In the following paragraphs, I would like to focus on the challenges facing the

China’s banking sector in the near future.

First, business decisions always mix with political decisions. The government, as

the major shareholder and regulator of banks, often set policy objectives at odds with

the profit-earning and prudent commercial decisions. For instance, to deal with the

surging housing property price, the government forbade commercial banks to loan to

those who have already owned two or above housing properties. Also, it raised the

down payment by 30% to 50%. These measures contain the opportunities of profit-

making because banks cannot make loan even when borrowers are at good credit

status. Besides, the government kept interest rates low under huge capital inflows and

pressure for Renminbi to appreciate, implying cheap source of funding to companies

which encourage their desires to borrow for investment. However, to reduce the heavy

dependency on investment as the main economic drive, the government used moral

suasion to persuade banks to reduce the amount of lending, which is inconsistent with

profit-maximizing business practices.

Another challenge facing the china’s banking sector would be the appreciation of

Chinese Yuan. On June 19,

China announced it was adopting

a 'flexible' currency policy after

tying the yuan to the dollar since

2008. According to the graph,

although yuan did not

appreciate sharply, the expectation of yuan’s appreciation is indeed increasing under

the insistent pressure from the United States Senate. Banks such as China

Construction Bank (CCB) had acquired certain amount of foreign capital via overseas

IPO. And the foreign assets of the Bank of China (BOC) account for around 30% of
the total assets. Thus, yuan’s appreciation will definitely decrease their assets value.

In the first half year of 2008, BOC and CCB incurred a foreign-exchange loss of as

much as 3.5 and 2.4 million respectively. Goldman Sachs also estimated BOC’s profit

will drop by 3.3% when yuan appreciates by 1%. Of course, the foreign business such

as foreign denominated deposit and derivatives will also be affected. And banks now

have to take the risk of lending to those exporting companies as the possibility of

default payment by them rises. Therefore, it is essential for the banks to put more

effort on handling the exchange rate risk.

http://orientaldaily.on.cc/cnt/finance/20090612/00202_027.html
http://www.hkblog.com.hk/index.php/143/viewspace-2465
Third, the China’s banking sector has to tackle the problem of non-performing

loans (NPL). In 2009, the banking sector had loan out around 11.4 trillion yuan to the

local governments in order to fund the local government projects. However, the

ability of local governments to repay their debts is uncertain since many of these local

infrastructure projects were not profitable. Ideally, local governments could raise cash

by selling land. However, if interest rate rises and the property market crashes, this

may not be possible and bad-loan levels could soar. Sometimes, local governments are

not willing to support those infrastructure-building enterprises in debt to which they

originally supported. Besides, with the measures pressing down housing price, those

who borrowed for houses may not be able to

repay the loans fully. In these ways, bad debts occur and the effect on small to

medium size banks will even greater. From the

chart, we can also see that the NPL is still high in China

compared to other countries. Although there is

a downward trend of the NPL to loan ratio

from 2009, its decrease is largely (70%) contributed by the increase in loan rather
than the decrease in NPL (30%). To improve the ability of survival under such tough

situation, the China Banking Regulatory Commission (CBRC) planned to set the

lower limit of provision to loan ratio to 2.5%. Yet, according to the chart, only

Agricultural Bank can achieve this limit. The increase in provision also means that the

amount of money that can be loaned drops and hence the profits. Thus, the banking

sector should maintain a good balance between the quality of capital and the risk of

default payment.

http://video.online.hk/watch/20817
Fourth, China’s banks are facing foreign competition. According to the diagram,

foreign banks did not do well. Their earnings in China plunged last year. For example,

Standard Chartered China reported a loss in profit of 34%, to 423 million yuan.

However, their advantages should not be neglected. For example, in 2009, the number

of American banks included in the first 10 of the Global Bank Market Value Ranking

increased from 3 to 5 while that of China remained 3. Also, many of them have good

operating systems, rich expertise and innovative products. Furthermore, China’s banks

may face a brain drain with foreign competition. Senior posts of China’s banks are

always appointed by the government based on political status rather than talent. And

the compensation system is not as attractive as that of foreign banks. For example, the

average salary of graduates working in China’s banks is 2628 yuan while that of

foreign banks is 3798 yuan. Therefore, China’s banks should sharpen their edges to

retain those talented employees.

Finally, China’s banks have to be alert to inflation. From the chart, the real

interest rate has already been negative for 7 consecutive months. According the past

experience, the average period that negative real interest rate lasted for would be 20

months. To relieve the inflationary pressure, the People Bank of China is becoming

more likely to increase interest rate to attract people to put their money in banks.

Table 1. CPI & One year deposit interest rate

Although this would increase the cash of banks, the net interest margin (NIM) would

certainly decline. As NIM is the main revenue of banks, there would be pressure on

their profits in short term. Also, the CBRC had set a limit on the deposit to loan ration

to 75%. It will affect the small and medium sized banks more seriously as their ratios

are relative high. And it is estimated that NIM will drop by 0.1% to 0.25% for 1%

decrease in the ratio. So, they have to better prepare for this situation.

Provision: http://skullnbone.mysinablog.com/index.php?

op=ViewArticle&articleId=2214115

Raise interest rate:

http://cn.wsj.com/big5/20100913/bch084712.asp?

source=NewSearch

Foreign HR:

http://paper.wenweipo.com/2007/06/14/NS0706140001.htm

-ve r: http://www.takungpao.com/news/newsyw/1383198_big5.html

Yuan’s impact:

http://cn.wsj.com/big5/20100622/rec124330_ENversion.shtml