Landmark Regulations Expand China's Banking Sector

On November 11 2006, the State Council of the People's Republic of China (PRC) promulgated the PRC Regulations for the Administration of Foreign-invested Banks (中华人民共和国外资银行管理条例)(new Regulations). The new Regulations were issued to fulfill China's commitments to the World Trade Organization (WTO) to open the PRC commercial banking sector to foreign competition.

The new Regulations became effective on December 11 2006, the fifth anniversary of China's accession to the WTO. They replaced the Regulations of the People's Republic of China for the Administration of Foreign-invested Financial Institutions, which had been effective since February 1 2002. On November 24 2006, the China Banking Regulatory Commission (CBRC) published the Implementing Rules for the PRC Regulations for the Administration of Foreign-invested Banks (Implementation Rules), which also became effective on December 11 2006.

Since China joined the WTO, the PRC government has taken a series of measures to open China's banking market and fulfill its commitments to the WTO. According to the CBRC, as of September 30 2006:

i. the total assets of foreign-funded banks in China exceeded US$100 billion;

ii. a total of 73 foreign banks established 199 branches and 61 sub-branches in China;

iii. a total of 183 foreign banks opened 242 representative offices in China, and

iv. a total of 111 foreign-funded banks received permission to conduct Rmb banking business in China.

By permitting wholly foreign-owned enterprise (WFOE) banks or Sino-foreign joint venture (JV) banks to fully engage in renminbi business in China, the new Regulations widen the PRC banking sector and encourage foreign banks to conduct business in China via PRC-incorporated subsidiaries. The new Regulations also reduce the differences between the requirements for domestic banks and those for foreign-funded banks. This allows domestic and foreign-funded banks to operate and compete under a consistent regulatory system.

LIFTING RESTRICTIONS ON renminbi BUSINESS

The old Regulations allowed foreign-funded banks (essentially WFOE banks, JV banks and foreign bank branches) to engage in a broad range of banking activities comparable to those of domestic banks in China. However, before doing so, foreign-funded banks were required to receive the Commission's approval. They were also subject to geographic and customer restrictions, which only allowed them to provide renminbi-denominated banking services to enterprise customers in 25 Chinese cities.

The new Regulations categorize representative offices of foreign banks within the scope of foreign-invested banks. According to the new Regulations, representative offices are not allowed to conduct business activities in China and can only participate in non-business activities (such as, networking, market research and consulting services) that relate to the foreign bank they represent.

The new Regulations remove the geographic and customer restrictions for foreign-funded banks. Now, WFOE and JV banks can provide renminbi banking services to both individual and enterprise customers throughout China. However, the new Regulations impose the following restrictions on foreign bank branches, which do not apply to WFOE or JV banks:

i. banking services for PRC citizens are limited to renminbi-denominated deposits of at least Rmb1 million per deposit; and

ii. foreign bank branches cannot offer bank card services in China.

There are other countries which observe the minimum threshold on retail deposits received by foreign bank branches. In the United States, for example, branches of non-US banks must receive initial deposits in denominations of at least US$100,000.

According to Article 34 of the new Regulations, foreign-funded banks that wish to provide renminbi-denominated banking services in China must:

i. seek the CBRC's approval,

ii. have an operating history of at least three years in China; and

iii. have been profitable for the most recent two years.

In addition, according to the Implementation Rules, foreign-funded banks must have the following attributes to fulfill the CBRC's prudential requirements:

i. a good industrial and social reputation;

ii. a sustainable operating record and good asset quality;

iii. competent professional and management capabilities;

iv. risk-control system that can control transaction risks;

v. an internal control system and an effective management information system;

vi. financial statements in accordance with accounting principles;

vii. no qualified audit opinion issued in the past three financial years;

viii. no record of material violation of laws and regulations;

ix. effective capital management and supply mechanisms;

x. a functional corporate governance structure; and

xi. an appropriate distribution network.

ENCOURAGING DOMESTIC INCORPORATION

The new Regulations encourage foreign banks to conduct PRC banking activities via a subsidiary instead of using a branch for this purpose. As mentioned previously, the new Regulations do not allow foreign banks branches to issue credit or debit cards, or to accept deposits of less than Rmb1 million.

Foreign banks waited for many years to enter the credit card and retail banking market in the PRC. Of the foreign banks that invested in PRC banks, some included plans in their cooperation agreements to establish future joint ventures to conduct credit card business.

Following the promulgation of the new Regulations, Standard Chartered Bank announced that it submitted applications to the CBRC on November 16 2006 for approval to establish a PRC-incorporated subsidiary and launch renminbi banking business. Reportedly, HSBC, Bank of East Asia, Hang Sang Bank and Citigroup are also interested in converting their respective China branches into domestically-incorporated subsidiaries.

The new Regulations permit foreign banks to convert their China branches into WFOE banks in accordance with conditions and application procedures outlined in the Implementation Rules. Encouraging foreign companies to engage in banking activities in China via domestically-incorporated subsidiaries is consistent with the recent regulatory trend in the PRC. Notable examples include:

i. The Ministry of Construction and other ministerial authorities' recent regulations on foreign investments in the real estate sector require certain foreign investors to make real estate investments via PRC-incorporated investment companies. (See Article 1 of the Opinions of the Ministry of Construction, the Ministry of Commerce and the National Development and Reform Commission, the People's Bank of China, the State Administration of Industry and Commerce and the State Administration of Foreign Exchange on Regulating the Access to the Administration of Foreign Investment in the Real Estate Market.)

ii. The Ministry of Information Industry's recent circular, which indicates that any foreign investor who engages in the PRC telecommunication business must establish a foreign-funded telecommunication enterprise as the operating entity. (See Article 1 of the Circular of the Ministry of Information Industry on Enhancing the Administration of Foreign Investment in Value-added Telecommunications Services.)

iii. The China Securities Regulatory Commission's recently