Chinese banks are employing various strategies as they march into international markets

by Jonathan Calkins

Industrial and Commercial Bank of China (ICBC), the world’s largest bank by market value, received final approval from US regulators in May 2012 to purchase 80 percent of the US unit of the Bank of East Asia. The deal was agreed upon more than two years ago, and despite its small size in dollar terms, the Chinese bank had to clear an 18-month approval process. (The US unit of Bank of East Asia operates 13 branches in New York and California.) This marked a milestone for the Chinese banking industry: ICBC became the first Chinese financial institu­tion to assume control of any US bank.

The expansion of Chinese banks into offshore markets has strategic and practical implications. The ICBC acquisition, along with similar purchases and investments made by Chinese banks into offshore financial markets in recent years, represents the lat­est push in the Chinese government’s ‘going global’ strategy, as well as the government’s efforts to expand international use of the renminbi (RMB).

In addition, Chinese businesses have been successful in expanding into underdeveloped markets, and Chinese banks can provide a fi­nancial support network for Chinese busi­nesses as they move into overseas mar­kets, such as the Middle East, Africa and Latin America. These overseas businesses, especially those engaged in petroleum and construction en­gineering industries, often require enormous credit lines to finance day-to-day operations. Chinese lenders abroad are, for the time being, primarily focused on commercial banking, instead of offering asset manage­ment and investment banking services.

Why ‘Go Global’?

Chinese businesses and brands are gaining recognition in international markets. A recent Millward Brown analysis highlighted the growing success of Chinese businesses in foreign markets. Chinese businesses have been investing heav­ily in research and development (R&D), and management and branding capabilities. These businesses want a streamlined financial system that allows an easy trans­fer of money between the mainland and offshore, and Chinese banks are better equipped to provide this service.

Chinese banks are extending their services by taking advantage of their relative isolation from financial systems in developed economies. Acquisi­tions and equity investments by Chinese banks in major overseas financial institu­tions come at a time when mature US and European banks are struggling to manage risk and rebuild portfolios in the lingering aftermath of the 2008 financial crisis and Eurozone debt crisis. Declining bankrupt­cy and asset prices for offshore financial institutions are providing more choices for merger and acquisition (M&A) deals by Chinese banks, and many countries are lowering market entry barri­ers to encourage financial investment.

“China has a huge volume of foreign currency reserves, and many Chinese businesses were not negatively affected by the financial crisis. State-owned enter­prises are looking to invest abroad because the domestic market is over-invested, and Chinese banks help them do this,” says Zhou Shaojie, associate professor at Ts­inghua University School of Public Policy and Management.

Chinese companies have also increased investment in the United States in recent years. According to the Heritage Foundation’s research on China’s global investment activity, invest­ment in the United States hit record levels in 2012, reaching $54.2 bil­lion. ICBC’s acquisition in the United States was not a coincidence. China’s ‘Big Four’ state-owned banks are being encouraged to expand their over­seas financial profiles in order to provide financial services for major Chinese busi­ness interests operating in foreign markets.

Yet China’s top four lenders remain depen­dent on domestic financial operations for a majority of their annual revenue. Current overseas operations by major Chinese banks account for less than 10 percent of their total assets, according to a 2012 Standard & Poor’s report. Despite a heavy reliance on domestic financial services, Chinese banks com­pleted a total of 38 overseas M&A deals between 2002 and 2011, for a total value of roughly $20.2 billion, according to financial services firm Deloitte.

Go Global, Serve Local

ICBC is not the only Chinese bank expanding abroad. Agricultural Bank of China has opened branch offices in New York, Hong Kong, Seoul and Singapore. By the end of 2010, Bank of China had overseas assets totaling $351.6 billion, according to the bank. Xiao Gang, chairman of the board of directors of Bank of China, explained in June 2012 why the bank must go global: “There is good reason to believe that the Chinese economy has reached a point where its status as the biggest country will lead it to become the biggest in out­bound direct investment. This new model not only requires Chinese enterprises to expand their global businesses, but also China’s banking sector to accelerate its in­ternationalization,” Xiao wrote.

But Chinese banks still largely cater to Chinese businesses. The international arms of Chinese banks and financial institutions generally lag behind the operational and managerial capacities of more established multina­tional banks, and often lack the prereq­uisite language skills and knowledge of local culture and regulations necessary to compete for local clients.

“Chinese banks find it very hard to do business with local [non-Chinese] customers. They dream of serving local clients but are forced to follow preexist­ing clients as they move into international markets,” says Liu Jing, associate dean at the Cheung Kong Graduate School of Business.

Liu’s comments touch on why Chinese businesses abroad remain the focus of Chi­nese banks. Beijing is active in financing infrastructure projects across the develop­ing world, where Western financial institu­tions control a smaller share of the market and the potential for growth is higher.

Over the long term, Chinese banks active in markets such as the Middle East increase the volume of RMB cross-border pay­ments. RMB-based transactions are a key part of the central government’s agen­da for internationalizing the RMB and strengthening the central bank, but it will have to meet the International Monetary Fund’s (IMF) requirements first.

Internationalizing the RMB

In 2009, People’s Bank of China, the country’s central bank, began loosening currency controls by passing the Administra­tive Measures for Pilot Implementation for RMB Settlement in Cross-border Trade. This allowed companies on the Chinese mainland to use RMB in cross-border transactions. By 2011, cross-border RMB transactions were recorded in 181 coun­tries and regions, and cross-border RMB settlements reached ¥2.5 trillion ($406 billion), a growth rate of 394 percent over the same period in 2010, based on Deloitte data. In 2011, financial consultancy SWIFT said that more than 900 financial institutions in more than 70 coun­tries were doing business in RMB.

Previous Chinese President Hu Jintao described the current US dollar-led cur­rency system as “a product of the past,” and summarized China’s recent moves at “internationalizing” the renminbi in a written interview with the Washington Post and Wall Street Journal in 2011. But it is unlikely that the RMB will supplant the US dollar as the world’s reserve currency.

“You only have one real international currency, and that’s the US dollar. The United States has what I call ‘the ability to print out money and have everyone take it.’ This financial benefit makes it very de­sirable to have an international currency,” says Yukon Huang, a senior associate in the Carnegie Asia Program and World Bank’s former country director for China.

There are numerous benefits to having an international reserve currency, including lower transaction costs in overseas markets for domestic exporters, more busi­ness for financial institutions, and seignorage and political power for governments. Beijing will likely adopt a more prag­matic approach by lobbying the IMF to support the use of the RMB, rather than push for an international alternative to the dollar or euro.

“Beijing wants the RMB to grow to become part of a ‘basket of currencies’ held by the IMF during the next five to 10 years,” says Eswar Prasad, a senior fellow at the Peterson Institute for International Economics.

As of February 2013, the RMB ranked 13 in world curren­cies, with only a 0.63 percent share in total payments, according to SWIFT. China’s currency cannot go into the IMF basket until the RMB’s share of total international payments ap­proaches its portion of global exports, which was roughly 10.4 percent in 2013, according to the World Trade Organization.

Chinese banks will continue to pair with Chinese businesses as they expand into new offshore markets. This will pro­mote payments in RMB and increase the level of RMB currency reserves held by foreign countries. Western banks likely will not compete directly with Chinese fi­nancial institutions as they begin to ex­plore less developed regions and the Mid­dle East. To maintain expansion, Chinese banks will have to begin offering more so­phisticated financial products as they adapt to local clients’ needs and expectations.

[box] This article has been reprinted with permission from CKGSB Knowledge, the online research journal of the Cheung Kong Graduate School of Business (CKGSB), China’s leading independent business school. For more articles on China business strategy, please visit CKGSB Knowledge. [/box]

(Photo by Slices of Light via Flickr)