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Should international banks move into The Pilot Shanghai FTZ?

Written by Zennon Kapron || October 30 2013

Over the past few weeks, the Shanghai Free Trade Zone (FTZ) has captured business headlines here in China and abroad as discussion continues about the impact that the zone will have on reform in China. As of October 30th, 208 companies have registered in the zone in just under one month, notably 36 in the asset management sector.

One of the early announcments was the commitment from Citibank and DBS to enter the zone. When we initially heard that these banks were so committed, we were a bit skeptical. Often foreign companies in China support government programs to better their relationship with the government. However, in the past couple of weeks, we have changed our view.

The FTZ itself, although the future reforms are somewhat unclear, will open up a number of immediate near-term opportunities for international banks in the shanghai free trade zone. These opportunities primarily revolve around non-reform related products and services:

Chinese Yuan / RMB fungibility – One of the key aspects of the zone will be what happens to Chinese Yuan (also known as RMB) fungibility or the ability to exchange RMB freely for other foreign currencies. Although it is a bit unclear exactly what exchange will be possible, the feeling is that some reforms to help open up convertibility will happen. At a minimum, a RMB system somewhat similar to the Hong Kong CNH where the RMB currency is held offshore and is essentially treated as a completely separate currency – although still limited by exchange restrictions.

Trade – Interestingly, although this is a fairly obvious one, as the Shanghai Pilot FTZ is currently setup somewhat like a mini-HK or offshore port, trade services for companies setup in the FTZ will either need to come from international banks within the FTZ or overseas banks. So if you think about this, currently, if you are a manufacturer in China, you would likely either be using a domestic bank or the domestic branch of a foreign bank for LCs, Loans, Bank Guarantees, etc.. If you are a manufacturer in the free trade zone however, you will need to have a bank either also in the free trade zone or overseas as the FTZ is essentially an offshore market.

Interest rate exposure – As a few industry experts have pointed out, interest rates in the FTZ do not have to necessarily be the same as those outside of the zone. While this may bring some somewhat challenging issues for corporates who are setting up in the zone to manage interest rate risk both in the zone and outside, it does offer banks an opportunity to provide interest rate related services and risk management tools to the corporates they serve in the zone. It will take some time before we can really determine what these might be, but certainly will be an opportunity.

Experience with reforms – Finally, by being in the zone, banks will learn through first hand experience how any reforms will change their industry. Although there is some debate as to how lined up the Chinese government is behind real reform, especially with the November plenary on the near horizon, but certainly any of the near-term reform will happen in the Shanghai FTZ at least as a test and then for further roll-out through-out the country. Banks that are there now will be able to test and try reform.

Good relations and good opportunities

So overall, it would be remiss to say that banks and companies like Microsoft, Citi and DBS are not entering the zone to better their relationships with the government, there certainly is some of that involved in their decision-making process. It is also clear that first movers will likely have better advantages in the long-term. What the examples above do show as well is that there are additional product and service opportunities for banks in what will be a relatively open and uncompetitive market – at least in the short term. 

Shanghai’s Free Trade Zone: What should your strategy be?

Written by Zennon Kapron || October 28 2013

Few initiatives in the past couple of years have captured the attention of China’s financial services community more than the recently opened Shanghai Free Trade Zone. Situated in the eastern part of Shanghai and encompassing 29km2 of land which, like the rest of Pudong, was all farmland as little as ten years ago.

Opportunities for Foreign Banks in China

Written by Kapronasia || October 24 2013

In a heavily regulated market like China, it’s easy to point out what can’t be done, but sometimes difficult to identify what can be. Many banks look at the market and see it as being too difficult or as you might say in Chinese ‘mafan’ or troublesome. It is easy to look at any industry in China being like this, but what’s critical in the market is to find a unique opportunity and take advantage of it. For western banks, that could be the slow but steady internationalization of the RMB.

The most recent Bankcard Consumer Confidence Index (BCCI) in China numbers show a continuing increase in consumer confidence since March 2013. According to the data released by China UnionPay (CUP) and Xinhua News Agency, the BCCI peaked at 86.69 in September; the BCCI has stayed high level for three months. It increased 0.89 compare to the same period in 2012 which is a positive sign that the macroeconomic environment is growing steadily in China, at least in the minds of consumers. 

According to the figures from Chinese Academy of Social Sciences’ ‘Chinese financial industry supervision report’, the official figures show the shadow banking industry reached an AUM at the end of 2012 of about CNY14.6tn, but other research shows that the actual market is much larger, about CNY20.5tn. The number is so large that it even takes 40% of GDP according to the numbers and 2013 is expected to be even higher.

The shadow banking system in China is not sufficiently regulated and often many of the products created are carry high risks which are not explained clearly to the investors. In general, a more regulated shadow banking system should be beneficial to the banks and investors in long-run. If the current issues were not solved effectively, then the dramatic volume increase could be a financial time bomb that might severely damage the Chinese economy and financial stability.   

Year 2012

Scale of Chinese shadow banking (CNYtn)

Proportion of GDP

Proportion of total asset of banking industry

Official data

14.6

29%

11%

Actual Market

20.5

40%

16%

 

Great Expectations – the Asian Retail banking Customer

Written by Kapronasia || October 16 2013

The Asian retail banking customer is changing. Increasingly wealthy and connected, customers want even more from their banks and are becoming picky about who they bank with to get it.

Development of Wealth Management in China

Written by Zennon Kapron || October 15 2013

Cash is always king and no more so than in China. Traditionally a very cash-based market with many High Net Worth Individuals (HNWI) skeptical of having someone else manage their money, wealth management got off to a slow start in China. It started with the establishment of few foreign private banking such as Citi Bank, UBS, and HSBC in China in 2006. In 2007, Bank of China was the first Chinese bank that established a private banking department in Beijing and Shanghai.

Business was slow initially for both foreign and domestic banks. Trust was a key factor – many HNWIs were not comfortable with someone else managing their money, much less a foreign bank, but the sophistication of services offered was also very low. Even today, the private banking business mainly provides consulting services for asset allocation and very little forward planning. Most banks push particular products rather than tailored financial plans that take into account not just a person or family’s financial situation, but their future life events.

Although wealth management is still in a nascent stage, the HNWI population in China has increased dramatically, reaching 700,000 by the end of 2012. In addition, the total AUM in Chinese private banks was 573.6 billion yuan in 2008, but is over 2 trillion yuan today. With this growing trend, we see the huge potential in the wealth management sector in the near future.

China’s large banks also see this opportunity and are focusing more and more on wealth management. The wealth management business does not only bring significant intermediate business income, but also provides an opportunity for organisations to re-structure their retail banking business. This has become especially important as it appears that regulators are finally going to reform interest rates. More flexible interest rates will mean that banks will face increased competition and be able to rely less and less on traditional spread income – this is where higher margin wealth management products and services can help.

Nevertheless, Chinese banks still need a long time to build trust with their customers. In western countries, many private banks already have more than a hundred years of history. Will Chinese banks accomplish the same in less than 90 years?   

 

Total Customers

Customer Growth Rate

AUM (Billion RMB)

Minimum Amount (Million RMB)

BOC

40000+

-

450

8

ABC

35000

12.90%

396

8

ICBC

26000+

18.18%

473.2

8

CCB

-

18.82%

-

10

CMB

19518

18.34%

434.2

10

Source: Bank Annual Reports, 2013 

Strategy and Positioning of Supra-regional Banks

Written by Fay Zhou || October 15 2013

Although the Asian banking market presents a tremendous opportunity for banks, it is also increasingly competitive as smaller banks grow and innovate to compete against their large rivals. This competition, coupled with slowing growth in many countries is pushing large domestic banks to start looking abroad outside of their home countries. China’s Industrial Commercial Bank of China (ICBC), Hong Kong’s Bank of East Asia (BEA) and Singapore’s Oversea-Chinese Banking Corporation (OCBC) are great examples of domestic heavyweights who are rapidly expanding across the region.

So the reasons for expanding are fairly clear, but what about the strategies? How are banks able to justify expansion, at least in the short-term? If we look historically, many of the Japanese banks that initially expanded overseas in the 1970s and 1980s for access to deals as their customers moved abroad; we’re seeing much of the same trend today.

Although the Chinese banks started expanding for access to new f/x markets, but are increasingly following their Chinese customers as those firms also expand to ‘escape’ domestic competition and slowing demand in their home markets.

Facing almost the opposite problem, Taiwanese banks have been eager to enter the mainland China market for nearly a decade as their domestic market is relatively small and very saturated. Yet, similarly to Chinese banks, Taiwanese banks are looking to first enter the market to support their domestic customers who are represented by some of the largest manufacturers in the world like Foxcon, makers of most of the world’s iphones.

So following existing customers into new markets seems to be a good strategy to enter a new market, but what about positioning and expanding once you get there? That is actually where the challenge lies and where both supra-regional banks and global banks often struggle. How do you differentiate? How do you position your product?

Using China as an example, regulations on banking products and services for foreign banks are pretty controlled which doesn’t leave much scope to compete or innovate in terms of product scope or breadth, but where we have seen banks be more successful is looking at different underserved markets like rural banking.

BEA and HSBC in particular have been working with the government and regulators to follow the ‘go west’ policy and tap those new markets. Although the jury is still out on whether the strategy will be successful, it has helped the banks better their relationships with key stakeholders like the regulators and has positioned the two banks differently in the market.

How about you? What have you seen work in Asia? What are banks doing to successfully compete outside their home country?

This blog is part of the Oracle / Kapronasia series on Future Finance. For more information, please visit the Future Finance blog at here.

Hidden Risks in Mobile Banking: how are you overcoming them?

Written by Zennon Kapron || October 11 2013

According to a user survey on mobile banking security conducted by the CFCA (Communications Fraud Control Association), users’ assessment of how safe mobile banking is has really not changed since 2010. But are the users’ security concerns valid or do they arise from a lack of understanding of how mobile banking works? Perhaps even more so than mobile payments, mobile banking seems to provoke more worries as it seems more closely attached to their banking accounts; no one wants to the risk before they understand how it works.

There is some validity to the concerns. Although mobile banking accounts and nearly all  phones have passwords, they still cannot stop professional fraudsters. According to the Internet Security Report by Symantec, attacks on mobile phones have been increasing in recent years. Mobile hackers are possibly targeting users’ financial and personal information. With increased use of mobile financial services, banks will need to devote more effort in in eliminating these threats and customer concerns.

This is even more the case in Asia where mobile phone penetration is increasing faster than anywhere else in the world and millions of individuals are becoming ‘banked’ via mobile banking services. Although the region has pockets of very sophisticated and mature user bases, there are millions of rural users who may never have had a phone before much less mobile banking products and services.

In a fraud example that we found in China, one mobile banking user in China found 40,000 RMB (~US$6,700) missing from her bank account. An investigation with the bank revealed that someone used her phone number to report a lost mobile phone. After receiving her phone number, the fraudster transferred all of her deposits out of her account by using her mobile banking service.

Unfortunately these few examples of fraud stand out much more in the press and in consumers minds more than many examples of successful transactions. We have seen financial institutions put education programs in place as well as implementing new more secure versions of their mobile banking software.

But what have you seen? What ways have you seen Asian banks mitigate risk and security concerns and still drive consumer adoption?

This blog is part of the Oracle / Kapronasia series on Future Finance. For more information, please visit the Future Finance blog at here.

Risk Issues for Expanding Supra-regional Banks in Asia

Written by Fay Zhou || October 09 2013

China’s banking system was historically quite segregated: each of the original four state owned banks were created for a specific purpose. China Construction Bank was created to administer and distribute government funds for domestic infrastructure and construction projects, Agricultural Bank for farming / agriculture projects, etc..

The challenges these banks face as they expand both geographically and by business sector across China is not unlike supra-regional banks as they expand across Asia. One of the biggest challenges is Risk Management. Typically, existing risk management systems in many markets have been built and customized for their home markets, but may not be robust enough for foreign markets.

As an example, Chinese banks have, until recently, been operating in an environment with essentially fixed interest rates, so many of the risk management systems implemented in China never really had to adapt to a rate changing environment. These systems that had been customized for the mainland market might struggle in a more mature market such as Australia where a fully liberalized interest rate environment makes understanding loan profitability (in some cases even down to the individual loan level) very important.

In addition to the market risk that can be presented by newly liberalized interest rates, credit risk can be a challenge as banks may not be familiar with the operating status and financial standing of the enterprises in other countries. This makes it difficult to understand and manage credit risk effectively and increases the possibility of losses arising from credit risk.

Finally, as banks expand more rapidly, operational risk can increase if operational procedures and standards maybe involved if the rapid expansion leads to ineffective internal control. Differences in employee attitude and habits across culture can vary dramatically.  

All of these risk management issues can be identified and controlled, but it takes focus and consideration. Too often organisations look at new markets they fail to take this into account, but in this case, it could mean the success of a new country’s business or the failure.

This blog is part of the Oracle / Kapronasia series on Future Finance. For more information, please visit the Future Finance blog at here.

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