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R 070803Z APR 06
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RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC
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UNCLAS SECTION 01 OF 03 GUANGZHOU 010672 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
USDOC FOR 4420/ITA/MAC/MCQUEEN 
TREASURY FOR OASIA/INA-CRANE 
STATE ALSO PASS USTR/STRATFORD 
STATE ALSO PASS FEDERAL RESERVE 
 
E.O. 12958: N/A 
TAGS: ECON WTRO EFIN EINV CH
SUBJECT: Getting a Piece of the Action: Foreign Banks Try To 
Get Their Foot in the Door of Chinese Banking 
 
REF: A) Shanghai 1354 
B) Guangzhou 5379 
C) Beijing 3454 
 
¶1. (U) Summary: Under a five-year transition period in its 
WTO accession agreement which ends December 11, 2006, the 
Chinese Government is gradually becoming more liberal in 
allowing foreign investment to enter China's banking 
industry. With the Chinese Government opening its RMB 
currency market later this year, how do foreign banks get 
into the market?  The quick way is for foreign banks to 
invest in local Chinese banks to access the latter's usually 
extensive system of bank branches and customer networks. 
Such strategic investment can also effectively help foreign 
banks to circumvent the Chinese Government's barriers to 
slow the growth of the foreign banking sector through 
licensing procedures as well as the difficulties most 
foreign banks face in accumulating RMB deposits with their 
few branches.  End Summary. 
 
¶2.  (U) Economic Minister Counselor Robert Luke and 
Congenoff met with Milton Lau, General Manger of Citigroup's 
Guangzhou Branch, and Professor Lu Jun, Dean of the Finance 
Department of Lingnan College of Dr. Sun Yat Sen University 
in late February.  Interlocutors discussed their opinions on 
China's opening of the banking industry. 
 
Restricting Trade: Control through Indirect Means 
--------------------------------------------- ---- 
 
¶3.  Administrative barriers govern foreign bank expansion at 
present.  According to Citigroup's Lau, RMB business is 
currently restricted.  Foreign banks, with only a two 
percent share of the banking sector, are eager to get a 
larger share.  Even if there were an RMB license available, 
only 20 cities in China are approved for foreign banks to 
offer RMB transactions.  Currently, RMB services by foreign 
banks are only allowed for foreign customers.  According to 
Lau, whenever a foreign bank wants to open a new bank branch 
or launch a new product, it will face delays due to lengthy 
application and permit procedures.  Lau mentioned another 
foreign bank that was delayed for six-nine months in opening 
a branch office.  And approval is not an approval.  After 
leasing an office, installing IT systems, and providing 
training, the local China Banking Regulatory Commission 
(CBRC) office then does an on-site inspection.  Only then is 
a final license issued. Large capitalization requirements 
are also required as per CBRC requirements, depending on the 
level of services provided.  For each additional sub-branch 
an additional RMB 10 million (USD 1.25 million) is required. 
To provide foreign currency trading, RMB 100 million (USD 
12.5 million) is required.  To provide RMB banking business 
services to individuals, a foreign bank needs to have RMB 
200 million (approximately USD 25 million) in operating 
capital.  For comprehensive RMB services for businesses, RMB 
300 million (USD 38 million) is required.  Lu Jun also noted 
that even if a bank obtained approval for opening a new 
branch, it may still face zoning restrictions, limiting the 
number of banks that can be allowed within a certain 
geographic area.  Starting December 11, at the end of 
China's WTO transition period, the Chinese Government will 
fully open its banking industry and lift all current 
geographical and product restrictions on foreign banks. 
 
Domestic Banks are the Most Efficient Choice For Expansion 
--------------------------------------------- ------------- 
 
¶4.  (U) To work locally, foreign banks need access to local 
currency, i.e., RMB.  RMB most commonly comes from local 
depositors.  Without access to local depositors, banks could 
use interbank lending to get access to RMB but would be at a 
competitive disadvantage from the start due to the higher 
acquisition costs.  Ready access to RMB would also allow 
foreign banks to offer loan services to a sector that had 
defaulted on them earlier.  Though many foreign banks, 
including Citigroup, had earlier suffered from bad loans to 
some of China's large state-owned enterprises (SOEs), in 
recent years, according to Lau, foreign banks have found 
that large reformed SOEs to have become good customers. 
Since domestic banks have a long tradition of providing the 
majority of their loans to SOEs, these banks have very 
 
GUANGZHOU 00010672  002 OF 003 
 
 
close, long-term relations with the big SOEs.  Additionally, 
domestic banks holding full business licenses already 
maintain a far-flung branch network with ready access to 
local depositors.  China is already well known as a country 
with a savings rate as high as 40-50 percent with banks 
awash in cash.  Lu noted that management, not finance, is 
the problem with domestic banks.  Buying into domestic banks 
can provide foreign banks with the fastest access to the 
local market, especially in getting RMB deposits after 
November 1.  The current average three percent gap between 
the deposit and loan interests also make the RMB currency 
market very attractive to foreign banks.  Investing in a 
domestic bank with its built-in advantages is the most 
efficient and cost-effective way for foreign banks to expand 
in China. 
 
But No Free Lunch: Citigroup Plays Catch-up To Rivals 
--------------------------------------------- -------- 
 
¶5.  (U) All of this opportunity comes with costs and 
limitations.  Some domestic banks carry a high percentage of 
non-performing loans, so acquiring a share of a domestic 
bank often means acquiring a net negative value, though it 
obviously is not entirely without value.  In theory, each 
foreign bank is only allowed to invest in two domestic 
banks.  Citigroup is trying to catch up with rivals in China 
such as HSBC Holdings, which already has a bigger stake in 
China's financial sector.  Citigroup has already invested in 
Shanghai Pudong Development Bank with a 4.6 percent share, 
is in negotiations for an increased share, and is currently 
bidding for a significant share of Guangdong Development 
Bank (GDB).  Lu's understanding is that GDB's capitalization 
rate is already negative seven percent but still described 
Citigroup's bid as "good risk management."  Despite this 
negative worth, GDB already has a built-in infrastructure 
that will save Citigroup much money and time it would need 
for its own expansion with the purchase.  The success of 
Citigroup's bid depends on whether the Chinese regulators 
make an exception in the ownership cap of 20 percent set for 
a single foreign firm and 25 percent for collective 
ownership.  As reported on ref A, Citigroup hopes to acquire 
a 40 percent stake in GDB.  Citigroup believes the 
Government might still approve the purchase because of the 
seriousness of GDB's current situation. 
 
Citigroup's Strategy 
-------------------- 
 
¶6.  (SBU) Lau outlined several steps that Citigroup would 
take to expand its business.  Beginning with its current 
multinational corporate clients, Citigroup would expand its 
services to Guangdong's top tier of SOEs and to Taiwan- 
invested businesses, building on its strong business in 
Taiwan.  Later, Citigroup would develop services 
specifically for small and medium enterprises (SMEs) and 
commercial banks; groups Lau said were often ignored by 
local banks.  Lau noted that Citibank Hong Kong already has 
a well-established SME banking business begun in 2005.  This 
sector has just opened to foreign banks.  Citigroup China 
has promoted the former Guangzhou Citigroup director to be 
the head of all China commercial banking in an effort to 
begin planning.  Taking a long-term view of the China 
market, Lau said that both Citigroup and HSBC would expand 
into consumer banking, an area he suggested few foreign 
banks would penetrate, preferring to stick with corporate 
banking. 
 
Encouraging a Foreign Lifeline 
------------------------------ 
 
¶7.  (U) Lu also pointed out the Chinese Government and 
domestic banks acknowledge the value of attracting foreign 
investment.  The Chinese Government, which formerly held 
that the banking industry was a strategic sector of the 
economy and therefore no portion of it could be sold to 
foreign interests, has seen that keeping domestic banks 
fully state-owned is not the best way of keeping them 
 
GUANGZHOU 00010672  003 OF 003 
 
 
healthy, particularly given their previous track record. 
Foreign banks offer strategic investment, financial 
expertise, advanced management, and experience in a 
competitive global world, all of which domestic banks will 
need to survive in a more open post-WTO transition period. 
Starting from January 1, 2007, three weeks after the 
transition period ends, all domestic banks will be required 
to meet an eight percent capitalization rate before they can 
provide new business products, critical for their survival. 
Foreign banks could provide much of this capital. 
 
Comment: Possible Breakthrough for Mutual Benefit? 
--------------------------------------------- ----- 
 
¶8.  (SBU) The Chinese Government is protecting its domestic 
banks by using intangible administrative measures to push up 
the expansion costs for foreign competitors.  Foreign banks' 
investment in domestic banks will have a win-win effect of 
providing a fast and comparatively low-cost expansion for 
foreign banks while bailing out and encouraging the 
comprehensive upgrading of domestic banks.  A successful 
Citigroup bid for Guangdong Development Bank may open the 
door to more rapid access to this sector by foreign banks. 
End Comment. 
 
DONG