Market Access Report: The Banking Sector

Quest for RMB

As China's economy continues to grow as a result of its WTO accession and other factors, demand for RMB financing is likely to accelerate. This need is accentuated by China's current exchange control system, which is likely to stay for the near future. Thus, all else being equal, those banks able to access and channel RMB funds in the most efficient manner will be better positioned to come out ahead of the competition. In fact, with Chinese household and corporate RMB savings already totalling about US$1.2 trillion, it would appear that bankers do not have to look far for their source of funds. Because of current regulatory limitations, however, foreign banks have significant disadvantages in attracting these funds.

Under current regulations, once a foreign bank has received its RMB business licence, its initial RMB operating capital will be a fixed amount of at least Rmb30 million. If the bank subsequently wishes to exchange foreign currency funds for additional RMB operating capital, it must receive prior approval from China's central bank, the People's Bank of China (PBOC), or its local delegate, for the increase, which is capped at Rmb100 million pursuant to relevant regulations. If the bank wishes to address its RMB shortage by taking in more RMB deposits, it would soon be hamstrung by the rule that the total amount of RMB liabilities it holds cannot exceed 50% of all of its foreign currency liabilities. The foreign bank is further forbidden from issuing RMB-denominated bonds or seeking financing through China's stock market. Borrowing from PBOC is not an option.

If the foreign bank wishes to borrow in the short-term from domestic Chinese banks and use the proceeds for its loan operations, it is likely to run into two problems. First, the rates on these short-term loans are floating rates, whereas the rates on loans the bank offers are fixed within a relatively narrow range by PBOC. Thus, the interbank loans could become very expensive. Second, current regulations technically prohibit the use of short-term interbank borrowings to finance loans. The next option for the foreign bank might be long-term interbank borrowings; however, any foreign bank that attempts to utilize this option will run into another set of problems. First, the interest it pays to the Chinese banks cannot be deducted from its interest income when calculating PRC business tax; second, because the interest rate ranges for practically all RMB loans in China are fixed by PBOC (except for the rates on short-term interbank loans), there is not likely to be much interest rate spread.

As a result of China's entry into the WTO, some of the regulations contributing to the RMB sourcing dilemma are likely to be phased out over the next five years. The Chinese banking authorities will most likely abolish the requirement that limits total RMB liabilities to 50% of foreign currency liabilities. In addition, China is likely to gradually liberalize interest rates on RMB loans and deposits. However, it is unclear whether other restrictions on the ability of foreign banks to access and utilize RMB funds will be liberalized in the near future.

Conclusion

Some foreign banks are considering a three-part strategy while awaiting China's implementation of its WTO commitments. First, they are concentrating on fee-based services that tend to require little capital input. Second, they are considering acquiring equity interest in domestic Chinese banks. Third, for their retail business, they are focusing on niche markets. China's WTO accession represents an unprecedented opportunity for foreign banks. If these opportunities are seized, foreign investment in China's banking sector is likely to pay off, perhaps even sooner than expected.

Mitch Dudek and Kan Liang

Jones Day Reavis & Pogue,
Shanghai