Until the foreign banks are allowed to fully participate in the local currency markets and access retail customers, China's WTO agreement to progressively open up its banking sector is unlikely to lead to explosive growth by foreign banks. For foreign banks to succeed in China over the next ten years they also need the Chinese banks to be successful in their restructuring programme so that the market as a whole develops and matures.

　　The foreign banks' entry

　　Brendan Nelson, Chairman of KPMG's Global Banking Practice, said: "The size of the Chinese market makes it one of the most difficult in the world, not one of the easiest, for outsiders to break into. At the moment the foreign bank with the biggest presence in China - HSBC - has just 9 branches, compared to over 30,000 for ICBC, China's largest domestic bank. It will take many years to build a presence in a country the size of China. Alliances and joint ventures will therefore be a likely route for many foreign banks, but these will need to be carefully chosen and may require significant levels of investment."

　　The high capital requirements and tough prudential controls over opening new branches would also limit foreign bank's expansion. However, the prospect of foreign banks gaining full access to the domestic market by 2007 will push Chinese domestic bankssintosstreamlining and sharpening their operations, insgroupsto become more competitive, over the next few years.

　　The Chinese government and the regulators are considering selling minority stakes in the domestic sector to foreign banks, so as to speed up the local bank reform process. However, despite the possible advantages of such alliances, concerns over the high entry price and the unknown extent of structural problems, such as over staffing, may cause many foreign banks to adopt a wait and see approach. These banks will either hope to get better deals in the future or will set up their own operations, especially for corporate banking business.

　　Brendan Nelson added: "It is the big foreign banks with a presence in Hong Kong that have been best positioned to start making inroads in the Chinese market - four of the largest foreign banks in China (HSBC, Standard Chartered, Citibank and Bank of East Asia) also happen to be four of the top five banking groups in Hong Kong. Interestingly one reason why they are so strong in Hong Kong may be the fact that HSBC, Citibank and Standard Chartered bank were all present in China before the establishment of the PRC in 1949. These banks have had the advantage over banks from further a field of extensive contacts in China, a pool of managers who were able to transfer to their China operations and a deep understanding of the Chinese culture and market.

　　Cultural issues and understanding of the corporate and private customer base is always a key factor in entering a foreign market. Other foreign banks who want to close the distance on these early leaders, in the race to build a franchise in China, will have to make a concerted effort over the medium to long term to build market share - entrysintosthis marathon event is not for the faint-hearted."

　　"Whilst foreign banks can be expected to present real competition to local banks, I would not expect them to acquire more than 10% of the overall market in the next ten years," Paul Kennedy, Managing Partner of KPMG Shanghai, said. "They are growing from a very low base, of approximately 2% market share today, in what is still a tightly regulated environment andswheresfull access to the market under the WTO agreements does not happen until 2007. However, that would still be a very significant level of business in a market the size of China's and would represent a very real achievement for the foreign banking community."

　　"Whilst for many businesses in China over the past 20 years joint ventures and alliance have been very careful, they would appear to have something to offer to both Chinese and foreign banks at the current stage of development of the market - foreign banks need local market access and distribution and Chinese banks need overseas expertise. However, partners will need to be chosen very carefully to ensure that a win-win solution is available making it worthwhile for both parties to devote the resources and management necessary to guarantee a successful outcome."

　　"For foreign banks to succeed in China over the next ten years they also need the Chinese banks to be successful in their restructuring programme so that the market as a whole develops and matures," Kennedy said. "There is truly a win-win outcome here if all segments of the banking community recognize the benefit of improving the competitiveness of the PRC banking industry as a whole, so that everybody can have a share of the bigger pie that will be created."

　　The Chinese government has come out with detailed rules on governing foreign banks in February this year. Richard Stanley, country corporate officer of Citibank China, said the implementation of the rules is an important measure taken by the Chinese Government to further open its banking sector.

　　Experts say that the Chinese Government should continue to maintain a clear and stable regulated banking environment to further encourage foreign banks to continue to invest and participate in the development of China's banking sector. However, some other foreign banks expressed their disappointment. The rules and the foreign banks' expectations have a certain gap, said one representative of the foreign banks, who declined to be identified.

　　The rules also stated that foreign banks with two or more branches in China must appoint a main branch to combine the financial statements of all their branches, giving a complete picture of their operations in the country.

　　The Chinese banks' defense

　　The foreign banks' arrival on the Chinese financial market has exerted a significant impact on banking management and concept rather than market share reshuffle as people expected.

　　Local banks lack the necessary understanding of foreign markets and international rules of practice and in this respect, it is right for them to learn from their foreign counterparts.

　　From the perspective of the Chinese banks, KPMG warned that, while they have a five year 'grace period' to gear up to meet full outside competition, decisive measures will need to be taken very quickly if they are to protect their market share over the longer term.

　　Failure to improve services to retail customers by 2007, when foreign banks will be able to take local currency deposits from PRC individuals, could see the loss of many of the higher value accounts to foreign banks. This loss of the most profitable segment of their deposit base could prove extremely damaging to local banks. More sophisticated customer relationship management tools are therefore needed to identify and then improve services to these higher value customers. Operational and risk management systems also need to be improved to better manage risk, improve profitability and to meet the capital adequacy requirements of the Basel accord, due to be introduced in 2006.

　　Over time, Chinese banks also need to build stronger ties with banks and corporations around the world to prevent their large corporate clients going elsewhere, as they expand their operations overseas, as well as to protect themselves from a likely brain drain of staff to foreign competition.

　　Furthermore, domestic banks will need to adopt a more commercial approach to loss-generating clients, projects and business units. They must also cut their costs, dealing with both surplus branches and headcount, and develop better products and services for both corporate and private customers. Due to their low capital adequacy ratios, Chinese banks also need to turn to the capital markets as alternative sources of finance and we expect to see a large number of bans.

　　For Chinese banks, the challenge is very much on - compete at an international level, offer a more sophisticated range of products at a higher level of service, or watch some of your more profitable business move to another bank, be they foreign or local.

　　Financial experts hold that with the gradual lifting of business restrictions on foreign banks, the competition between Chinese and foreign banks will intensify in China's financial market. The changing concept of management by China's commercial banks is both timely and critical to their development prospects.

　　Chinese banks have proved to be quick responding to the changed market conditions and have performed satisfactorily in adapting themselves to the new conditions.

　　The four state-owned commercial banks, the mainstream of China's banking industry, have worked out new reform measures this year, gave up some traditional ways of management and adopted some up to date advanced business ideas in line with international practice.

　　"Different services for different clients" is one of the ideas Chinese banks have learned from their foreign counterparts and China's commercial banks mostly have adopted the system of arranging managers for specific clients.

　　The China Construction Bank announced earlier this month that its president Zhang Enzhao has taken the lead and will act as a chief manager for 10 quality clients. The bank has also arranged chief managers for 1,000 key clients to provide them with the best services.

　　In China's large cities and developed coastal areas such as Shanghai, Guangzhou and Beijing, many banks have opened VIP services for key clients.

　　People concerning the banking sector believe the pressure from foreign banks has not only helped promote China's banking reforms, but also brought about great changes in traditional banking concepts and people's ideas about how to manage their finances.

　　Statistics show that large international banks get more than 70 percent of their income from intermediate businesses, while Chinese commercial banks get only about 10 percent as interest margins remain the major source of profit for Chinese banks.

　　When Citibank in Shanghai began to charge a monthly financing service commission of US for deposit accounts of less than US in March, it has set off a heated debate on whether Chinese banks should follow suit. Although this debate has come to an end without any result, it will certainly encourage Chinese banks to charge for intermediate business.

　　Chinese banks have all listed intermediate business as a key area to develop, and by far this year their income growth from intermediate businesses has mostly exceeded their overall income growth.

　　Sources close to the central bank say procedures governing the charging of intermediate businesses are under formulation and will be promulgated soon in a bid to promote the development of intermediate businesses.

　　Chinese banks have also stepped up their efforts to build good corporate governance. This year the four state-owned commercial banks have begun to release information about their major activities, and for the first time published details of their assets.

　　At the same time, the banks have invited international accounting firms to audit their assets and improve their methods of management.

　　Background

　　According to the rules published in February, foreign bank branches must have at least 600 million yuan (US158372.3 million) in operating capital to qualify to conduct a wide range of businesses.

　　Qualified foreign banks will be able to conduct all forms of foreign and domestic currency business with foreign and Chinese firms, and with individuals.

　　Of the minimum 600 million yuan (US.3 million) requirement, the branch must maintain at least 400 million yuan (US.2 million) in domestic currency and at least 200 million yuan (US.1 million) in foreign currency.

　　Solely foreign-funded banks and Sino-foreign joint venture banks must maintain a minimum registered capital of 1 billion yuan (US million), 60 percent of which in yuan and the rest in hard currencies.

　　Solely foreign-funded and joint venture non-bank financial companies must have a minimum registered capital of 700 million yuan (US.3 million) - at least 400 million yuan (US.2 million) and the equivalent of 300 million yuan (US.1 million) in hard currency.

　　China pledged to allow more foreign financial institutionssintosthe banking sector following its WTO membership on December 11.

　　It has pledged to let foreign banks conduct yuan business with domestic firms in two years after entering the WTO and with Chinese individuals within five years.