2013 will remembered as an incredibly dynamic year for China’s financial services industry. From the increasing number of hedge funds in the market to the emergence and regulation of Bitcoin, industry observers, investors, participants and regulators have had their work cut out for them keeping up with the market.

The year started out with the prospects of a new government taking a new stance on reforming what had been a highly regulated financial services industry; we weren’t disappointed. Regulators unveiled a reform agenda both at the fall plenary session and throughout the year that has, and will have, a significant impact on interest rate reform, capital market investment in and out of China and the financial industry as a whole. Although some of the measures are still somewhat vague, some of the implementations, including the removal of the floor on lending rates, have already have a significant impact on banking profitability – it will be a new market in 2014.

China's finance in 2013 also brought an increased focus on development zones and centers. Opened to much fanfare, but little detail, the Shanghai Pilot Free Trade Zone (FTZ) was formally established in late September. Although it is still early days, if news reports and indications from the regulators are to be believed, the FTZ promises to be a new test-bed of reform for ‘value-add’ services similar to what Shenzhen was to the manufacturing / production industry in the late 70s and early 80s; arguably, one of the most important developments in China’s economic history. Smaller initiatives such as the Hongkou Hedge Fund Center in Shanghai sought to make it easier for hedge funds to enter the market and trade on China’s expanding base of capital markets products.

And last but certainly not least, we would be remiss if we didn't touch on Bitcoin. Chinese investors and tech enthusiasts were truly ‘chomping at the bit’ in 2013 as Bitcoin went from a little known US$13 cryptocurrency, to a US$1,000 potential economic destabilizer. China topped the world in Bitcoin wallets in May 2013 and then surpassed that again in November with over 150,000 wallet downloads. With the world’s biggest Bitcoin exchange and increasing popularity, China had little choice but to weigh in on the matter and in early December the People’s Bank of China annouced that Bitcoin was not a currency, banks could not deal in it, yet it could continue to be used in China. The price of Bitcoin fell, only to rise almost immediately afterward.

Will the sequel to 2013 in 2014 be as exciting? Will Xi Jinping continue to push reforms? Can the PBOC accept Bitcoins as a legitimate currency? Whatever happens, 2014 will be another dynamic year for Chinese markets and we’ll be here every step of the way to help you understand what’s happening in China’s financial services industry. 

After 18 years of economic development, China’s Tier 2 Banks, mainly city commercial banks, are growing to fill a gap in-between state-owned banks, and rural commercial banks. As part of their growth, many city commercial banks are attempting to expand their branches in other regions, however, the Chinese Banking Regulatory Committee (CBRC) regulations are, in certain cases, holding them back.

The recent tight regulation regarding supra-regional city commercial banks is largely the result of increasing internal fraud cases in city commercial banks such as Qilu Bank and Hankou Bank. The good news is that the CBRC is not prohibiting city commercial banks from expanding supra-regionally. Instead, the approval process is just longer and the standard of regulatory evaluation indicators such as asset scale, capital adequacy ratio, profit margin, and non-performing loan ratios are higher than before. In this case, if city commercial banks attempt to expand outlets in other regions, they need to enhance their internal control and risk management abilities above the required standard.

Because the asset scale and business model vary based on the local economies in each city, the evaluation regulation will be different. If the investment in other regions is excessive, the CBRC will require a higher capital adequacy ratio; if the risk management does not match the fast growing asset scale, the CBRC will restrict the expansion of these city commercial banks. Thus, regulators support supra-regional expansion if the tier 2 banks meet the entire set of regulatory requirements.

China’s tier two banks are some of the more dynamic banks in China in terms of business models and innovation – they have had to be in order to compete with their larger counterparts that typically have much larger deposit bases and distribution networks.

The tier-2 banks are still focused on expanding their asset base and while supra-regional expansion will help them accomplish this, it is not the ultimate goal of the banks, at least not in the near future. The regulations do serve a valuable purpose to ensure that banks’ expansion is based on quality assets and business practices.  

As fixed interest rates in China start to loosen up, banks' bottom lines are starting to feel the pressure. According to the latest figures from China major banks’ annual reports, the net profits of China Mingsheng Banking Corp.(Minsheng), Industrial & Commercial Bank of China Ltd.,(ICBC), Bank of China Ltd. (BOC) and Agricultural Bank of China (ABC) in the third quarter 2013 shrank on a YOY base. 

As shown in the graph below, the net profits growth rate of Minsheng, a relatively smaller bank, dropped dramatically almost 25% comparing with the same period last year, likely due to its relatively large interbank business, which was heavily affected by high interest rates in the middle of June. The high interest rates in China also had a big impact on ICBC. The banks' profitability growth rate dropped to around 7.5%.

With a wide range of channel choices for retail customers, banks need to be aware of the usage and preferences for each channel which can vary for multiple reasons including the purpose of the transaction, complexity and where the person is from.

On the digital channel, customers usually require a fast and convenient service such as simple transaction or checking an account balance, but for branch service, customers, especially affluent customers require tailored personal interactions such as loan servicing, investment advice, and other complex transactions.

In self-service channels, Asian customers not only need a convenient and easy channel, but also a personalized interactive service to increase their loyalty to the bank as competition is rising and switching costs are lowering, especially in the wealth management space.

These wealthier customers produce higher value for banks, and usually they have a wide range of choices on banking services. In Asia, affluent customers show greater loyalty to their banks, while in most European countries and the U.S., affluent customers have relatively lower loyalty to their banks. Thus, maintaining affluent customers is important for banks to generate higher revenues.

Citi, one of the major players in Asia's wealth management space offers tailored services in Singapore. Their Citigold service provides a dedicated center for nonresident Indians. The personalized interaction improved the loyalty from their affluent customers because Citigold satisfied nonresident Indians’ special requirement on banking services.

However, China is showing a significant gap between affluent and mass-market customers on loyalty because the affluent customers receive much better service from their bank than mass-market customers do.

Banks should not only rely on channel innovation but also focus on improving service on the existing channels. Maintaining the existing affluent customers with tailored service is crucial to the bank since the affluent customers will continually show a high loyalty to their banks in Asia, but enhancing a required service or product for mass-market customers through different bank channels will also increase the overall customer loyalty.  

Hongkou is a geographic district in Shanghai, on the west side of the Huangpu River, north of the center of Shanghai and close to Pudong District. The Hongkou Hedge Fund Park was officially established on Oct. 18, 2013, as the first test-bed specifically for developing local hedge fund industry and introducing foreign hedge funds in China. Through market reforms and special incentives, the Hongkou government hopes to make the Hedge Fund Park a key part of Shanghai, and indeed China’s, hedge fund industry.