Redux on Chinese Banking Fraud, Western Naivety & Greed
In our serialization of Chinese Banking Fraud, Western Naivety and Greed Parts One through Five, we mused about the global economic systemic risk that China's fraudulent banking system presents to naive and greedy western bankers. We present some excerpts from an excellent follow up by the Economist.
It is a staggering thought: communist China now has a bank more valuable than Barclays, American Express or Deutsche Bank, financial institutions at the heart of Western capitalism. At more than $66 billion following its initial public offering in Hong Kong on October 27th, China Construction Bank (CCB) boasts a larger market capitalisation than any of these three.
This is quite a transformation for a bank that was technically insolvent less than two years ago and which, despite a hastily applied commercial gloss, is still a government agency, plagued by bad debts and corruption so pervasive that just five months ago its then chairman was arrested for bribery.
Given China's failure to develop healthy stock and bond markets, bank assets have ballooned to almost 30 trillion yuan ($3.7 trillion) in 2004, or 210% of gross domestic product (GDP). That is the highest of any big economy, says Nicholas Lardy at the Institute for International Economics in Washington, DC: India is at 170%, Brazil 160% and Mexico 100%.
Sadly the banks have been disastrous middlemen, lending on government instruction without a view to their profits. They have poured money into wasteful infrastructure projects and kept broken state-owned enterprises (SOEs) afloat.
Not only has this created huge non-performing loans for the banks themselves, but also because China's investment is so unproductive, it has to shovel ever more money into its economy to maintain its current growth.
Already, China needs almost $5 of fresh capital to generate $1 of incremental output, a far worse ratio than Western countries and even India. In the first quarter of 2005, fixed-asset investment reached an incredible 54% of GDP, 10 percentage points above the household savings rate. No country can sustainably invest more than it saves and China must raise the productivity of its economy.
China's banks went on a lending binge between 2003 and 2004, partly to “grow out of” their bad loan problem. Many loans will go sour, as Beijing has moved to curb overheated sectors such as steel, cars and property. If economic growth slows, a new wave of bad loans will hit.
A new surge in bad debts would be bad enough if Chinese banks had the earnings power to absorb them, but they do not. Behind the headline numbers, their basic profitability is very poor. The return on assets (ROA) generated by China's banks, at less than 0.5% last year, is the worst in Asia. More crucially, the Chinese banking sector's 11% ROE reflects inadequate levels of equity (in other words, capital) rather than high returns. The industry has a capital-adequacy ratio of barely 8%.
Two sobering conclusions follow. The first is that even a tiny deterioration in business conditions that either reduces margins or increases bad loans would wipe out earnings at China's banks. The second is that even if the economy remains good, the banks cannot generate enough internal capital to support their current levels of loan growth.
The lure of China's high growth and huge population has triggered an astonishing stampede, attracting some $18 billion in foreign direct investment in China's banks in one year. The first big deal was the $1.7 billion HSBC paid for a 19.9% stake in Bank of Communications (BoCom), the fifth-largest lender. Then came CCB. Since then, a consortium led by the Royal Bank of Scotland has put $3.1 billion into BOC, Temasek another $3.1 billion and Switzerland's UBS $500m, while Goldman Sachs and Germany's Allianz are investing in ICBC.
CCB's listing, which raised $8 billion from foreign investors for 12% of its shares, is the largest global flotation for four years, China's biggest and the biggest ever for a bank. CCB garnered another $4 billion ahead of its float by selling stakes of 9% to Bank of America and 5.1% to Temasek, Singapore's investment agency.
By rushing poorly reformed banks to market and sucking in a bit of money and know-how (not to mention greater scrutiny) from foreign investors, it hopes to improve them sufficiently and sufficiently rapidly before the economy runs into a headwind. The size of that gamble should not be underestimated.
It is a staggering thought: communist China now has a bank more valuable than Barclays, American Express or Deutsche Bank, financial institutions at the heart of Western capitalism. At more than $66 billion following its initial public offering in Hong Kong on October 27th, China Construction Bank (CCB) boasts a larger market capitalisation than any of these three.
This is quite a transformation for a bank that was technically insolvent less than two years ago and which, despite a hastily applied commercial gloss, is still a government agency, plagued by bad debts and corruption so pervasive that just five months ago its then chairman was arrested for bribery.
Given China's failure to develop healthy stock and bond markets, bank assets have ballooned to almost 30 trillion yuan ($3.7 trillion) in 2004, or 210% of gross domestic product (GDP). That is the highest of any big economy, says Nicholas Lardy at the Institute for International Economics in Washington, DC: India is at 170%, Brazil 160% and Mexico 100%.
Sadly the banks have been disastrous middlemen, lending on government instruction without a view to their profits. They have poured money into wasteful infrastructure projects and kept broken state-owned enterprises (SOEs) afloat.
Not only has this created huge non-performing loans for the banks themselves, but also because China's investment is so unproductive, it has to shovel ever more money into its economy to maintain its current growth.
Already, China needs almost $5 of fresh capital to generate $1 of incremental output, a far worse ratio than Western countries and even India. In the first quarter of 2005, fixed-asset investment reached an incredible 54% of GDP, 10 percentage points above the household savings rate. No country can sustainably invest more than it saves and China must raise the productivity of its economy.
China's banks went on a lending binge between 2003 and 2004, partly to “grow out of” their bad loan problem. Many loans will go sour, as Beijing has moved to curb overheated sectors such as steel, cars and property. If economic growth slows, a new wave of bad loans will hit.
A new surge in bad debts would be bad enough if Chinese banks had the earnings power to absorb them, but they do not. Behind the headline numbers, their basic profitability is very poor. The return on assets (ROA) generated by China's banks, at less than 0.5% last year, is the worst in Asia. More crucially, the Chinese banking sector's 11% ROE reflects inadequate levels of equity (in other words, capital) rather than high returns. The industry has a capital-adequacy ratio of barely 8%.
Two sobering conclusions follow. The first is that even a tiny deterioration in business conditions that either reduces margins or increases bad loans would wipe out earnings at China's banks. The second is that even if the economy remains good, the banks cannot generate enough internal capital to support their current levels of loan growth.
The lure of China's high growth and huge population has triggered an astonishing stampede, attracting some $18 billion in foreign direct investment in China's banks in one year. The first big deal was the $1.7 billion HSBC paid for a 19.9% stake in Bank of Communications (BoCom), the fifth-largest lender. Then came CCB. Since then, a consortium led by the Royal Bank of Scotland has put $3.1 billion into BOC, Temasek another $3.1 billion and Switzerland's UBS $500m, while Goldman Sachs and Germany's Allianz are investing in ICBC.
CCB's listing, which raised $8 billion from foreign investors for 12% of its shares, is the largest global flotation for four years, China's biggest and the biggest ever for a bank. CCB garnered another $4 billion ahead of its float by selling stakes of 9% to Bank of America and 5.1% to Temasek, Singapore's investment agency.
By rushing poorly reformed banks to market and sucking in a bit of money and know-how (not to mention greater scrutiny) from foreign investors, it hopes to improve them sufficiently and sufficiently rapidly before the economy runs into a headwind. The size of that gamble should not be underestimated.
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