Are Chinese Banks Weak?

If one reads Wall Street Journal and Financial Times, likely that person is not going to have any high regards of Chinese banks: slow, bureaucratic, weak control. They are often associated with the high NPL ( nonperforming loan), large overhead, and strange entanglement with government. Some more ideological authors might even state their underlying belief- these Chinese banks are almost all state-owned, and from their Cold War belief experience, it is only natural for these banks to be perpetually weak. In the view of these media and many similarly minded, the only reasons the Chinese banks survive to this day is because of Chinese government’s protection: restriction of charter issuance and business permit, forced Chinese venture partner etc. Once protections are removed, these banks will fail to their international competitors, who will win the control of capital market in the second largest economy in the world. From what being revealed in the Sino-US trade negotiation, the aforementioned belief in the inherent weakness of Chinese banks seems to be underlying the American request to open Chinese financial market.

As a risk manager educated in the American, I would not argue that Chinese banks are fully efficient. Quite contrary, not only do I believe it has inefficiencies, but I have been personally impaired by its inefficiencies. Yet, I have a firm belief that those banks are very adaptive to the political, cultural, and economic realities of China- it is not weak, just have much room for improvement. Under the leadership of managers and regulator, the banks have largely been improving its capacities as Chinese economy and political mandate evolves over the years.

James McGregor has a brilliant account of such adaptability of China International Capital Corporation (CICC) in the second chapter of his great book, One Billion Customers. CICC is the first true Chinese investment bank by the least of global standard, and it was a joint venture between China Construction Bank, a major state-owned bank, and Morgan Stanley. The mandate on the CCB’s side was to reform China’s financial system and later other major state-own enterprises with the know-how and connection of Morgan Stanley. Like all money-driven banks, Morgan Stanley’s intention was to dominate the future Chinese financial market, which in its view to be a gigantic profit center in the future. After describing various internal struggles, McGregor concluded in the end Morgan Stanley failed this objective, and I can verify that with my own experience, although it did make large profit from its venture investment as well as the future Chinese deals channeled through CICC. One can imagine that experience like these are the forces behind which canceling the foreign ownership restriction on banks in the trade deal derives.

When HR director assigned by CCB, Fang Fenglei, showed up in CICC, the crew from Morgan Stanley thought Fang was just some ignorant peasant who knew nothing about finance, and who would remain ignorant. Little did they know that Fang and his people studied the American finance and its players very effectively. The first major deal , the IPO of China Telecom, was actually originated by Fang, as a way to modernize then capital-craving Chinese state telecommunication industry. When he naturally took the deal to CICC's stockholder, Morgan Stanley, it was casted away, and Fang was viewed by the Morgan bankers as "dumbshit". Fang then went to Goldman Sachs, with the assistance of whom the 4 billion IPO was made real. Morgan Stanley lost big, for it essentially lack the skill and knowledge to weigh correctly the value of Chinese business and the policy context, and it did not trust its partner's ability to do those.

Eventually, both Morgan Stanley and CCB view Morgan Stanley unnecessary in CICC, and Morgan was bought out. Years later, Fang Fenglei made the following very revealing comment to McGregor:

"Morgan Stanley never did understand me. This was a learning experience for them. They didn't expect the Chinese to learn so fast. They expected it to take ten years for CICC to grow up". And at the moment of this writing, I and investment banking professionals still view CICC as the giant in Chinese finance.

Ever since restriction on the foreign ownership of securities companies being lifted, we have seen a row of non-Chinese controlled securities companies formed: Nomura Orient International Securities, and Morgan Stanley Securities (China), etc. Nomura stated that 99% of its hires has been Chinese, and did not see Morgan Stanley to repeat its past mistakes twice by underestimating Chinese. Chinese did not open its market this time believing it will lose, and apparently those banks know it.

As a practicing risk manager, I have observed how regulator and industry working to improve the industry's risk management capability. Many rules were rolled out from 2014, and domestic and foreign hires were made to accelerate the effort. Money were directed into FinTech and internal IT systems. I do not believe any vision of absolute domination would become real in China now. Personally, I see this might be the beginning of the going abroad effort of Chinese banks, and that of how the rest of the world truly understand China. There might be a day when I would be able to see deals for foreign companies issuing bond or stock in Shanghai Stock Exchange in my computer. We will just have to wait and see.