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February 26, 2009

Heading for the exit

As Chinas economy begins to slow, Western banks which took equity stakes in leading Chinese banks are looking to bolster their own capital bases by offloading their shares

By Verdict Staff

As China’s economy begins to slow, Western banks which took equity stakes in leading Chinese banks are looking to bolster their own capital bases by offloading their shares. What will this mean for those banks with payment card joint ventures in the country? Divya Guha and Victoria Conroy report.  

In an interview which preceded Royal Bank of Scotland’s (RBS) investment in China, John Shelley, a senior executive at RBS expressed his enthusiasm for gaining a stake in the Chinese banking sector.

“This is not a short-term game, but it’s tremendously exciting, a huge opportunity for the banks that can go about it in an organised way,” he said. These words have returned to haunt him just over three years later.

China, the world’s third-largest economy, was at one time something of an exclusive members’ club – thanks to the government’s policy of keeping foreign banks out of the marketplace.

For years, entry was denied to eager Western banks desperate to partake of the country’s economic boom, which only made them lobby the country’s government even harder, wooing regulators and promising to abide by the rules should they be fortunate enough to be admitted.

Eventually the Chinese government relented and a select few banks were allowed to buy minority stakes in commercial Chinese banks, setting up joint ventures in the fields of payment cards, retail financial services and commercial banking with assurances of strategic partnerships and risk management assistance.

Western high-rollers such as Citi, HSBC, Bank of America, RBS and ING were just some of the banks that eagerly took their place at the table. Payment cards were a key priority for growth, given that China has one of the fastest-growing consumer markets in the world which offered incomparable potential.

These acquisitions, mostly made in 2005 and 2006, provided the means for China to exchange capital and expertise for product launches, marketing, information technology and risk management to help its largely underdeveloped banking sector. Today, after the sale of the stakes, the Chinese regulators may be wondering if this ‘love me then leave me’ attitude of the Western banks should be tolerated.

So far, none of the cards and payment joint ventures have been completely dismantled – but the world looks very different in 2009 to the way it was in 2005.

Slowing market expansion

Even though the Chinese payment market lags behind the US and the UK, the Chinese card acceptance environment is improving in most big cities. The global economic downturn intensified in 2008, and Chinese consumer spending has slowed while issuers’ marketing costs remain high.

The debit card market seems to be quickly approaching saturation too, with growth rates slowing down rapidly. Experts also predict the credit card delinquency rate, which has risen sharply, could double in 2009. Regulators have warned issuers of the rising risks, and new cards are being distributed with greater caution.

Providers are now gearing towards servicing their existing card accounts more carefully as the country enters a new phase of development, one in which risk control and planned growth become key. Analysts say that though the market will continue to grow, the pace will slow down.

“This may not be a bad thing after all,” says principal analyst Terry Xie, of Mercator Advisory Group, speaking to CI. “The economic slowdown might be a disguised blessing to the development of China’s credit card industry. There is little question that it would further delay the whole industry from breaking even. Nonetheless it provides an opportunity for Chinese credit card issuers to slow down their pace and re-examine their developments, and possibly rethink their growth strategies before the problem becomes too big.”

Amid the ongoing downturn, foreign banks that have been hit hard by the credit crunch are desperate to shore up their balance sheets. Some viewed the price of membership to the Chinese banking club as being far too steep for them to continue paying their dues and sold up.

The Chinese economy is beginning to look increasingly unhealthy, said Wu Yonggang, an analyst with Chinese brokerage Guotai Junan, to the Financial Times: “The Chinese stock market is in a terrible situation right now and if all the big foreign investors are running away from the banks, then that would hurt confidence even more and the government would not be keen to see that happen.”

Reasons for leaving

There are several factors driving the full or partial exit of Western banks from China, with the well-documented cash-strapped state of Western banks likely to be a prime concern.

Although it remains a formidable economic power, China’s economy is starting to show signs of cooling and it is a possible Western banks want to jump ship before things get any worse.

Rising bad debts are another worry. Chinese banks have already raised provisions against bad debts in the fourth quarter of 2008, but asset quality is likely to slump further in coming months. With interest earned on loans and credit cards comprising upwards of 70 percent of Chinese banks’ operating income, according to global credit ratings agency Fitch, credit risk continues to represent the single largest threat to Chinese bank performance as the economy weakens and puts more pressure on borrowers.

A spate of interest rate cuts by the central bank (five times in 2008) means that Chinese lenders in 2009 will be less well off than in recent years, with earnings reduced to single-digit growth ranges. However, Fitch cautioned that this decline will take significantly longer than expected to show up in loan quality data, due to features regarding the way loans are extended and classified in the country.

The agency highlighted that the financial strength of China’s largest banks has improved noticeably in recent years, in tandem with falling non-performing loan (NPL) ratios, rising loan loss provisioning, and substantial capital raising. In October 2008, the China Banking Regulatory Commission reported that Chinese commercial banks had an overall NPL ratio of 5.49 percent at the end of September 2008, down 0.67 percent from the beginning of the year. NPLs of commercial banks amounted to CNY1.27 trillion ($186 billion) at the end of September, a decrease of CNY3.02 billion since the start of 2008.

Though current levels of loan loss reserves and capital (better than at any point during the reform era) may overstate the degree of future asset-quality deterioration, the country’s banks are able to withstand this climate, according to Fitch. The report stated that “as we look into 2009 and 2010, it is clear that Chinese banks’ exposure to credit losses is rising, but exactly when and how this will manifest itself clearly in financial data is less certain.” Fitch added that NPL ratios could remain steady or even decline in the short term, but the overall outlook hinges also on the quality of data and reporting from Chinese banks.

However, rival credit ratings agency Standard & Poor’s warns that NPL ratios may rise by as much as 204 basis points in 2009, due to an economic stimulus package from the country’s central bank, People’s Bank of China (PBoC) which could lead to declines in revenue and margins.

Consultancy KPMG also reports that many foreign lenders have failed to develop sufficient local controls over their joint ventures with Chinese commercial banks as they underestimated the financial commitment involved in entering the country’s market. Also as the economic outlook darkens, Western banks are likely to see more impasses if more regulation rather than less is put into place.

A too hasty retreat?

The Chinese are also likely to suffer from the Western banks’ reduced incentive to continue with current levels of co-operation and investment, and they have hinted that this desertion is not one they will forget easily. It will not be easy for foreign banks to fall back in favour should they decide to return, once they have taken care of business at home. They may have to pay significantly higher prices the second time around, leaving them at a disadvantage to their peers who remained in the country.

“If a foreign bank sold off all its shares in Chinese banks at this hard time, that would certainly complicate any of their future efforts to re-enter the market. Regardless of the reasons for the selling, it looks bad to Chinese banks and foreign banks might have to eat up the costs of losing trust among Chinese banks and the regulators, which could be expensive,” Xie told CI.

According to the central bank, the People’s Bank of China (PBoC), in the third quarter of 2008, outstanding credit lines of credit cards stood at CNY891.04 billion, a rise of 70.9 percent compared to the same period in 2007, and 3.5 times as much as that of the same period of 2006. This means China is still fertile ground, offering plenty of room for growth for western banks with the stamina to stay the course.

Two years on, foreign banks who may seek to return may have to fight for their niche and face tough competition from the much more experienced Big Four in the domestic market.

Prominent card partnerships

RBS and Bank of China (BoC)

RBS and BoC established their credit card joint venture in early 2007, co-operating in product design, direct selling, risk management and information technology, rolling out a range of functionally-enhanced credit cards.

Financial results from BoC show that the joint venture has been a success for both partners, immediately following the launch of the business.

By the end of 2007, BoC had issued 11.4 million credit cards, with core features such as EMV and automatic repayment functions being added to offerings. By June 2008, BoC had issued nearly 14 million credit cards.

On 14 January 2009, RBS announced its disposal of its 4.26 percent equity for £1.6 billion, selling 10.8 billion shares, having first purchased a 10 percent stake in August 2005. However, RBS will still operate its network of 20 branches in conjunction with ABN AMRO, and will continue to operate in the areas of retail and commercial banking and wealth management.

When contacted by CI, an RBS spokeswoman said that no decision had been made regarding its continued involvement with its credit card joint venture with BoC, only that following the sale of its stake, the two banks were in “ongoing” discussions regarding the future direction of the venture, and that no timescale had been put in place relating to any decision regarding its continued existence.

HSBC and Bank of Communications (BoComm)

HSBC and BoComm established their joint venture in 2005, with HSBC providing technical support in business operations and concepts, management tools and product marketing and development.

By the end of 2005, they had gotten 657,000 cards into the Chinese marketplace, with that figure rising to 3 million by the end of 2006 and to over 5 million by the end of 2007. By mid-2008 that figure had increased to over 7.7 million cards, with total consumer spending amounting to RMB38.5 billion by mid-2008.

HSBC may be in a stronger position than its peers thanks to its diversified asset base and already-healthy tier 1 capital ratios, and so this far it has not needed to raise capital through share offerings or divestitures of assets. In a mid-2008 investor presentation, HSBC stated that organic growth in China remained a key priority, along with deepening strategic partnerships already in place.

“HSBC considers China a more important part of its longer term strategies and they don’t want to change that for now,” Xie explained.

It has the largest foreign bank network in China with 75 branches as of September 2008, and plans to increase that number over 2009. Given its extensive presence in China and its relative good financial health, it is unlikely that HSBC, with its deep roots in the Asia-Pacific region, will be looking to exit the Chinese market any time soon.

When contacted by CI, an HSBC spokeswoman said that the bank had no plans to divest its stake in BoComm, and that it would be continuing its credit card joint venture.

Bank of America (BofA) and China Construction Bank (CCB)

BofA and CCB established their credit card joint venture in April 2007, and have since set up sales and service processes for high net worth customers, completed IT planning and data governance and scorecard procedures. A leading player in credit cards, CCB had boosted its credit card issuance numbers to 15.6 million by mid-2008, compared to 4.47 million in 2005, and 6.34 million in 2006.

In 2007, CCB set up 32 ‘experience sharing’ projects with BofA, including a credit card joint venture and retail branch transformation. The implementation of scoring cards for mortgage lending and credit cards has enabled the bank to grant automatic approval of credit card applications, and to proactively adjust the credit limits of cardholders.

BofA offloaded 13 percent of its stake in CCB in early January 2009, having invested $3 billion in 2005 and subsequently increasing its share, paying $7 billion in November 2008 to increase its stake to 19.1 percent, the maximum stake allowed by the Chinese government.

BofA made a profit of around $1.1 billion from the sale of its Hong Kong-listed CCB shares, reducing its stake in the Chinese bank from 19.1 percent to 16.6 percent. In mid-December last year, the bank announced it planned to sell $2.8 billion of its shares.

However, BofA’s decision to sell was rumoured to have dismayed the Chinese government. The intended sale fell under the Chinese Securities Law which prohibits investors holding more than 5 percent of the shares of a local, publicly-traded company from selling their shares within six months from the date of purchase.

BofA’s dominance of the US credit card market (with over 70 million accounts at the end of 2008) could expose it to massive credit losses over 2009.

It also needed to fund its $33 billion acquisition of Merrill Lynch. BofA went ahead with the partial CCB stake sale. In response, CCB said that BofA sold its shares because of its “financial situation”, stressing that both banks would continue their strategic partnership and continue to co-operate in all business areas.

American Express and Industrial Commercial Bank of China (ICBC)

American Express bought into ICBC in mid-2005 as part of a consortium, having had a previously-established card alliance agreement with the bank stretching back to 2004.

Amex’s expertise in the fields of innovation, co-branding and segmentation helped ICBC to issue 23.4 million credit cards by the end of 2007, with spending reaching RMB161.9 billion. ICBC also tapped overseas institutions to issue cards as agents, with a view to expanding outside China. By mid-2008, card numbers had reached 33 million, and CNY110 billion in consumption.

A sharp rise in cardholder defaults in the US market has obliged Amex to turn to the US TARP programme for extra capital, and with US unemployment rates skyrocketing, Amex is braced for even bigger credit losses in 2009. With this in mind, rumours are swirling that Amex is planning to sell its stake in ICBC when its lock-in period expires at the end of April 2009, which would return around $500 million into Amex’s coffers. But Amex told CI that they had not expressed any plans for the ICBC investment and refused to comment on market speculation.

An Amex spokeswoman said: “ICBC is a key partner, and our partnership started in 2004 with the launch of the ICBC American Express Card – the first American Express-branded card in China. Since then, we have successfully introduced a broad array of consumer, corporate and co-brand cards with strong value propositions.”

Citi and Shanghai Pudong Development Bank (SPDB)0

Citi and SPDB teamed up in 2005 to launch their credit card operation, in that year issuing 200,000 cards, rising to 500,000 by the end of 2006 with spending of CNY5.1 billion. By the end of 2007, SPDB had issued 1.67 million credit cards, with spending amounting to CNY11.9 billion.

Despite the 3-year lock-in period expiring in December 2008, SPDB stated in early January 2009 that Citi had no plans to sell its stake. For its part, Citi would only comment that its partnership with SPDB remained strong and that it looked forward to developing the partnership going forward for the mutual benefit of both parties. However, Citi’s recently-announced restructuring and its continued bad run of financial results make it look likely that Citi will divest its stake at the earliest opportunity.



Chinese equity stakes

Chinese bank

Foreign investor

Stake purchased (%)

Cost ($m)

Industrial and Commercial Bank of China

Goldman Sachs, American Express, Allianz Group



China Construction Bank

Bank of America



Bank of China







Asian Development Bank



Bank of Communications




Bank of Dalian

Bank of Nova Scotia


not disclosed

Shanghai Pudong Development Bank




Huaxia Bank

Deutsche Bank



Sal Oppenheim


not disclosed

Industrial Bank

Hang Seng Bank



Guangdong Developmnet Bank




Bank of Beijing

ING Group



Bank of Shanghai




Shanghai Commercial Bank



Bank of Nanjing

BNP Paribas



China Bohai

Standard Chartered



Bank of Hangzhou

Commonwealth Bank of Australia



Asian Development Bank



Xi’an City Commercial Bank

Bank of Nova Scotia



Ping An Bank




United Rural Co-operative Bank of Hangzou




China Everbright Bank

Asian Development Bank



Bank of Tianjin

ANZ Bank



Shanghai Rural Commercial Bank










Urumqi City Commercial Bank

Habib Bank



Jilin Bank

Hana Bank



Bank of Qingdao

Intesa Sanpaolo



Rothschild Bank



Xiamen International Bank

Asian Development Bank






Changsa City Commercial Bank

Groupe Banque Populaire



Qingdao International Bank

Hana Bank



Jinan City Commercial Bank

Commonwealth Bank of Australia



Nan Tung Bank

Morgan Stanley



Bank of Chongqing

Dah Sing Bank



Yantai City Commercial Bank

Hang Seng Bank



Wing Lung Bank



Bank of Chengdu

Hong Leong Bank



Source: CI

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