An Important Question, Awaiting An Answer

This comes from yesterday's Wall Street Journal (page C1 of the print edition):

The world's banking titans, including Bank of America Corp., Royal Bank of Scotland PLC and Merrill Lynch & Co., have spent billions of dollars buying small stakes in China's biggest lenders. So far, they are looking pretty smart.

When Bank of America took a 9% stake in China Construction Bank Corp. last June, the North Carolina lender agreed to pay $3 billion. That stake is valued at about $9.2 billion, following a surge in the shares after the bank's initial public offering of stock in October. HSBC Holdings PLC's 19.9% interest in China's fifth-largest lender, Bank of Communications Co., is valued at more than $5 billion, more than double what the British bank invested. Shares in both Chinese banks have soared about 40% so far this year.

Those numbers help explain foreign investors' decision to put down a lot of money with not a lot of say in how their investments are managed. The investors have minimal influence over the operations of their Chinese partners, and so far they have received few of the benefits they anticipated, such as credit-card joint ventures. They are barred from holding more than 25% of a Chinese lender.

Here is at least part of the reason:

Risks like China's chronic bad-loan problem have in part been mitigated through guarantees that the Chinese banks have made against future financial troubles. A recent Standard & Poor's Corp. report said the sector is high-risk in comparison with its global peers, but found that profitability, asset quality and the quality of information have improved.

More competition (and opportunity) looms...

China is opening its vast retail-banking market to foreign institutions at the end of the year, under its World Trade Organization obligations. Foreign investors will then have a shot at China's $1.7 trillion in savings.

... sort of:

But foreign banks' true access to that money is limited by their tiny branch networks. HSBC has the biggest presence of any foreign bank in China, with its 20 banking outlets, compared with some 20,000 for ICBC, the country's biggest bank.

And there is this (also on page C1):

Chinese regulators are planning a policy change that could trip up foreign banks in China just when they are being granted fresh rights to expand.

Within the next few months, the China Banking Regulatory Commission plans to ask foreign banks to change the way they are incorporated, as well as to make accounting and management changes, to roughly conform to the way Chinese banks are structured, according to a senior official at the watchdog agency...

The most far-reaching measure is a request that foreign banks put China operations into a stand-alone entity that is locally incorporated, according to the official and a senior officer of a foreign bank who has been briefed on the plans. The steps are necessary to enhance regulation and control risk, the regulator said.

Under the new rules, foreign banks would face requests to pony up more capital and possibly higher taxes than they now pay, the official said.

From the original article, the mulit-billion dollar question:

For a major Western bank, though, it remains an open question whether taking a minority stake with little control makes for a good China strategy. The returns can be huge, but there is no assurance that the investors' highflying stakes won't decline before their three-year lockup expires -- or that China will succeed in turning its banks into institutions that the foreigners will be glad to be part of...

Investors "have these short-term windfalls and huge returns on their investments," says Mei Yan, a banking analyst at Moody's Investors Service in Hong Kong. As to the chance they will find long-term partners, she says, "we have questions in our mind whether eventually that will work out or not."