a fishing village in Guangdong Province next to Hong Kong—jumped from nowhere to fifth position. Those of us who have visited Shenzen on business or in an official capacity know the vision of the city’s leaders and the determination of its administration. Perhaps it should not come as a surprise after all.
At a meeting later that week in Pittsburgh, global leaders confirmed that the G20 would become the forum for economic debate in the future, replacing the G8 in this field and putting China, at last, on the world’s economic “supervisory board.”
And, as further justification of this rightful role, President Hu gave his own advice on global economic recovery, warning that this was fragile and that all countries should maintain their economic stimulus plans. Speaking from a position of domestic strength, President Hu’s leadership stance was further evidenced by the news that China’s economic growth would return this year to 8% and that the rate of growth would increase again in 2009.
The month finished with the decision by HSBC to relocate its chief executive to Hong Kong, a sign that the bank sees much of its future in Asia, particularly in China. Commenting on the move, chairman Stephen Green said that the move was “both symbolic and practical. Asia and China are the centre of gravity of the world and of our business.” His chief executive, Michael Geoghegan, went one step further: “To drive the business, you have to be here—Hong Kong is the gateway to China.”
With memories still lingering of the stunning displays at the successful Olympic Games in Beijing in 2008, it is clear that the world order is not just changing, it has changed. And, with the 60th anniversary of the founding of the People’s Republic on October 1, the Chinese government and its people have much to celebrate. China has come of age and has returned to its rightful place as a major world power, participating in global organizations and leading the debate.
The Banking Sector
Now that China has the largest foreign exchange reserves in the world, with much of it invested in US Treasury bonds and eurobonds, China’s role as banker is being viewed with interest, suspicion, and concern. Does the PRC’s financial sector have the skills and experience to be a leading global player?
China’s banking industry has undergone a revolution in the last 15 years. In the mid-1990s, the banks were largely state-owned and controlled. They were instruments of economic, social, and industrial government policy, funding the loss-making operations of many state-owned enterprises. The nonperforming loans were horrendously large. It was difficult to come to a view about the quality of the business and of the earnings. There was little transparency.
Since then, the sector has been transformed. With government encouragement, new banks have been established. The China Minsheng Bank was founded in 1996 under the chairmanship of Jing Shuping, the son of a senior figure in prewar Shanghai’s insurance industry who was educated at the international St John’s University in Shanghai, survived the Cultural Revolution, and then became one of former Vice-President Rong Yiren’s trusted cohorts.
Another stimulus to change has been the public listing of shares in China’s mega-banks. Of the world’s top 10 banks, three are PRC-based: the Industrial and Commercial Bank of China, or ICBC (no. 1), the China Construction Bank, or CCB (no. 4), and the Bank of China (no. 5). Each has had experience of listing shares overseas, which has been preceded by significant changes to business practices, corporate governance, and transparency.
These changes have been further encouraged following China’s entry into the World Trade Organization (WTO), which, under Premier Zhu Rongji’s leadership, encouraged market-oriented international practices, including greater competition and transparency.
China’s banks have also weathered the recent global storm much better than their Western counterparts. Their business is less international. Drawing on historical experience, they have become more cautious. Strong economic measures were taken by the PRC government to counter the worst features of global recession by stimulating the domestic economy, particularly in rural areas. And, perhaps most importantly, they have had a strong, seasoned regulator in the China Banking Regulatory Commission and its accomplished chairman Liu Mingkang.
An Opinion Survey
This assessment is confirmed by an analysis of the Chinese financial sector produced by PricewaterhouseCoopers China and the China Banking Association in September 2009, which was based on interviews with 81 senior bank executives and 732 questionnaires completed by banks.
The bankers also believed that, although there is still a huge gap between their competence and that of established Western banks, the global financial crisis gave them a rare chance to learn and improve.
Most respondents are concerned that the evolution and transformation of corporate governance from one of form to one of real substance will be tough, even though great strides have been made in recent years among the larger banks, particularly those with overseas listings. Nearly 40% believed that the role and responsibilities of shareholders at shareholder meetings, the board of directors, the supervisory board, and the management are not sufficiently clear.
Incentive systems for executives are still in their infancy. More than half those surveyed believed that they were inadequate, focusing on short-term remuneration incentives, with few providing longer-term incentives such as stock ownership, stock options, and stock appreciation rights.
In stark contrast to the response of the West to the financial crisis, there is great enthusiasm in China for continuing financial innovation and the development of comprehensive financial services and products. Deposit and loan-related products are thought to be the areas most in need of financial innovation, followed by syndication and M&A.
Some 85% of the respondents believed that the relatively more rigorous regulation of financial derivatives and other innovative activities had the biggest positive impact on the Chinese banking industry during the recent global crisis.
The survey showed that bankers, particularly from the larger firms, believe that they are becoming more competent at risk management. They are busy preparing for the New Basel Bank Accord, establishing risk management rules and procedures, building internal rating systems, data-capturing, and model-building. The lack of adequate data remains a major headache.
There was also concern that the rise in lending would lead to an increase in nonperforming loans. Chinese banks have reacted accordingly. Many are becoming much more cautious about real estate developments and are concentrating far more on examining the sustainable nature of business enterprises. They are also becoming more influenced by such factors as the energy consumption of an enterprise and whether it is environmentally friendly.
The Chinese government’s actions at the end of 2008 to stimulate the economy were backed by four out of five respondents, while 70% believe this policy would mean that lending this year will be 20% higher than last year. Indeed, by the first half of this year (2009) this target had already been met. During 2009 there has been increased focus on infrastructure projects, particularly in energy and agriculture.
The strongest message to come from the replies of Chinese bankers is that the global financial crisis has not affected the resolve and commitment of the Chinese banking sector to achieve globalization. However it has made them more cautious.
Few expect a decrease in M&A activity, but most consider a lack of accurate and detailed understanding of the overseas environment, practices, and policies and the limited capabilities of Chinese banks in the areas of management and control as the biggest obstacles to going global.
They warn that the biggest problem to overseas expansion through acquisition of foreign banks is the difficult task of integrating resources and extracting the synergies post acquisition. In this, they have learnt the lesson of how difficult it is to achieve growth through acquisition far better than some Western counterparts.
They are very positive about the involvement of foreign investors in Chinese banks as this has brought management competence, improved corporate governance, better product innovation, and the introduction of new technologies.
It is clear that, some 30 years after the “opening up” of the Chinese economy, the banking sector is developing well. Predictably, this has lagged behind the achievements in the manufacturing sector, not least because this latter was the first to enjoy market competition and foreign participation.
The domestic nature of the banking sector and the competence of the regulatory environment and government response have all combined to protect the industry from the global financial crisis. Lessons from this have been learnt.
The next step is globalization—and the major Western banks are fully aware of this and are preparing accordingly. The relocation of the HSBC’s chief executive to Hong Kong is just one illustration of this. With its origins in Shanghai and Hong Kong, the HSBC more than anyone understands the importance of China and its emerging dominant global position.
One is reminded of the lines in Alfred, Lord Tennyson’s account of the Passing of Arthur from Idylls of the King: “The old order changeth, yielding place to new, and God fulfils himself in many ways, Lest one good custom should corrupt the world.” Change is inevitable.
China has become the world’s manufacturing center. It is on course to become the home of the world’s major financial institutions. China’s role as world banker is about to begin.