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Chinese Banks Test Investors' Patience

Foreign firms buy stakes to get into the huge market, but bad debt and corruption remain.

September 11, 2005|Don Lee | Times Staff Writer

SHANGHAI — Foreign companies have been practically stepping over one another to invest in Chinese banks, but it will probably be a long time before anybody walks away with happy returns.

Just ask Frank Newman, a turnaround artist who took the helm at Shenzhen Development Bank a few months ago. When the former No. 2 man at the U.S. Treasury Department arrived at the bank, an institution with $25 billion in assets, he was amazed that there were no financial reports on the company's divisions. The bank's thick book of bad debts was fraught with surprises: One real estate loan had been neglected for 12 years. Many others, he learned, were actually collectible because borrowers had hidden assets.

"In all my years of banking, I've never seen anything like it," said the 63-year-old Newman, who helped revive Bank of America in the 1980s and Bankers Trust a decade later.

Analysts consider China's financial sector to be the weakest link in the nation's booming economy. The Chinese central government has poured tens of billions of dollars to prop up its big banks, which have been hobbled by corruption and lax lending practices. At the same time, Beijing has encouraged foreign firms to buy a stake in them, to inject capital and much-needed technical and management know-how.

Many have been happy to oblige. In recent months, Bank of America Corp., Royal Bank of Scotland, American Express Co., Goldman Sachs, Merrill Lynch & Co. and others have pledged to invest billions of dollars in Chinese banks.

The allure is China's huge banking market, which is dominated by four state-owned banks but will be open to all comers at the end of 2006 under Beijing's agreement when it joined the World Trade Organization. Foreign banks are buying stakes now to get a toehold in that market, and investors are betting that China's banks will be reformed and someday become valuable publicly listed companies.

Chinese banks have made progress, but they're still loaded with bad debt and operate inefficiently. Weak corporate management and corruption remain a problem at many banks. Last weekend, China's bank regulator reported that 1,700 employees were held for embezzlement and other bank crimes in the first half of this year.

There could be more trouble ahead.

Leading analysts say China's economy is downshifting. Corporate profits are weakening, as are Chinese imports of steel, oil and capital goods. Real estate activity in places such as Shanghai is slowing.

"For the last three or four years, [China banks] have been operating in a very benign environment," said Nicholas Lardy, a China expert and senior fellow at the Institute for International Economics. But now, he said, "I think we're at a turning point where the economy is likely to grow more slowly."

That doesn't mean China's economy will tumble; few are expecting that. But given that Chinese banks have been lending liberally to private enterprises during good times, a downturn is almost certain to set the financial industry back, said Stephen Green, senior economist for Standard Chartered Bank in Shanghai.

"Inevitably, there will be a second large wave" of troubled loans, Green said.

The central government will see to it that the biggest banks don't fail because that could lead to social disorder, which could be disastrous for the Communist Party leadership. But a relapse would be more costly to Beijing, which already has handed out about $100 billion to banks, mostly to the big four: Industrial & Commercial Bank of China, Bank of China, China Construction Bank and Agricultural Bank of China.

The cash infusion has helped those four banks collectively trim the percent of bad loans from 35% a few years ago to about 10%, according to Chinese government figures. But some analysts think that the share of problem loans is much higher than that. When analyzed with government support excluded, each of these four Chinese banks has an unfavorable D rating from Standard & Poor's.

"We don't think their credit quality will improve substantially because of a new partner," said Connie Wong, an S&P analyst in Hong Kong, explaining that it was partly because foreign investors can acquire only a minority stake, thus giving them relatively little control over operations and management.

A foreign company is essentially restricted from owning more than 20% of a Chinese bank. And a Chinese lender can have only up to 25% of its total shares in foreign hands before it faces significant constraints.

In June, Bank of America announced it would spend $2.5 billion for a 9% stake in China Construction Bank, which is expecting to list its shares on the Hong Kong Stock Exchange this year. For that, the Charlotte, N.C.-based bank got one seat on the Chinese bank's board of 14 members, although analysts say the deal also could give BofA opportunities to jointly market credit cards and other fee-generating products.

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