By Chen Kuncai Business China
A somewhat narrow and cramped passageway leads into Li Renjie's office. The office is small, a far cry from the “magnificence” and spaciousness you might expect from the office of a bank president.
In fact, IB's office building is small and cramped throughout, but this has not stopped the bank from setting one record after another: its total assets grew from RMB 340.522 billion at the end of 2004 to RMB 1.332162 trillion at the end of 2009 and after-tax profits have grown from RMB 1.1 billion in 2004 to RMB 13.282 billion in 2009.
The Industrial Bank is a success story in China's banking sector. The bank is based in the city of Fuzhou, which is not an economic or financial center. Despite this, IB has managed to grow rapidly on the power of its unique development mode. Today, it has the highest share price among all listed banks in China, and it has attracted a group of devout “followers” in the form of small and medium-size banks.
Small banks refer to this development mode as “outwards expansion based on organizations and asset services”. As Li Renjie states, however, “we have been misunderstood. We have always been committed to being different”. So-called “extended expansion” is just a temporary strategy in a particular environment, and is by no means permanent.
Since 2006, IB's ROE has remained above 25%. Rapid growth and high incomes can be summed up as the characteristics of IB's development. But can the Industrial Bank maintain such rapid growth?
Li Renjie introduced in detail IB's unique way of realizing high ROE through the precise adjustment of the asset and liability structure. He also stated that he and his team have always been able to identify market opportunities and the “most profitable businesses” ahead of others, which is made possible by IB's refined management mode and unique operational philosophy.
Hence, Li Renjie defines the bank's development mode as a sustainable development strategy. He gave us a detailed introduction of IB's strategic positioning on the basis of macroeconomic trends and the restructuring of processes in line with the development patterns and trends of well-established banks throughout the world.
Li Renjie smiled confidently throughout the course of the interview, which lasted for more than one hour. He said that he is used to thinking the other way. True, he has often expressed disagreement with many viewpoints held in the industry.
IB's alchemy
Business China: IB's high rate of return on capital has left an impression in the industry. Since 2006, IB has maintained a weighted average ROE of above 25%. Its ROE at the end of 2009 was 24.54%. IB also has the highest share price among all domestic banks at present. A simple analysis of IB's asset and income structure does not reveal any apparent differences from other banks, namely, business credit loan incomes and interest incomes comprise the primary sources of income. How then do you realize such a high ROE?
Li Renjie: this is about the art of operations. The role of management is to control risks and increase incomes within the framework of existing conditions. Now, regulators, analysts and even the media all tend to look at a bank with reference to industry averages. They think that there is something wrong with a bank if it veers away from industry averages. I don't agree with this. Over the past few years, we have pursued an approach of being different from others and developing our own characteristics. We differ from other banks in terms of asset and liability structure and development pace.
For instance, some people say that IB is practically a real estate stock because it gives so many loans out to the real estate sector, and that it is facing high risks now. But I don't agree with this way of thinking. It does have to be admitted that the real estate sector accounts for a large part of our business, but I think that this is reasonable. Firstly, this is in line with the general development trend of China's economy. The economy determines finance, and finance serves the economy. No bank can develop off the general track of macroeconomic development. The Chinese economy has been developing rapidly since 2003. The main driving force behind economic development has been urbanization, as opposed to globalization and industrialization. Urbanization also drives on the development of other sectors. We have aggressively developed various types of assets that are related to urbanization, such as individual housing and commercial property mortgage loans, real estate development loans, land storage loans, public infrastructure loans, etc. At one stage, these loans accounted for more than 40% of our total credit loans.
Actually, IB would have had higher profits if the loan interest rate hadn't been marked down by 30% below the base rate last year. In terms of ROE, mortgage loans make a great deal of sense. For instance, for a corporate loan, statutory capital of 1 Yuan is the equivalent to a loan of 12.5 Yuan where the rate of capital sufficiency is 8%. However, for a mortgage loan, we can lend 25 Yuan, and the margin is essentially the same as general loans. Moreover, mortgage loans have a low rate of bad loans, i.e. only 0.14% at the end of 2009. Most bad loans are actually because of deferred payments, and most of the loan can be retrieved, or if not the collateral can be mortgaged off, so the rate of loss is very low.
When we saw overheated market in 2008, we slowed down a little bit and started to decrease the proportion of mortgage loans. Actually, most of our mortgage loans were provided before 2008. Following two years of repayments, the proportion of mortgage loans is now less than 50% and even lower considering the market prices of real estate properties. Therefore, the risk is very limited. It is hence understandable that we have a higher ROE than our peers, even though our profits also come from loan margins. In other words, we have a higher efficiency of capital use and a lower rate of losses.
For instance, we have long adopted the EVA-based assessment internally. For various branches of IB, not only book profits are considered, but also various costs and taxes are considered. We have often been able to identify a market opportunity half a year ahead of other banks, and we would quit when they rush in. For instance, we identified some differences between national debts and financial debts some years ago, i.e. national debts didn't occupy statutory capital and could be tax exempted although they had a low yield. On the contrary, 20% in risk assets had to be considered for financial debts. For that reason, we sold financial debts and purchased national debts. Financial debts have a higher yield, as only pretax profits are assessed. However, national debts have a higher overall yield considering statutory capital occupation and after-tax profits. Some people might have noticed that IB had very low taxes for a certain period of time, and that was due to our operations as mentioned above. Generally, we employ different scopes and services to other banks, although on the surface interest margins still constitute our primary income.
Business China: Does IB try to increase ROE through control of capital costs? We have also noticed that buying back the sale of financial assets accounts for a large proportion. The incomes from these businesses are similar to those from capital services. Can this effectively increase ROE?
Li Renjie: we do not necessarily have lower capital costs than our peers. Many people only see part of the truth. On the surface, our capital costs are not necessarily lower than that of other banks. However, we save costs associated with branches, human resources and management, hence effectively controlling the overall costs of capital. For instance, how can we get higher returns with limited resources considering the limited scale of loans this year? As you can see, the increase of buying back the sale of financial assets, particularly short-term ones, helps us to conserve our statutory capital to a large extent compared with general credit assets. In terms of margins, these assets do not have a high margin, only slightly over 3%, as against a yield of 4% or 6% from loans. However, we can still achieve considerable returns by matching the capital that we absorb from our peers with buying back the sale of financial assets.
Frankly, there are many opportunities in the Chinese market. We are highly sensitive to market opportunities and we are flexible in internal adjustments, resource allocation and business management.
For instance, it is commonly believed that IB has low liquidity, which I disagree with. The biggest challenge to China's banking sector was overly high liquidity in 2008 and 2009 and that caused rate of return on assets to decrease. Therefore, liquidity risk was not the main problem. In consideration thereof, we increased loans to different sectors in order to get higher returns and that is the main strategy that we adopted one to two years ago. We don't arrange our asset and liability structure according to the formulas you see in textbooks or the industry averages.
Another feature of IB is that the proportion of our credit assets is lower than that of our peers, or not over 50% in most cases. We get returns primarily through investments in the bond market and the tax exemptions of national debts. However, we have increased the proportion of our credit assets since 2008, particularly last year, because the yield of other assets decreased considerably amidst the excessive liquidity in 2009. Comparatively, loans have the highest yield and are not limited in scale.
Generally, different asset structures are needed at different stages. Although gains are always represented as interest margins in the profit and loss statement, it is not necessarily deposit and loan margins in all cases. We will make more arrangements with other assets and focus on interest-accruable assets with a higher profitability this year.
Regeneration of IB
Business China: IB's client deposits and interbank placements increased by more than RMB 300 billion last year. Was this an intentional effort or the result of loans?
Li Renjie: we are good at analyzing the major trends and making specific operational strategies for particular stages. Banks encounter different operational problems at different periods. It was not difficult to get deposits last year. The difficulty lied in how to get high-quality and high-yield assets. Therefore, we started to increase our rate of returns on assets by reducing our bill assets early last year, and we were one step further ahead of our peers in this regard. We also intentionally slowed down our retail lending last year considering the overheated real estate market. For that reason, we didn't have a high growth in retail lending. Our loans were primarily given to businesses, registering a growth of 40%. Unlike last year, we will need to stabilize the source of our liabilities and increase the proportion of long and medium-term deposits this year. Regarding retail lending, we will focus on Xingyetong this year, which is oriented towards individual business owners and small enterprises. But we will be cautious with regard to mortgage loans.
Business China: how have you reached the judgment to increase the proportion of long and medium-term deposits?
Li Renjie: we are used to thinking differently from others. We are more worried about inflation. The main goals of macroscopic regulations are likely to be adjusted once the economy stabilizes. For that reason, we need to make arrangements now, even though there is still a high liquidity and the bid rate of treasury bills is still at a low level at present. We would be wrong to wait until liquidity decreases. We need to look at the next two to three years instead of just this year.
Generally, in order to get such a high ROE, the first thing we need to do is to accurately read the current situation, identify the main problems at different periods and make prior arrangements accordingly. Sometimes, liability businesses are the main problems. At other times, asset businesses are the main problems. We have generally made correct judgments over the last couple of years. Secondly, we have responded flexibly to market opportunities and our systems of resource allocation and assessment are also highly responsive. Thirdly, we emphasize EVA assessments and various branches make meticulous calculations and consider general costs, which includes asset costs, risk costs and the costs of human, financial and material resources. However, income cost ratios can't fully reflect the situation because it does not include taxes and capital occupation costs. The thing that really reflects cost controls is ROE, i.e. our cost rate for every 1 Yuan that we earn is the lowest.
Business China: how do you guarantee the fast and effective execution of the process from judgment making to determination of phased operational strategy and to implementation?
Li Renjie: the sustainable development of a bank requires several things. It is not only necessary to make strategies and take a differentiated approach according to the general trend of macroeconomic development, but also necessary to reshape the bank according to the development patterns and trends of well-established banks worldwide.
The prerequisite of differentiated services is a highly uniform system of internal management. It this wasn't the case, differentiated services would be impossible, or even if they were possible they would be limited in scale. High efficiency and lost costs would be unthinkable. We emphasize conformity in a number of respects internally. Firstly, our strategic goals need to conform to our assessment system; secondly, the rules of internal transfer pricing and cost distribution must confirm to one another; thirdly, resources shall be distributed in a uniform manner; fourthly, background operational management has to be carried out in a uniform manner.
We have remodeled the bank in several aspects for the purposes of such conformities. Firstly, process regeneration: processes are divided into foreground, middleground and background processes and differentiated services and marketing principles shall be adopted for different customer groups in order to increase the efficiency and value of foreground services. Secondly, regeneration of organizational structure: it is necessary to gradually establish various divisions to be in charge of different customer groups according to customer and market needs. With an aim realize strategic development and rapidly respond to market needs, we need to gradually move away from the old separate branch management mode to a matrix-based management. We need to centralize background operations if possible in order to simplify on-the-counter operations, avert the operating risks of our grassroots employees and reduce operating costs.
The third thing is the regeneration of corporate culture, including the culture of corporate governance, risk management, financial management and talent management.
Diversification is the future trend
Business China: based on your basic judgment of the macroeconomic conditions, how will you plot out the restructuring of profit-making systems over the next five years?
Li Renjie: we are currently making a plan for this purpose. Our preliminary assumption is that market orientation, internationalization and diversification are the future trends for the development of China's banking sector.
Firstly, market orientation is the inevitable trend, although this process may take longer than was originally anticipated. This includes the marketization of interest rates. The problems that have been seen in the western banking sector are related to the market orientation of interest rates to a certain extent. When the interest margin is below 1%, banks will naturally increase leverage and exclude assets from statements in order to increase capital returns. The sound performance of China's banking sector has something to do with interest rate controls.
Secondly, China's banking sector needs to gradually go international. I mentioned some years ago that we need to play to our strengths and avoid our weaknesses in the process of internationalization. What advantage do we have if we go the US? Our destination should be developing countries, with Southeast Asia being the main choice. Internationalization is also reflected in internal management, i.e. we need to regenerate the bank according to the development patterns and trends of well-established banks worldwide. We also need to attract international talent to join the bank.
Thirdly, diversification is also an inevitable trend. I usually mention to my peers that we need to develop towards diversification. Since the financial crisis broke out, criticism has been directed towards diversification both in China and overseas. Regulatory authorities have also been worried about the possible existence of loopholes in the regulation system and the failure of the regulatory system leading to the intensification of risks. I personally feel that the situation in China is different. There have been excessive innovations abroad in addition to loopholes in regulatory systems. But China is still in the start–up phase. So we don't have to take the same medicine just because others have fallen ill. Finance serves the economy and clients demand diversified services. Therefore, our clients wouldn't be satisfied if such diversified services were not available from banks. Economy determines finance and client needs determine banking services.
But not all banks have to diversify their business portfolio. With total assets of over 1 trillion Yuan and a profit of over 10 billion Yuan, the Industrial Bank is by no means a small bank by international standards, and therefore diversification is the inevitable trend. For that reason, our clients are no longer small clients. Many of our clients are high-end clients and we need to satisfy their needs for diversified financial services.
Business China: although it is the general trend, is the need for diversification really so urgent?
Li Renjie: I personally feel that it is urgent. We will maintain our efforts in traditional businesses. But relying exclusively on traditional businesses is not going to solve the problem. We will make efforts in other fields as long as there are opportunities. Our rate of returns on loans to large-size clients is very low. Therefore, we need to diversify our services. Some big clients affiliated to the Central Government do not lack loans, and so we have to look to other fields for opportunities, e.g. structured financing, bond issue, etc. High-end retail clients have investment needs, e.g. private banking, miscellaneous investments, etc. For that reason, diversification is an urgent need. Otherwise, we are not going to be able to attract clients.
Business China: IB was formally given approval to establish a financial leasing company recently. What are the bank's plans for diversification in the near future?
Li Renjie: we are cautious in the selection of fields for diversification. Firstly, we have to make a plan and decide what can become our main services and products. The scope of financial leasing is wide, covering airplanes, ships, etc. We emphasize environmental protection, energy saving and emissions reduction, as well as small and typical services available for medium-size banks. We hope to establish brands in specific fields and then link this to other business, instead of trying to do everything in all fields. Secondly, we need to establish firewall in internal management so that different businesses have their respective independent decision-making mechanisms and certain risk coverage. We also hope to increase transparency of our businesses. Thirdly, we will employ professionals. The advantages of a bank lie in customer resources and not talent in the process of diversification. For that reason, we have to select talent according to market demands.
There have already been lessons for the banking sector of China. In the early 1990s, there was a wave of diversification among banks, but it was totally chaotic because of the absence of rules, the lack of professional talent, absence of firewalls internally and irrational decision making. Problems are a certainty when you expect to do everything.
Financing platform and controllable risks of real estate loans
Business China: IB increased loans to hydropower, environmental and public infrastructure sharply by RMB 59.46 billion, or 242.8%, in 2009, leading to a balance of RMB 84.05 billion in these sectors and accounting for 11.98% of total loans. Analysts have deemed these as financing platform loans. Meanwhile, essentially speaking, the Top 10 borrowers are all financing platforms in a broad sense. What do you think about the quality of your loans given through the financing platform?
Li Renjie: it is necessary to emphasize financing platform loans and avoid potential risks. But it is not right to intentionally over-blow risks and even demonize local governments. We are doing things for the economy, it is not a movement. We need to be practical and analyze the actual conditions. There are good-quality and bad-quality local government financing platforms. Conditions vary hugely in China because it is such a huge country.
The balance of IB's financing platform loans was RMB 196.8 billion at the end of 2009 according to the statistical standards of the People's Bank of China, and the balance was over RMB 40 billion according to the statistical standards of the China Banking Regulatory Commission. The loans given to governments of developed regions account for 52% of the total, and the loans given to governments of a provincial, municipal and county level account for 21%, 58% and 21% respectively. Although the loans given to governments of a county level are involve greater risk, we restrict our loans to the top 100 countries among the 6,000-plus counties nationwide, and the vast majority of these loans are mortgaged.
The financing platform loans that we grant go to specific projects. As to the source of repayment, it is the case sometimes that local governments play an overseeing role, but this is done so with special funds listed in local fiscal budges and approved by the national people's congress. For example, the treatment of sewage is a government responsibility. However, as price reform has not yet been completed, such a project will not be able to generate enough funds to repay the loan. In this case, it is perfectly legal for the local government to offer subsides as approved in the budget. What is the problem with this kind of project?
We assess our financing platform loans in terms of fiscal revenues, the sources of capital and various other factors. According to the requirements of the China Banking Regulatory Commission, we have successfully broken down all package loans and a corresponding project has been identified for all our loans. In addition, 99.7% of government financing platform loans are Class A loans (note: loans that have stable and sufficient cash flows and primary source of repayments with sustainable development, complete mortgages and fully-cleared formalities). Generally speaking, the risks of our government financing platform loans are controllable.
Business China: as of the end of 2009, IB's loans to the real estate sector and individual mortgage loans accounted for 30.6% of total loans, which is a high proportion among the listed banks. Are you worried about the quality of these loans considering the inactivity of the market today?
Li Renjie: we have to look at this practically. The structure of our loans to the real estate sector has changed. Our focus has shifted towards the renovation of old city areas and affordable housing construction. Why? We noticed the drastic increase in real estate prices in some areas. With the introduction of national policies to crack down upon speculation, the development of general commercialized residential buildings will be affected. But this is not the case for slum renovation, because this is a government responsibility and these projects relate to the livelihood of the people. On the other hand, the demands in this area are clear and definite and oriented towards a specific group of people. Considering the capital investments from the local governments, I think these projects involve fewer risks as banks loans play a supporting role. Also, this helps us to increase our corporate banking and individual clients simultaneously, e.g. deposits of relocation compensation. In regard to land reserve loans, they are primarily distributed in regions where the local governments have abundant fiscal revenue and where there is a well-regulated and active real estate market with highly-guaranteed sources of repayments, e.g. Beijing's Chaoyang District.
We have always been strict about management of loans relating to the real estate sector. Therefore, various loans have reliable primary sources of repayments and high-quality mortgages and pledges. As I mentioned just now, there is a low rate of mortgages for individual mortgage loans. Our land development loans are primarily given for land acquired before 2008, when the purchasing cost was relatively low. Considering the constructions as well, we actually have a very low rate of mortgages. For that reason, the overall risks are comparatively controllable.
Regarding loans against lands and real estate properties, our previous experience shows that they can basically be claimed back due to sufficient mortgages. But it is more difficult to claim back other types of loans actually.
We carried out pressure testing before the China Banking Regulatory Commission demanded, and so we were one of the first banks to carry out such a pressure test in China. There was a major round of fluctuations late 2007 and early 2008. IB's real estate loans increased rapidly in 2006 and 2007. When the sign of a bubble appeared in Shenzhen in 2008, we immediately carried out a pressure test. I even personally led a delegation to learn from the Hang Seng Bank, one of our strategic investors, regarding their measures in response to the 1997 financial crisis when Hong Kong real estate prices slumped by over 50%. They managed to keep a high quality of mortgage loans. As a matter of fact, urban banks are characterized by a high proportion of mortgage loans. We have a higher proportion of mortgage loans than our peers, but that does not necessarily mean that we have higher risks. We prepared a full set of precautions back then.
The recent pressure tests show that IB's rate of bad real estate loans to businesses and individuals will only increase by about 0.98 and 0.21 percentage points respectively even if subjected to dual pressure (i.e. real estate prices fall by 30% and interest rates increase by 108 base points) and that the impact will be minor. The changes of these indexes only show the possibility of some bad loans. However, the overall risks are controllable considering the sufficient rate of mortgages.
Business China: IB plans to maintain a 22% growth of credit loans this year. What specific sectors will be the focus of new loans?
Li Renjie: firstly, urbanization is a clear and definite trend, and therefore urbanization-related loans are still a major focus of our attention. Secondly, we also focus on green financing. An upper limit and a loan-to-deposit ratio are imposed on all loans except for green projects. Thirdly, loans for small and medium-size enterprises will be an area of focus, including microfinance to individual businesses and loans to small companies.