Bank of China Thinks Global
China's second-largest bank is poised to transform itself from principally a lender to state-owned industry to a global merchant bank
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By Bruce Gilley/BEIJING
Issue cover-dated December 7, 2000
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BANK OF CHINA is China's most globally dispersed bank, with branches in such unlikely locations as Zambia and Kazakhstan. It's also the second-largest bank in China in terms of assets and the 18th biggest worldwide.
But despite the impressive measures, the bank is nothing like a global bank. Virtually all of its business is in some way linked to China. Its management and operations, meanwhile, remain deeply redolent of a state-owned and state-run financial institution from the socialist era.
All that is supposed to change, however, under plans outlined by Chairman Liu Mingkang in a recent interview with the REVIEW. Bank of China will revamp its commercial-banking unit to create a fully-fledged global merchant bank and will consolidate its Hong Kong retail operations to serve as a springboard for expansion in Asia, Liu says.
The changes also will include moving the bank's overall treasury operations from Beijing to Hong Kong to better finance the expansion and possibly appointing foreign experts as independent directors of the state-owned bank. If all goes well, says Liu, more than half of the bank's total assets will be outside mainland China in five years' time, up from a third last year. More important, the bank will be well-placed to meet an influx of foreign competition after China's entry into the World Trade Organization. "We are confident in our ability to swim in the international tide," Liu says.
The ambitions carry significant risks, analysts say. Like other state banks in China, Bank of China is technically insolvent. It also has acknowledged shortcomings in its risk management and disclosure. Normally, this would preclude a major overseas expansion drive.
But in the strange logic of state-industry reform in China, moving assets and operations overseas is often the only way to straighten out a company's domestic mess. Businesses are rebuilt from scratch overseas and then transplanted back home. That appears to be the logic behind the moves by Bank of China. "The impact of our international expansion will have a huge significance on our domestic business," says Liu, who helped steer China through the Asian Crisis as a deputy governor of the country's central bank from 1998 to 1999.
Analysts generally applaud the plans, although they warn that there is a risk the bank could overstretch itself financially and waste precious management time that should be spent sorting out its domestic problems. Still, they note, Bank of China has been successful in the highly competitive banking market in Hong Kong. More of that kind of experience elsewhere could transform the bank's domestic operations.
"It's doubtful whether they can become a truly global bank, but being globally competitive is achievable rather quickly for them," says John Hobson, Asia banks analyst for investment bank Credit Suisse First Boston in Hong Kong. If Bank of China is successful, it would mark a significant milestone in China's attempts to fashion competitive companies out of the tatters of its planned economy. That is a major goal of reformers who worry that the country's state-owned businesses will be buried after WTO entry. If Liu has his way, the Bank of China will be ready and waiting.
"If China is ever to produce a world-class bank, BOC should have the best shot at it," says Charles Tan, China banks analyst for ratings agency Moody's Investors Service in New York.
Founded in 1912 on the remains of Da Qing Bank, the Qing dynasty's de facto central bank, Bank of China helped finance the corrupt Nationalist regime until it was seized by China's new communist rulers in 1949. It then became the specialized foreign-trade and foreign-exchange bank for the Peoples' Republic of China. Since the start of the country's economic opening in 1978, the bank's overseas network has expanded from two dozen branches and subsidiaries to about 70 today.
Along with China's other three major state banks, Bank of China remains in a parlous state. It employs 198,000 people at 14,000 offices around the country, making its ratio of noninterest expenses to operating income roughly a third higher than the mixed-ownership commercial banks in the country. At the end of 1999, it reported that 15% of its 1,254 billion renminbi ($152 billion) in domestic loans, or about $23 billion, were nonperforming. CSFB says the figure is closer to 30% if calculated according to Western accounting methods.
Enter Liu Mingkang, 54, with plans to turn Bank of China into the country's first globally competitive bank. Liu, who holds an MBA from London's City University, was appointed chairman in February following stints at the central bank and the State Development Bank, the central government's infrastructure-oriented soft-loan arm.
Within mainland banking circles Liu is known as an avid reformer, urging banks to bite the bullet by clearing their balance sheets of bad loans. Under his leadership, Bank of China has made provisions equivalent to 2.6% of its total loans, double the domestic average, according to Moody's. Liu was also behind the unprecedented disclosure of details about its loans and deposits in the bank's latest annual report.
"We must be honest and we must tell everyone--investors, customers and regulators--the true story," says Liu. "This is the philosophy to be a good guy as well as a good bank." Philosophy aside, Liu is counting on the bank's growing overseas business to stimulate changes at home. Increased trade and investment in China linked to WTO entry could provide the bank with a bonanza in its traditional core businesses like trade finance, foreign exchange and commercial banking. But it will also face stiffer foreign competition. Just preserving its hold on financing China trade will be a major task. "There are different kinds of international success for different banks," says Liu.
More important, the learning provided from international expansion would help the bank move into areas in China where it has not traditionally been strong, like consumer banking, credit cards and insurance. "We need a global strategy in order to achieve overall growth," says Liu.
At the heart of the global plan is Hong Kong. For many years, the bank's Hong Kong operations relied on the patriotic feelings of its clientele rather than good service to survive. But since the mid-1980s the operations have been professionalized through the injection of local banking talent.
The Hong Kong branch, its six consolidated sister banks and Bank of China's merchant and asset-management operations in Hong Kong accounted for 63% of the bank's global pretax profits last year (see chart). If five other sister banks were included, as they will be under a planned consolidation of the loosely-knit group, the figure would rise to almost 80%. And if the mainland operations were forced to make realistic provisions against bad loans, the proportion would be well over 90%. "Our Hong Kong operations are magnificent," says Liu.
Still, while it's the golden goose of the group, the Hong Kong operation is the ugly duckling of the Hong Kong banking industry. The Bank of China Group, which includes all eleven sister banks, has 400 branches and nearly 18,000 staff in Hong Kong and Macau. It accounts for a fifth of deposits in the territory. But it remains grossly inefficient.
CSFB says its net interest margin--a key indicator of bank profitability that measures the difference between the weighted average interest rate a bank earns on loans and investments and what it pays to depositors--was just 1.66% last year. That is higher than the dismal 1.06% spread that Moody's reckons was the bank's margin as a whole. But it compares poorly to the 2.5% at most listed banks in Hong Kong and more than 3% for the industry leaders.
GOOD MONEY AFTER BAD
"They are not making the profits from their franchise that you would expect," says Deborah Schuler, a banking analyst for Moody's in Hong Kong. Analysts say as much as $6 billion of the group's loans could be bad, most of them to mainland customers. That represents about 15% of the Hong Kong group's total loans, double the proportion reported at the end of 1999.
"They use their good money in Hong Kong to make bad loans in China," says Schuler. To turn the Hong Kong group into a truly world-class banking operation, plans are afoot to cut staff and consolidate the 11 banks into a single entity that will eventually be listed, say analysts. The group will then move aggressively into the credit-card business and other areas of consumer banking in Hong Kong. The operation of a listed bank will provide a training ground for managers in China, where the entire bank is to be listed eventually. "Hong Kong will be a testing platform for our future global management system," says Liu.
It will also serve as a platform for the bank's expansion into commercial banking in the rest of Asia. The bank recently opened branches in Kuala Lumpur and Manila, while talks are under way to reopen a branch in Jakarta that was closed by former President Suharto after the 1966 military takeover. Also on the cards in Hong Kong is a restructuring of the bank's investment-banking arm, Bank of China International, to make it a bundled commercial and merchant-banking arm.
Goldman Sachs has been retained to help with the restructuring, which may give it a partnership with the investment bank that will compete against China International Capital Corp., in which Morgan Stanley has invested. CICC led the initial overseas stock offerings of all major state firms from China this year, including oil concerns PetroChina and Sinopec and mobile-phone operator China Mobile.
Liu cites the takeover of Cable & Wireless HKT by Pacific Century CyberWorks, the expansion of shipping concern Cosco in Panama and the expansion by electronics firm Konka in Southeast Asia as recent instances where BOCI has provided "bundled" services, from commercial loans to financial advice. "For the next five to 10 years, our strength will remain those customers with a link to China," says Liu. "After that, it's hard to foretell." Liu notes that the bank earned $800 million in profits from its U.S. Treasury Bill trading operations last year. Since its overseas operations as a whole earned less than $200 million, that implies a loss of $600 million on account of bad loans and high overheads.
At home, Liu sees BOCI becoming the global banking arm of China's array of new private and semiprivate banks. It has already signed deals with two of the biggest, Shanghai Pudong Development Bank and China Merchants Bank. "The idea is that my branches are your branches and your customer are my customers," says Liu. How will the bank ensure it can manage all this expansion? A flashy new headquarters building in Beijing, designed as its Hong Kong headquarters was by Chinese-American architect I.M. Pei, is just the outward symbol of a bank trying to operate more in line with international standards.
The number of information-technology centres for the bank will be reduced to just four from more than 1,000, which will allow easier global operations.
A new global risk system is being put in place under which independent assessments will be made in three different overseas centres--New York, London and Hong Kong--rather than just at headquarters. And the bank's treasury operations, which handle the bank's trading and fund-raising in both renminbi and foreign-currency markets, will be moved from Beijing to Hong Kong to ensure more efficient risk management, Liu adds.
"Very few organizations are changing as quickly as they are," says CSFB's Hobson. Liu, who did stints in London for Bank of China in his early banking career, is a big advocate of overseas experience. As a result, he intends to introduce a system under which all bank managers in headquarters will go overseas once every three years. Like the bank itself, he believes the moves abroad will strengthen the bank at home. As Liu puts it: "We get fresh air from being overseas."
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