What Opportunities do Foreign Banks Have in China?

On December 30 2001 the State Council issued revised PRC Administration of Foreign-funded Financial Institutions Regulations (the FFI Regulations). Effective February 1 2002, these replace the old regulations (of the same title) promulgated in February 1994.

The Implementing Rules for the new FFI Regulations were subsequently issued on January 30 2002 and became effective together with the FFI Regulations on February 1. These further clarify the application procedures as well as some of the details for calculation of the applicable deposit reserves and liquidity and asset ratio requirements.

One of the main objectives of the new FFI Regulations is to enhance the regulatory foundation of China's WTO commitments in the financial services sector. The new FFI Regulations seek to shift the basis of market-access and general banking supervision of FFIs to a more risk-weighted and prudential-based form of regulation, more in line with the international standards, and based on the Core Principles of Effective Banking Supervision of the Basle Committee (the Basle Accord). To give effect to the phased access to Rmb business, both Rmb and foreign currency businesses of FFIs are now dealt with in the new FFI Regulations, reflecting China's commitments to the terms of its WTO accession. To comply with WTO rules on national treatment, an attempt has also been made in the new regulations to begin to regulate FFIs' business activities in China on the same basis as domestic entities.

Major Changes and Rationale

The new FFI Regulations implement some major changes, including:

• FFIs may establish business operations in any city within China, as long as prudential and market access requirements have been satisfied.
• Removal of client restrictions on FFIs' foreign currency business within China. The Implementing Rules make it clear that enlarging the scope of target customers is still subject to PBOC application and approval (Article 39, Implementing Rules), a development that was foreshadowed by the PBOC on December 9 2001, when it announced a requirement for increases in working capital and replacement of financial business operation licences in connection with increases in business scope. It was reported that Citibank became the first foreign bank to obtain approval for expanding its business scope, and it is now able to do foreign currency business with Chinese enterprises and Chinese nationals.
• Removal of quantitative restrictions on the foreign currency business of FFIs as a condition to Rmb market access. The new FFI Regulations repeal the requirement that, one year prior to the application for an Rmb licence, the average monthly balance of foreign currency loans has to exceed US$150 million (for a foreign bank branch) and US$100 million (for a wholly foreign-owned bank, equity joint venture bank, wholly foreign-owned finance company or equity joint venture finance company).
• Relaxation of restrictions on establishing an equity joint venture bank or equity joint venture finance company: the Chinese partner no longer needs to be a financial institution. This obviously provides non-financial Chinese enterprises with greater opportunities to participate in the financial sector by partnering with a foreign financial institution.
• Broadening of permitted business scope: the permitted business scope of FFIs has been broadened to include foreign exchange, interbank loans and bank card businesses, among others. FFIs can now invest in government bonds, financial bonds and other foreign currency securities other than stocks.
• These activities were actually dealt with in separate regulations on the foreign exchange business of banks, but have now been drawn within the new FFI Regulations, reflecting a trend to greater uniformity in the regulation of different currency businesses. The explicit statements on bank card businesses and interbank loans will also be welcomed. It is understood that government bonds include Chinese sovereign paper as well as bonds issued by foreign governments and that financial bonds include bonds issued by Chinese financial institutions and non-financial institutions.
• Increases in minimum capital requirements: the registered capital of wholly foreign-owned banks, equity joint venture banks, wholly foreign-owned finance companies and equity joint venture finance companies must now be based on actual capital contributed (modifying the previous requirement that contributed capital be not less than 50% of approved registered capital).
• Relaxation of the requirement that total deposits received within China may not exceed 40% of total assets. This has now been changed to a restriction that foreign currency deposits received within China by a FFI may not exceed 70% of its total domestic foreign currency assets. The Implementing Rules make it clear that foreign currency deposits include interbank deposits, and a calculation methodology for total domestic foreign currency assets has also been provided. The PBOC reportedly included the overseas borrowings of FFIs operating in China as part of the country's foreign debt statistics for the first time in November 2001, apparently based on recommendations of the International Monetary Fund. The increase in the percentage threshold helps alleviate the negative impact of this move on foreign debt statistics.

The change also has a separate focus. As a Rmb business is separately licensed, the requirement will impact the sourcing of foreign exchange funds, with one objective being to continue to enhance the domestic US dollar interbank market by attracting offshore funding either through increases in capital or offshore inter-branch funding. The fact that a ratio that affects sources of funding continues to exist has attracted some criticism. One contention is that this is likely to result in higher costs for foreign exchange services provided by FFIs in China.

The Implementing Rules (Article 69) provide that total domestic foreign currency assets shall be calculated as total foreign exchange assets less foreign exchange assets of overseas affiliated institutions less overseas foreign exchange loans, less offshore interbank foreign exchange deposits less offshore interbank foreign exchange loans and less offshore foreign exchange investments (offshore foreign exchange investments, for these purposes, are deemed to exclude PRC government bonds issued offshore, and bonds issued by Chinese financial institutions and non-financial institutions).

The ratio is to be examined monthly by PBOC.

• General recognition of the Basle Accord and its capital adequacy requirements. The Implementing Rules make it clear that the capital adequacy ratio of the commercial bank or parent banking corporation in relation to any application for establishment and registration as a FFI must be not less than 8%. In addition, institutions must also comply with "any other prudential conditions prescribed by the PBOC" (Articles 6 to 8 of the FFI Regulations). The Implementing Rules (Article 7) outline such "prudential conditions" as follows:
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  • a good corporate governance structure;
  • a good risk management system;
  • a sound internal control system;
  • an effective information management system;
  • a good operating status with no record of any material violation or breach; and
  • the undertaking of anti-money laundering measures.

These conditions provide a relatively broad basis for controlling market access based on qualitative standards. For example, it is not clear whether "material violations" are restricted to the home jurisdiction of the FFI.

• As the Rmb is still not fully convertible (on capital account), currency risk is assessed separately. For a wholly foreign-owned bank, an equity joint venture bank, a wholly foreign-owned finance company, or an equity joint venture finance company, the ratio of Rmb assets to Rmb risk-weighted assets must not be less than 8%. For a foreign bank branch, the ratio of its Rmb working capital plus reserve funds to Rmb risk-weighted assets must not be less than 8%.
• Large exposure limits have also been tightened. For a wholly foreign-owned bank, an equity joint venture bank, a wholly foreign-owned finance company, or an equity joint venture finance company, its risk exposure to any one enterprise and its associated enterprises may not exceed 25% of the relevant institution's capital; this lowers the bar from the previous position, which stipulated that risk exposure couldn't exceed 30% of the sum of its contributed capital and reserve funds. The new limits reflect a smaller exposure to each individual borrower and a change in the calculation method of capital base to bring the regulations closer to international standards. The Implementing Rules (Article 66) define capital for these purposes as the sum of registered capital, paid-in surplus, surplus reserve, undistributed profits, reserve for losses from general loans, re-valuation reserve and long-term secondary bonds with maturities of five years (or more), with a deduction for investments in non-consolidated entities.
• The ratio of the balance of current assets to the balance of current liabilities shall be not less than 25%. This requirement also appears in the PRC, Commercial Banking Law (issued by the National People's Congress and effective July 1 1995).

The Implementing Rules (Article 68) now specify that for these purposes, "current assets" means cash, gold, deposits with the PBOC, deposits with other banks, interbank loans with maturities not exceeding one month, net credit balances in accounts with associated overseas banks and affiliated institutions, discounted and other purchased bills with maturities not exceeding one month, other account receivables and loans with maturities not exceeding one month, negotiable bonds with one month maturities and any other assets which can be realized within one month, in each case adjusted for estimated non-recoverable items.

Business Scope of FFIs

Wholly Foreign-owned Banks, Foreign Bank Branches and Equity Joint Venture Banks

Wholly foreign-owned banks, foreign bank branches and joint venture banks can conduct the following business operations:

(1) accept deposits from the public (note that the previous limit to foreign currency deposits has been removed);

(2) issue short-term, mid-term and long-term loans;

(3) handle acceptances and discounts on negotiable instruments;

(4) buy and sell government bonds, financial bonds and other foreign currency securities other than stocks;

(5) provide letter of credit services and guarantees;

(6) conduct domestic and overseas settlements;

(7) buy and sell foreign exchange on its own behalf or as an agent;

(8) conduct foreign exchange businesses;

(9) engage in interbank loans;

(10) conduct bank card businesses;

(11) provide safety deposit box services;

(12) provide credit investigation and consulting services; and

(13) conduct other business operations permitted by the PBOC (Article 17).

Wholly Foreign-owned Finance Companies and Equity Joint Venture Finance Companies

Wholly foreign-owned finance companies and joint venture finance companies can conduct the following business operations:

(1) accept deposits, each of which shall be no less than Rmb1 million or the equivalent in a freely convertible foreign currency for a term not less than three months;

(2) issue short-term, mid-term and long-term loans;

(3) handle acceptances and discounts on negotiable instruments;

(4) buy and sell government bonds, financial bonds, and other foreign currency securities other than stocks;

(5) provide guarantees;

(6) buy and sell foreign exchange on its own behalf or as an agent;

(7) engage in interbank loans;

(8) provide credit investigation and consulting services;

(9) provide foreign exchange trust services; and

(10) conduct other business operations permitted by the PBOC (Article 18).

Finance companies are to be restricted from bank card businesses, but interestingly, are able to provide foreign exchange trust services. In line with the previous regulatory trend, banks will continue to be restricted from providing trust services.

Geographic Scope and Client Base for Rmb Businesses

The geographic scope and client base of FFIs' Rmb businesses shall be determined by the PBOC according to relevant regulations. It is anticipated that these regulations will be in line with the WTO commitments. The requirements for a FFI to conduct a Rmb business are the following:

• prior to the application, the FFI shall have had its business operation in China for more than three years;
• for the two consecutive years prior to the application, the FFI's business operation in China shall have been profitable; and
• other conditions determined by the PBOC.

Supervision and Management of FFIs

Interest Rates

The lending and saving rates and the level of various types of service fees for foreign-funded financial institutions must be determined by the FFI "in accordance with the relevant provisions of the PBOC" (Article 22).

Rmb interest rate regulation is closely managed by the PBOC, especially in regard to macro-economic factors and the need for currency stability. In recent years there has been a continued trend towards relaxation of the "bands" within which authorized institutions are able to quote rates against official PBOC rates. The trend towards further interest rate liberalization is anticipated to continue, in line with developments on full convertibility of the Rmb on capital account.

The PBOC recently clarified its foreign currency interest rate policy (Notice No. 4 of 2002, March 7 2002). Banks can now set FX interest rates with clients for loans above US$3 million by reference to international rates, and rates for deposits above this threshold can also be set independently. Below this amount PBOC prescribed rates apply. Interbank rates that can be offered by foreign banks have been substantially liberalized in recent years. Interbank capital flows are now monitored through monthly and quarterly reporting to the PBOC rather than through direct intervention and control of interest rates on transactions between authorized institutions.

Mandatory Deposits

Any FFI that engages in a deposit taking business must place a deposit reserve with the local branch of the PBOC. Applicable ratios are determined by the PBOC and adjusted from time to time.

Deposit Reserve Fund

A FFI engaging in deposit services shall allocate a deposit reserve fund to a branch of the PBOC in the place where the FFI is located. The reserve ratio shall be determined by the PBOC and may be adjusted in accordance with requirements (Article 23).

Other Ratios

Other asset and liability ratios include the following:

• 30% of the working capital of a foreign bank branch shall be in the form of interest bearing assets designated by the PBOC, including deposits in PBOC-designated banks (Article 24). Interest bearing assets are defined in the Implementing Rules to include foreign currency interest bearing assets (namely, foreign currency term deposits with a term of more than six months) and Rmb interest bearing assets (namely, Rmb denominated government bonds or term deposits with a term of more than six months). The foreign currency and Rmb term deposits must be deposited in not more than three PRC commercial banks, liberalizing previous mandatory deposits with the PBOC at the official savings rate. Interest rates may be determined by the parties "in accordance with the relevant provisions of the PBOC" (see above). The banks with which the interest bearing assets of foreign bank branches are deposited and the details of the interest rates must be filed with the local branch of PBOC (Implementing Rules Article 65).
• The capital adequacy ratio for a wholly foreign-owned bank, an equity joint venture bank, a wholly foreign-owned finance company, or an equity joint venture finance company must be not less than 8% (Article 25).
• The fixed assets of a wholly foreign-owned bank, an equity joint venture bank, a wholly foreign-owned finance company, or an equity joint venture finance company shall not exceed 40% of its equity capital (Article 27). This represents a change in the calculation of capital more in line with an international, uniform definition of capital.
• An FFI must appropriate a reserve fund for its bad loans (Article 31).

Material Changes

Any material change in a FFI needs to be approved by the PBOC and registered with the State Administration of Industry and Commerce, including a change of ownership of more than 10% in its total capital or stock (Article 33). This simply re-states the requirement applicable to domestic banks in Article 24(5) of thePRC Commercial Banking Law (中华人民共和国商业银行法) (1995) and in the Equity Investments in Financial Institutions Tentative Provisions (issued by the PBOC in July 1994).

Credit Asset Transfers

The Implementing Rules also make it clear that the transfer of any credit asset from the head office or the associated bank of a FFI must be approved by the local branch of the PBOC. While the policy concerns here may merit this type of restriction, this is likely to represent an obstacle to interbranch risk transfers and allocations. The impact of this change in practice remains to be evaluated.

Reporting Obligations

The Implementing Rules set out in detail certain reporting obligations. Briefly summarized, FFIs must report the following events to the local branch of the PBOC:

• any serious problems (financial or operational);
• major adjustments to its operating strategy;
• important board resolutions;
• any change in shareholder of less than 10% of the total capital or shares of a FFI;
• any change to the articles of association, registered capital and registered address of the head office of a FFI;
• reorganization of the head office of a FFI and changes in its chairman or president;
• any serious problems (financial or operational) of the head office of a foreign bank branch or a foreign joint venture party;
• major changes in the laws and regulations of the place of the head office of a foreign bank branch or a foreign joint venture party;
• the local branch of the PBOC should be notified seven working days prior to any suspension of business by a FFI (apart from suspension due to force majeure); and
• any other event that the PBOC mandates as requiring notification.

Sanctions

The following sanctions are prescribed in the new FFI Regulations:

• The PBOC may ban and close any FFI that has not been approved by the PBOC or which conducts any illegal or unauthorized financial business. The FFI involved may also be subject to criminal liability. In addition, the PBOC may confiscate any illicit gain. If the illicit gain is less than Rmb100,000, a fine of between Rmb100,000 and Rmb500,000 applies.
• A FFI may be subject to criminal liability if it operates beyond the business scope (in terms of types of activity, geography or customer group) approved by the PBOC. In addition, the PBOC may confiscate any illicit gain. If the illicit gain is less than Rmb100,000, a fine of between Rmb100,000 and Rmb500,000 applies.
• The PBOC may suspend the operation of any new business that has not been approved by it. The PBOC may confiscate any illicit gains and impose a fine of one to three times the amount of such gains. If the illicit gain is less than Rmb50,000, a fine of between Rmb50,000 and Rmb300,000 shall be imposed.
• If a FFI operates its business in violation of Chapter IV (Supervision and Management) of the Regulations, the PBOC may issue a warning, confiscate any illicit gains and impose a fine of one to three times the amount of such gains. If the illicit gain is less than Rmb50,000, a fine of between Rmb50,000 and Rmb300,000 shall be imposed.
• If a FFI refuses or hinders legitimate supervision or inspection, or submits false documentation or information, the PBOC may issue a warning and issue a fine of Rmb100,000 to Rmb500,000.
• If a FFI fails to submit its financial statements and other documents or information on time, the PBOC may issue a warning and order it to rectify within a specified period, and may impose a fine of Rmb10,000 to Rmb100,000.
• In case of serious violations of the FFI Regulations, the PBOC may suspend the business licence of a FFI or revoke its business licence, and any senior management personnel involved may be disqualified from working in China.
• Breaches of other PRC laws and regulations will be dealt with by the relevant competent departments according to law.

As illustrated above, there is no doubt that there will be a lot of opportunities for foreign participation in the banking sector after China's WTO accession. Foreign banks may take advantage of these opportunities by expanding their business scope, focusing on Rmb businesses and making strategic investment in domestic commercial banks. Needless to say, an analysis of the opportunities offered by WTO is only one-fourth of the SWOT analysis. The business people at foreign banks will obviously need to put things into perspective and do their own SWOT analysis before putting together a sound business expansion plan for their investment in China.

Endnote

1 The full schedule of market access in the banking and finance industries can be found at the World Trade Organization website (www.wto.org) and is found in Document 02-0796, GATS/SC/135, Trade in Services