As the day of opening banking industry to foreign investors comes closer, all the shareholding commercial banks of middle class in China focus their breakthrough points on business transformation without exception.
After removing the "Fujian" from its title, the newly national Industrial Bank first came to public attention with the purchase of Foshan City Commercial Bank. Recently, it has been viewed with suspicion because of the frequ ent share exchanges am ong Chinese shareholders. But during all of this hue and cry, a swee ping inner refor m of the whole business from its capital layer to its business layer has been quietly an d systematically pushed through.
"Business transformation and market positioning a re the factors we regard as crucial in our plan for the next five years," says Li Renjie, president of Industrial Bank. During that period, Industrial Bank will take advantage and advice of its strategic partners, and will also bring in outside professional consultation agency to research future development. "These are the keys to Industrial Bank's survival in the next five years and more".
"Five Phases" of bank development
21st Century : What's your view toward the current transformation of Chinese banks?
Li Renjie : Th e transformation of Chinese commercial banks was motivated by its inner drive. First is the capital adequacy ratio. How can a bank expand its business with limited capital? If a bank is totally reliant on outdated management pattern, lack of capital can become a serious bottleneck.
Second is the constantly changing market. The bond market is developing rapidly, and the regulation of equity division reform has paved the way for advance in the capital markets. Our old practice of relying on inventory, particularly the inventory interest margin of big institutions, to support the bank's development will become more and more difficult to sustain.
21st Century : International banks have also been going through constant transformation. Could you compare Industrial Bank's situation with them?
Li Renjie : The development of international banks can be divided into five phases. At the very beginning, a bank simply dealt with the exchanges of money. When it went to the second phase, it became to add on deposit, lending and remittance on the base of previous stage, and that was what we called as traditional financial service. On the third phase, different kinds of innovative financial services were added to the traditional base and fulfilled fully-fledged banking service. The fourth phases came into being after non-banking financial services were added. Finally, the adding of different kinds of non-financial service to the forth stage marked the highest phase of all-round economic business.
21st Century : Which phase is Industrial Bank experiencing now?
Li Renjie : Right now Industrial Bank is making the transition from the second to the third phase. International banks are already moving from the fourth phase to the fifth.
21st Century : So what competitive edges do we have?
Li Renjie : What we have to focus on is developing our strengths and working around our weaknesses. We are basically a local bank, and our understanding of the customer base and sensitivity to local market is going to be better than any international bank. What we need to do now is improving our abilities in some specific areas. Chinese banks tend to be rather weak in the retail side, for example. In that respect all domestic banks are starting from the same scratch line. Industrial Bank is currently thinking along these lines, and in looking for strategic partners we aim to work with some relative banks, such as Hang Seng Bank, to develop our position.
Four major features of new operation
21st Century : As it enters the third phase, which areas will be Industrial Bank particularly focusing on for development?
Li Renjie : Asset management, loans to small and medium-size enterprises, retail service and intermediary service are our main targets in the following period. What these areas have in common is a move towards reducing the occupation of and dependence on capital, and increasing profits from commission charges.
To give an example, why do all banks want to develop their retail service? Because mortgages relies much less on capital and the relative risk weight is only 50%. Why do they want to discount bill? Because its risk coefficient is 0.2, while normal loans have a coefficient of 1. To put it another way, one yuan of capital can do five times as much when it is used for bill discounting as when it is used for ordinary loans. Asset management is another area. If we made a loan of one billion yuan before, we only gained the interest margin. Now we can reserve 500 million, and earn management commission by being appointed to manage the other half. That is to say, we make a transaction worth 1 billion, but it only occupy 500 million of our capital. The other 500 million does not use up capital, and we earn management commission rather than interest margin from it.
Industrial Bank has realized that the profits gained from loans to large business are getting smaller and smaller. The interest rate on short-term financial notes to a healthy company is only 3%. If we were too dependent on big scale enterprises, we would be squeezed out of the market soon. In services toward big business, Industrial Bank is going to emphasize on key project financing, syndicated loans, trade financing, asset securitization, financial consultancy and bond underwriting and issuance.
21st Century : Dose Industrial Bank has any plan to facilitate loans to small and medium-size enterprises?
Li Renjie : Although the loan has been mentioning a lot at the moment, the loan demand of most enterprises has not been well satisfied. There is a lot of potential space for making profits.
Small and medium-sized enterprises are going to be the main market for credit and loans in the future, and this is one of the areas that Industrial Bank has earmarked for particular expansion. We plan to focus on two kinds of enterprises to capitalize on our strengths. For enterprises marked by blurred line between individual and corporation, we take personal assets as security on enterprise capital turnover. This kind of service will be assigned to the retail department. For the small to medium-sized corporations which are closely linked to large enterprises, for example a vendor of a large company's products, it is easy for us to control risk when supplying financing service. The reasons are that their production and operation styles are going to be matched to the large corporations and their material and capital flows are linked into the large companies. They have formed highly integrated logistic chain and capital chain with the leading enterprises along the industry chain they follow.
Why are small and medium-sized companies difficult to work with? It's because that their financial reporting is not standardized, and there is often a lack of information about them. In the past, this has made banks reluctant to work with them. How do we solve this problem? I believe the banks should get involved in the material management, and not simply rely on financial report. This is actually a concept of trade financing which to manage an operation by material controls. This idea is in line with the operation of international settlement. When we have provided international settlement for import and export companies in the past, we have found that these companies often have high levels of debt and unclear financial reporting. However, their cash flow levels were very high. The bank controls risk in these situations by controlling the import and export settlement.
This year Industrial Bank has made great effort to improve this area, including a thorough investigation of the market situations in areas like Quanzhou in Fujian province, Foshan in Guangdong province and Zhejiang province, where small and medium-sized businesses are flourishing.
21st Century : Competition in the banking industry in China used to be homogenous. Now, even with this tidal wave of transformation, it seems that there is still some homogenous tendency appeared.
Li Renjie : That's true. It's a question we are thinking about right now as we make our five-year plan. Everyone is doing the same thing. If you ask how Industrial Bank is different, we would point out the thoughts which we are still demonstrating: adding value and leading service. For example, the HSBC could be taken for reference. They began their development program in 1998, known as "Adding value and striving for development". The plan involved two five-year periods with absolutely explicit emphases. To be frank, our emphases are not yet sufficiently clear as we are still adjusting to the new conditions. We must first define our goals, then plan our strategy.
The dilemma of capital adequacy ratio
21st Century : What difficulties has Industrial Bank encountered during its transformation period?
Li Renjie : Actually, capital adequacy ratio is still the hidden anguish of any bank.
Since the Banking Regulatory Commission was established, it has been pushing Chinese banks hard to manage themselves according to international practices, particularly in the management of capital adequacy. But the problem in reality is that the integration with international standards for capital adequacy ratio has not proceeded as fast as integration with the international capital replenishment environment. For example, many of the capital tools widely used by international banks do not yet exist in China; there are more varieties of debt which make up a bank's tier 2 and tier 3 capital; and the total of debt on each kind of capital can reach 100% of tier 1 capital. However in China , since 2003, when Industrial Bank first issued subordinate note, there has only been one variety, which only amounted to 50% of tier 1 capital. The difference between the two situations is obvious.
21st Century : What can be done to solve this problem?
Li Renjie : We hope that the government will address the problem of capital adequacy ratio from a long range strategic perspective. Here is a simple calculation with the assumption that the average rate of GDP in the eleventh five-year period (2006-2010) is 7%. If banks are still the main channel for financing, then the supply of M2 will be increased at around 14%, and the credits and loans will also be growing at between 10% and 20%. Capital adequacy ratio in the Chinese banking industry is now at only about 8%. If they can only use currently existing capital, the banks will be unable to fund future growth in credit.
21st Century : That is to say, there is dilemma existing to hamper the transformation of Chinese banks. Increasing the supply of capital is difficult because of the lack of capital instruments and the deficient capital replenishment sources; failing to raise the capital would be a problem because it would be difficult to maintain the growth in credit which the development of the national economy requires.
Li Renjie : That's right. Commercial banks can maintain their operations and development through this process of transformation. But the transformation is only the external factors that can supply support. The dilemma of capital replenishment not only affects the strategies of commercial banks, but also restricts the development of the entire economy. The transformation of the banking system has to be in accordance with the service demand raised from the growing economic situation.