The Banking Industry of China Analysis - Essay Example

Running head: The Banking Industry of China: Structure-Conduct-Performance Analysis The Banking Industry of China: Structure-Conduct-Performance Analysis [Writer's Name] [Institution's Name] Executive summary: The purpose of the paper is to undertake the Structure-Conduct-Performance analysis of the Banking Industry in China. With the increasing foreign direct investment in China and the adoption of relatively flexible trade policy and regulations the banking industry in China resulted as robust growth in the last decade. The foreign banks are giving a healthy competitive environment to the Chinese local and state owned banks. The local banks suffer the hindrances such as bad loans, modern bank management techniques etc. On the other hand the foreign banks are using these as the niche to compete. Overall the banking industry can enhance its performance by undertaking re-structuring process in some sectors. The "Structure-Conduct-Performance" Paradigm: The Structure-Conduct-Performance paradigm undertakes the analysis of the level of competition in the market, study the strategies of the firms in order to deal with the competition and measures the success of the industry by evaluating the customer value delivery by the industry. "Structure" can be defined as the market formulation pattern of an industry presenting the competition among the industry participating firms and institutions. "Conduct" is the responsive strategies of the firms and institutions, which they adopt in order to successfully, compete with other competitors and to maximize the profit shares. "Performance" is the analysis of the achievement success of the pre-stated goals of the industry. Market Structure: The Chinese Banking industry can be characterized as having the monopolistic competitive market structure in which the market is ruled by the state owned banks. It is because the consumers have relatively high level of confidence in investing in these institutions. The Banking system of China constitutes four state-owned commercial banks, as well as several joint-stock commercial banks, city commercial banks, rural credit cooperatives, finance companies, and trust and investment companies. With the adoption of the liberal trade policies and easing restrictions the role of the foreign banks is also increasing. But still the financial institutions in China are under close scrutiny of Government. The present state of Chinese economy has a significant role of the Banking industry. The industry had to face a set back due to the bad loans to the state owned enterprises, weak asset-liability composition and the lack of modern management techniques. The presence of these drawbacks is adversely effecting the performance of the financial system resulting in shape of hurdles in the path of economic growth (Bing-xiang and Mehta) The Government of China is introducing a crucial reform measures in the state owned commercial banks. According to the China Banking Regulatory Commission (CBRC) the Government is providing guidance, supervision and assessment in the process of the governance improvement in Bank of China and China Construction Bank. Special emphasis is also being given to the Risk management process taking maximum profits and capital safety as the core. "Meanwhile the departments will also take strict preventive measures against the rebound of bad loans and criminal cases and urge BOC and CCB to make thorough preparation for the stock listing." (People's Daily Online, 2005) There are several weaknesses in the corporate governance, internal and auditing which are leading to an increase in the corporate scandals. The degree of disclosure of financial information is also a main reason. Mostly the corporate running bodies do not find them answerable in front of any regulatory body. In fact the regulations of the Chinese government do not have any significant provision in the law regarding the off balance sheet transactions. This in turn is effecting the consumers trust on the privately owned domestic banks. On the other hand foreign banks are adopting relatively more transparent and increased disclosure practices and increasing their market share. Financial information in the form of audited accounts can prevent the system slipping into corruption. So in order to make the state owned bank competitive with these foreign banks the Government is taking steps to deal with the issues such as transforming some of the state owned banks into public companies, the level of auditor's independence, proper monitoring of the accounting practices of the financial company under a board, corporate social responsibility and enhancement in the financial disclosure to the prescribed level. Strategic risk evaluation techniques and contingency plans development is also being encouraged for the are also small-and-medium-sized commercial banks. (People's Daily Online, 2005) Conduct: Some of the banks are undergoing the process of management improvement. The new techniques of planning by objectives and improved decision making are being implemented by following the lines of the foreign banks in order to achieve the competitive edge among the industry participants. Another trend, which is gaining popularity in the industry, is the collaborative projects and ventures of the domestic and foreign banks proving fruitful for both. The foreign bank trains the officials about the modern banking techniques on the other hand the local bank facilitates environmental and legal adjustments of the foreign bank in the market. The Chinese regulatory bodies have opened the banking industry for the foreign banks in order to save the domestic banks having weak position. But with encouraging the foreign banks to support the domestic banks the Government has taken cautious measures to limit the role of the foreign banks to effect the monetary policy of the country. "Since foreign banks most often are well capitalized with direct access to external markets, are less likely to turn off the credit spigot during inflationary times when monetary authorities pursue tight monetary policies. As the RMB moves toward floating exchange rate system, the official reserves in the Chinese balance of payments would become insignificant. Under this scenario, foreign capital inflows will be accompanied by goods imports. This would then help alleviate inflationary pressures through both an increase in indigenous production capacity (that will not be discouraged by higher financing cost) and increased goods inflows. (Selective credit measures, naturally, may be needed to discourage investment in activities such as speculative real estate." (Bing-xiang and Mehta) Performance: The Banking industry of a country plays an important role in the economic well being of that country. The Chinese Banking industry is also effectively serving the purpose of supporting the process of economic growth in China. With the GDP growth rate of approximately 10% an year the assets of the Banking sector in China is also multiplying. Table 1. China's Annual Average Real GDP Growth Rates: 1991.2000 Year GDP* (billion Yuan) GDP growth rate** % Banking Assets* (billion Yuan) Banking assets growth rate* % 1991 2161.8 9.2 2397.3 31.6 1992 2663.8 14.2 2910.1 21.4 1993 3463.4 13.5 3705.6 27.3 1994 4675.9 12.6 4926.5 32.9 1995 5847.8 10.5 6262.9 27.1 1996 6788.4 9.6 7697.1 22.9 1997 7446.2 8.8 9418.2 22.4 1998 7939.6 7.8 11042.1 17.2 1999 8205.4 7.1 12323.1 11.6 2000 8900.0 8.0 13143.4 6.7 Source: China Statistical Yearbook, Almanac of China's Finance and Banking. *Data in value terms in these columns are calculated at current prices. ** The indices in this column are calculated at comparable prices. China's entry into the World Trade Organization on December 11,2001 and other liberalization policies: Being the member of WTO the Chinese government revised the rigid policies and made transition to more flexible policies, which were an attempt towards providing equal opportunity to the foreign and domestic competitors in the financial industry. The Government in shape of provision of legal, tax and regulatory support supports the entry in the industry. Domestic banks and financial institutes are promised an end to tax breaks for foreign investors and other changes designed to standardize corporate incentives. The tax preference provision to the foreign direct investment has attracted a massive number of investors in the banking industry. The foreign companies have offered a generous tax holiday of 10%-15% in China as compare to the base rate of 33% (whereas domestic companies are generally taxed at 33%). All this led to increased investor confidence in the Chinese market. Massive foreign investment potential in China's banking system: The adoption of flexible and open arm policy for the foreign investors in the banking industry by the Chinese government flooded the Chinese banking industry with the foreign investors. The privatization of the China's largest state-owned commercial banks (SCBs) is being supported by a large number of foreign investors. International financial institutions are interested in making the most of the opportunity by pouring money into the SCBs in a bid to capture a key strategic sector of the Chinese economy. The Bank of America has established a joint venture with the China Construction Bank to undertake corporate lending as well as consumer banking activities such as mortgages and credit cards. The China Construction Bank has 14,500 branches all over the country and has a huge number of 136 million deposit accounts. Likewise many foreign banks and financial institutions are investing in the Chinese financial institutions to gain strategic power in the Worlds largest growing economy. China's banks are now the second largest sources of finance, after Japan, to prop up the huge US budget and trade deficits. (John Chan, October 2005). Foreign Investment in the Banking Industry Representative offices as of June 2005 244 Branches/subsidiaries as of June 2005 214 Total assets as of April 2005 $76.22 billion Foreign currency loans as of April 2005 $28.5 billion Local currency loans as of April 2005 $10 billion Source: China Daily Barriers in the way of entry in Chinese banking sector: The Chinese government has applied a controlled competition culture which against the liberalisation provided by the WTO which lift most of the regulations from the trade & commerce (Yoost, 2005) Many assets in commercial and industrial sectors are state owned. This in turn gives rise to the problem of hidden state regulation imposition of the government on the foreign investors. This strengthens the view that China does not practise liberty in Business. Some of the sectors of economy are like banking are still protected by the government. Due to the situation the WTO commitments are not fulfilled which gives rise to local competition for foreign investors. The work undertaken in this paper is an improved one because it takes into account all the aspects related to the Chinese banking industry, including the practices of foreign banks which contributes towards the FDI in China. The contribution made by this paper is more fully evaluating the structure-performance-conduct of the Chinese banking industry Second, it takes into account national changes introduced by the Government bodies and the privately owned commercial banks to make the Chinese local banks competitive with the foreign banks. Future Recommendations: If the aim of attracting FDI to Chinese banking industry is to introduce advanced technology, improve management and expand markets, it would appear to be working. More and more private Chinese-owned spin-offs of the FIEs are capable of competing with these FIEs in China as well as in the global markets. China needs to learn from post-World War II Germany and avoid the experiences of Botswana. The former encouraged foreign investments but was not dominated by them - instead, it succeeded in strengthening its own innovation capacities. By contrast, foreign companies have to a large extent dominated the economy of Botswana, with daunting social and political consequences, even though FDI has contributed to the economic growth of the country. To many foreign investors with market-seeking motivations, preferential treatment is not the determining factor in their investment decisions anyway. Thus it is not a sustainable strategy for attracting efficiency-seeking FDI. China must create open and fair competitive environment for all financial institutions, domestic and foreign banks alike, to cultivate the growth of national champions. As it strives to build up a rule-based market economy that respects policy transparency, protects intellectual property rights and upholds fair competition, China will increase its advantages in attracting FDI, increase economic activity and capital inflow. (Zhang, 2005) Reference: Bing-xiang, L., & Mehta, D., Restructuring of Chinese Banking Industry, China & World Economy Number 3, 2001, retrieved on 08/05/06 from Chan, John, (October 2005),"Foreign Capital Pours into China's Banks", World Socialist Web site, International Committee of the Fourth International, December 2005, retrieved on 08/05/06 from . People's Daily Online, (2005). Shift of management mechanism vital to banking industry reform UPDATED: 08:40, February 17, 2005, retrieved on 08/05/06 from Zhang, Y., (2005). China must adjust its FDI policies if it wants to retain its global lead in inflows, Foreign Direct Investment, Financial Times Business, April 12, 2005, retrieved at 07/05/06 from http://www.fdimagazine.com/news/fullstory.php/aid/1211/Tips_for_the_top.html Yoost, Dean A., June 20-26,2005,"China's progress towards WTO Compliance", Orange County Business Journal, Vol.28, No.25, December 2005, retrieved at 07/05/06 from < http://www.ocbj.com/>. Read More