VZCZCXRO4191
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #0071/01 0112305
ZNR UUUUU ZZH
P 112305Z JAN 09
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 1780
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 03 BEIJING 000071 
 
SIPDIS 
SENSITIVE 
 
STATE FOR EAP/CM AND E/YON 
TREASURY FOR OASIA/DOHNER/WINSHIP 
TREASURY ALSO FOR IMFP/SOBEL/MOGHTADER 
NSC FOR LOI 
 
E.O. 12958: N/A 
TAGS: ECON EFIN CH
SUBJECT: Federal Reserve Visit to Beijing: Impact of Financial 
Crisis on Chinese Banks 
THIS CABLE IS SENSITIVE BUT UNCLASSIFIED.  NOT FOR INTERNET 
DISTRIBUTION. 
 
¶1. (SBU) Summary: In December 11-12 meetings in Beijing, Chinese and 
foreign financial sector representatives told San Francisco Federal 
Reserve Bank Senior Vice President Steven Hoffman that they expect 
ChinaQs cyclical downturn to increase non-performing loan volumes 
and reduce bank earnings, but not to the point of a Qseizing upQ of 
the financial sector.  Debate continues among bankers and officials 
on how best to keep prudent banking and banking supervision from 
being excessively pro-cyclical, particularly with regard to loans to 
the private, small- and medium-sized enterprises responsible for 
most of ChinaQs jobs; such companies typically experience more 
difficulty 
securing financing, particularly when perceived credit risks rise. 
Chinese banks appear set to test whether the U.S. Federal Reserve 
will allow them to take larger equity stakes in U.S. banks, which 
will likely impact perceptions among ChinaQs political leadership 
and the public regarding U.S. openness to foreign investment.  End 
Summary. 
 
¶2. (SBU) During his visit to Beijing, San Francisco FRB Senior Vice 
President Steven Hoffman met with PeopleQs Bank of China (PBOC) 
Director General for Financial Stability Zhang Xin, Bank of China 
General Manager for Overseas Business Management Department Wang 
Leejun, Industrial and Commercial Bank of China (ICBC) General 
Manager of Corporate Strategy Department Gu Shu, Dragonomics 
Managing Editor Tom Miller, Fitch Ratings Senior Director for 
Financial Institutions Charlene Chu, Price 
Waterhouse Coopers (PWC) Advisory Services Partner Tim Pagett, and 
Deloitte-China Consulting Managing Partner Norman Sze.  HoffmanQs 
conversations focused on the severity of the impact of the global 
economic crisis on the Chinese banks and likely policy responses. 
In addition, this report also incorporates some points raised in 
recent meetings by EmbassyQs Economic and Financial 
Minister-Counselors with officials of the Bank of China and ICBC. 
 
Varying Views on Intensity of Economic Downturn . . . 
--------------------------------------------- -------- 
¶3. (SBU) Miller of Dragonomics noted some similarities of the 
current crisis to ChinaQs previous Qhard landingsQ in 1989 and 1997. 
 First, all involved exogenous shocks: Tiananmen (a political 
shock), the Asian Financial Crisis, and todayQs global credit 
crisis.  Second, all involved sharp investment-led cyclical 
downturns.  And third, all occurred when economic structural 
adjustments were adversely impacting certain sectors: the late 
1980Qs price liberalization, the mid-1990Qs state-owned enterprise 
(SOE) rationalization, and the current attempted shift to more 
balanced and harmonious growth (less coastal and resource-intensive 
growth). 
 
¶4. (SBU) One difference, however, is that this time the Chinese 
Government has been more proactive with fiscal policies.  Miller 
estimates that 25-50 percent of the RMB four trillion stimulus 
package already was budgeted prior to its announcement in November, 
with the rest as new spending.  About half of the total will go to 
general infrastructure and a fourth for post-earthquake 
re-construction, both of which should boost the steel and cement 
industries that are depressed due to the downturn in real estate 
construction.  This, Miller believes, will help China maintain a 7-8 
percent real GDP growth in 2009.  He also predicts steadier and more 
balanced growth when the economy recovers, and 
speculated that the Chinese GovernmentQs goal is to allow 4 percent 
RMB appreciation per year against the U.S. dollar.  On unemployment, 
Miller noted the widely held belief that unemployment above five 
percent would trigger noticeable social unrest, but he conceded that 
the quality of Chinese unemployment and under-employment data 
remains poor. 
 
¶5. (SBU) FitchQs Chu is less optimistic.  She believes economic 
growth will deteriorate further before improving, especially in the 
southern coastal provinces.  SMEs will be severely affected.  The 
current, but not yet published, Fitch forecast for Chinese real GDP 
growth in 2009 is 6.5 percent, which Chu expects this to be revised 
down, as the impact of the fiscal stimulus on growth would be 
limited.  In addition, by targeting 
capital-intensive rather than labor-intensive activities, the 
stimulus will have only limited impact on unemployment and would 
exacerbate macroeconomic imbalances. 
 
. . . and the Impact on Chinese Banks 
------------------------------------- 
¶6. (SBU) According to BOC representatives, their bank is involved in 
two key government initiatives for the banking sector.  First, 
commercial banks will be allowed to provide bridge loans for mergers 
 
BEIJING 00000071  002 OF 003 
 
 
and acquisitions, although this change appears mainly geared towards 
domestic rather than overseas activity.  Second, the China Banking 
Regulatory Commission (CBRC) is encouraging banks to increase 
lending to SMEs, 
which tend to be hit hard during cyclical downturns (in part due to 
inability to access credit) but which also offer higher lending 
margins.  While the BOC has not set specific targets for SME 
lending, it will establish special SME credit officers in its 
branches and also has adopted a SME loan evaluation model from 
Temasek, one of its foreign strategic partners. 
 
¶7. (SBU) Despite the cyclical downturn, BOC officials remain 
confident that deterioration of BOCQs major asset classes will be 
limited.  Mortgage lending is mostly to first-time home buyers, for 
whom NPL ratios traditionally have been low.  BOC has strict 
guidelines on lending for second homes and has limited exposure to 
commercial real estate.  Education loans are extended only to 
students at accredited universities and are backed by Chinese 
government guarantees. 
 
¶8. (SBU) With real estate prices and sales declining, Dragonomics 
Miller believes the greatest risk facing Chinese banks is their 
lending to property developers, but he does not foresee a large rise 
in defaults on home mortgages.  Overall performance of banks to date 
has been good, although problems have grown for coastal branches 
with large exposure to 
the export sector.  However, FitchQs Chu thinks Chinese banks 
published accounts overestimate asset quality; she estimates that 
revenues for some listed banks could fall by almost half next year 
due to a rise in non-performing loans.  Given the deteriorating 
economic outlook, Chu expects the Chinese banks to remain reluctant 
to lend despite the governmentQs moral suasion, although they 
ultimately will relent as both the downturn 
and government pressure intensify.  She also believes the government 
will cover all losses for the policy banks (including China 
Development Bank, which recently became a commercial bank), but to 
mitigate moral hazard the government will ensure that some large 
state commercial bank losses are not covered, such as losses on 
their riskier businesses (e.g. subordinated loans). 
 
¶9. (SBU) DeloitteQs Sze stressed that two systemic weaknesses for 
Chinese banks remain:  management information systems and internal 
auditing.  PWCQs Pagett believes ChinaQs large banks can move 
relatively quickly towards meeting Basel II standards, though the 
quality of their compliance is unlikely to be as high as banks in 
other countries. 
 
International Ambitions 
----------------------- 
¶10. (SBU) BOC will seek overseas growth through both expansion of 
its branch network and mergers-and-acquisitions, according to the 
BOC representatives.  It wants more branches in the United States, 
particularly San Francisco, but remains subject to enforcement 
actions by the U.S. Comptroller of the Currency for regulatory 
violations at its New York branch. 
 
¶11. (SBU) For ICBC, the decline in U.S. asset prices is not driving 
its expansion strategy, as the bank already had decided to expand in 
the United States long before the financial crisis, in order to 
follow its corporate clients (e.g., in trade finance and settlement 
clearing) and service the Chinese immigrant communities (remittances 
and financial 
services).  ICBC believes, however, that organic growth is too slow 
so it is considering merger-acquisition opportunities.  It currently 
is engaged in discussions with East-West Bank of California, in 
which ICBC seeks a larger and possibly controlling stake and thus 
exemption from the 5 percent ownership cap; in ICBCQs view, a five 
percent purchase of 
that bank is Qnot worth it.Q  In October 2008 ICBC opened its New 
York branch, which it wants to expand; while in the United States 
for the branch opening, the ICBC Chairman met with Treasury 
Secretary Paulson and noted his bankQs intentions to buy a majority 
stake in a U.S. bank.  ICBC has also informed CBRC of its U.S. 
plans. 
 
¶12. (SBU) Hoffman explained that the United States was open to 
foreign participation and that 25 percent of bank assets in the U.S. 
are held by foreign organizations.  Foreign applicants need to meet 
the same standards as U.S. banks, including financial and managerial 
soundness and Comprehensive Consolidated Supervision (CCS).  The CCS 
standard for purchasing a controlling stake in a U.S. bank is more 
rigorous than for just opening a branch.  The ICBC officers said 
 
BEIJING 00000071  003 OF 003 
 
 
they understand their bank, as a bank holding company that already 
has a branch, can only purchase five percent of another bank; banks 
that are not deemed by U.S. regulators to be bank holding companies, 
such as China Minsheng, can purchase up to 10 percent. 
 
¶13. (U) VP Hoffman did not have an opportunity to review this 
report. 
 
RANDT