US, WASHINGTON (ORDO NEWS) — American bankers are brave bosses. From his spacious office in Manhattan, the boss of one of the country’s largest banks suggested at the beginning of February that he had few serious rivals – and all of them were located within one to two quarters. “American banks continue to increase their stakes in European banks,” he said. Asia is almost not worth mentioning. “Chinese institutions as a whole have proven their inability to expand globally. When they buy sports cars and large hotels, they don’t feel any strength in it, ”he added. A few days later, Morgan Stanley, the sixth-largest US bank, announced the acquisition of E-Trade, a $ 13 billion broker, was the largest Wall Street bank acquisition since 2008.
A few weeks later, China began to export another threat. When investor instability caused by the coronavirus prevailed, the Dow Jones index, reflecting the position of the largest US lenders, collapsed by 50%, while during 2019 it added one third. The collapse of the market did not destroy these lenders. But this is an event of this kind that can lead top-level executives to self-isolation – and accelerate the spread of Chinese banks in emerging markets, which does not attract special attention. In addition, this country is opening its own market and hopes to receive advice from new players on its home site during this process.
Chinese banks are already huge in size. Their total assets today surpass those of American and European banks. They also provide cross-border loans, which are bread and butter for international banks. Since 2016, the amount of loans they provide abroad has increased annually by 11%. Even more surprising for the uninitiated is the fact that they are strengthening their influence in the complex world of capital markets. Last year, Chinese banks received income from investment banking, which is three times higher than the income of all Asian banks, excluding Japanese. Their total share soared from 1% in 2000 to 14%.
Balance sheet strength
On the eve of the collapse of Lehman Brothers in 2008, European banks were kings in providing cross-border loans. They accounted for 71% of the total flow, which increased from $ 10 trillion in 2000 to $ 35 trillion in 2008. However, the reduction in the volume of subprime loans (subprime), which began the field of the eurozone crisis, forced them to leave their positions. Since regulators demanded that global banks have more assets on a rainy day, other lenders chose to increase capitalization or reduce revenues. However, the conditions prevailing in Europe meant that the choice of European banks was limited, and they had no choice but to make changes to their balance sheets. Banks have reduced their foreign assets. Branches remote from the center were sold or closed.
Events of a cyclical nature are likely to put them in an even more difficult position. It is not easy for banks to grow faster than the economy of the country in which they are located. Europe has seen weak growth in the 2010s. The crisis caused by coronavirus will make 2020 even weaker in terms of performance. Interest rates, which have been negative in the region for several quarters, are breaking new ground. The income of European banks from fixed capital (rote) fell to 6.6% last year (investors believe that the usual figure is 10%). The largest US banks, supported by positive ratings and a peppy state of the economy, showed double-digit rote rates in 2019.
In addition, structural factors will create obstacles to Europe. American lenders draw strength from their large and single market. They also have the opportunity to reduce risks by restructuring loans and directing them to the country’s large capital market. The European Union does not have any of these opportunities. Conflicts arising between its members impede the implementation of plans to create a banking union. Cross-border mergers could give the largest European banks a larger scale, but such options run into political difficulties, emphasizes Irene Finel-Honigman (Irene Finel-Honigman) from Columbia University. At the same time, plans aimed at merging capital markets continue to be incomplete (the probability of their completion decreased as a result of Brexit.
The most important question is where exactly are European banks located within the existing financial system. For all their significance in the cross-border area, they are mainly intermediaries transferring dollars from New York to other parts of the world. Outside Europe, most of the loans they issue in dollars. Some are long-term loans and cannot be withdrawn. However, they do not have a natural source of dollars, so many finance themselves through short-term borrowing from money-market funds. This makes them hostages of not the prettiest players. Many of them thoroughly staggered in 2012, when American funds, which feared default on the debts of some European countries, deleted European customers from their registers.
Asian rivals fill part of the gap. As Japan is stagnant, its megabanks are actively looking for opportunities to make a profit. Currently, they account for 16% of cross-border loans, which is two times higher than their share that existed before 2008. However, their offensive operation looks rather fragile – they invested heavily in American securities. The emerging “super-regions” of Southeast Asia seem stronger. They didn’t take rash steps in the 2000s, so they didn’t have a hangover, says Edmund Lin of Bain, a consulting company. They upgraded their technical capabilities. Impudent economies give them some extra energy. Their total assets in this region have increased five-fold since 2002.
Many might think that China is not on this list. In 2008, China by a large margin took third place, with $ 40 trillion of assets at its disposal, and today it is leading both in the eurozone and in America. The list of 30 “global systemically important banks”, compiled by the Financial Stability Board, a controlling company, today includes the entire Chinese Big Four: Bank of China, Industrial and Commercial Bank of China , China Construction Bank and Agricultural Bank of China. And in 2012, only one of them appeared on this list. However, skeptics claim that Chinese banks are sitting on bad loans at home, and, in addition, they are controlled by the state, which is their owner.
Chinese banks, in fact, have long been absorbed in their domestic market, where their share is 98%. However, their first attempts to enter the international arena failed. Many hoped to get advice on how to get into the global league, and lured American stars like Goldman Sachs and Bank of America to do this, making them “strategic shareholders” with Hong Kong initial public offerings (IPOs). However, these positions were liquidated after the crisis in the field of subprime loans. In addition, Chinese banks realized that they could make more money at home. Therefore, plans for internationalization have been reduced.
One Belt, One Way Initiative by Chairman Xi Jinping Is an Important Catalyst
However, in recent years they have begun cautious advancement. Banks followed their corporate clients, who also wanted to go beyond their already saturated domestic market. They began to finance trade, took local deposits from local affiliates, and served their usual needs related to cash flow management or foreign exchange operations. They also funded China-built infrastructure in emerging economies. Thanks to the huge balance sheets, as well as the insider knowledge of the business history of the contractors, they often defeated their foreign competitors, emphasizes John Ott of Bain.
Their tentacles spread further. Banks from the Big Four today have a total of 618 branches outside mainland China – this is a conservative option of intermediary services, as commercial banks do not need a large number of branches. Since 2015, their share in global cross-border lending has increased from 5% to 7%. Foreign assets today make up 9% of their capital. Their impact is different from that of their Western counterparts – Chinese banks provide two-thirds of all cross-border lending in emerging markets. According to Hansen Varawalla of Absa’s South African bank, their presence in Africa is constantly increasing.
Chairman Xi Jinping’s One Belt, One Way Initiative is a powerful catalyst. According to RWR consulting company, since 2013, Chinese banks have provided loans worth $ 600 billion for various projects as part of the One Belt, One Way Initiative. Unofficial amounts may be even larger. According to the Bank of China, between 2013 and mid-2019 (other data have not been disclosed yet), he alone provided loans of $ 140 billion for 600 projects. Chinese lenders are expanding their activities along the line of this route – today they have 76 branches in countries participating in the One Belt, One Way initiative, and many of them were opened after 2018.
Commercial banks operate together with “political” banks such as the China Development Bank and the Export-Import Bank. They mainly seek to finance low-profit projects such as ports and railways, while banks from the Big Four often serve more profitable related transactions, including shopping centers and real estate. Apparently, significant lending is carried out through non-bank branches of Chinese banks (no one knows what amounts are involved in this case). Many government departments also provide “hidden” loans. An article written in 2019 by German economists says international agencies are unable to track nearly 50% of Chinese government loans.
The medium-term effects of the coronavirus are likely to lead to a further increase in activity of the Chinese Big Four. Global Chinese firms — they account for approximately 24% of the Fortune 500 and are second only to American firms — can focus on Asia, where they have a natural advantage. These banks also want to diversify their activities and go beyond the domestic market, where the number of bad loans is growing. According to Jamie Dimon of JP Morgan Chase, the Chinese, unlike Japanese banks that were actively buying expensive real estate in the 1980s, “have more strategic reasons to win “.
Perhaps they are not fighting the battle that they need. After the financial crisis, a growing number of people and firms began to finance themselves by issuing securities on the capital market, while avoiding traditional lenders and favoring such “shadow” banks as pension funds and insurance companies. Since 2008, these organizations have been increasing assets twice as fast as conventional banks. Today, they account for almost half of the global financial system – approximately $ 184 trillion. Securities issuers are still dependent on banks, but today they give preference to those structures that earn their living mostly from fees (we are talking about consultations in the field of insurance or providing guarantees), and not at the expense of interest on loans issued from their balance sheets.
James Gorman, head of Morgan Stanley Bank, believes that American banks have a huge advantage. They receive 60% of their income at home, in the country where the largest and most profitable capital market is located (today it accounts for 45% of global income from investment activity, whereas in 2009 this figure was 36%). All five banks with the largest incomes are American. Some European banks, including BNP Paribas, have intercepted customers and firms from their aging colleagues, said Jean Lemierre, chairman of the board. But even in their own backyard, the best places belong to their transatlantic rivals.
To achieve excellence in investment banking, you need to have a global network of investors and companies, however, while Chinese banks do not have such a network. In addition, many Chinese banks lack independence. In 2015, the state was forced to rely on companies issuing securities to save the stock market. Attempts to establish interaction with foreigners were also unsuccessful. The tough hierarchy of Chinese state-owned firms doesn’t mix well with the freedom-loving spirit of Wall Street, bankers say. Many employees left CSLA, a respected company in Hong Kong, and this happened after it was acquired by the Chinese broker Citic.
However, Chinese banks are making stealthy leaps. In an effort to diversify funding and build up firepower for acquisitions abroad, local companies are rapidly accumulating dollar debts. Insurance volumes reached 310 billion last year, while in 2016 this figure was at $ 71 billion. In this case, Chinese banks act as leaders of a group of investors or as insurers, which allows them to have closer ties with local titans, as well as establish contacts with foreign investors. Some also use outsourcing services and attract Western banks if they themselves do not possess the necessary skills in areas such as sales or electronic commerce, and then offer these services under their own brand.
They are also progressing in a prestigious stock business. In 2019, Citic bypassed Goldman Sachs and became the first local bank in the list of leading banks in Asia. Chinese firms are very helpful in moving up their domestic market – local companies have raised half a trillion dollars over the past ten years as a result of initial public offerings (Refinitiv, a data-collection and analysis company, cites this). They are strengthening their position in Hong Kong, which became the largest stock center in 2019. Chinese sites may not be able to replace Wall Street competitors in the near future, according to Ivy Wong of Baker McKenzie Law Firm. However, they are able to exert a certain influence. Chinese issuers run into resistance in America, but they can win over Hong Kong investors without any political scandals. The Stock Connect platform, launched in June 2019 and allowing companies listed on the Shanghai Stock Exchange to raise equity in London, can also help.
Elsewhere in Asia, China’s progress is not so noticeable. However, it does not matter much. Last year, due to protests in Hong Kong, there was talk of an outflow of capital to Singapore, a rival regional center. However, few wanted to cause anger among Chinese officials, so only a small number of firms decided to transfer their employees, says the head of an American bank in Hong Kong. The middle kingdom consolidates its status as a gravitational center for this region – income from investment banking in China has increased to $ 12 billion from $ 550 million in 2000.
This kind of bright prospects attract investors from other regions, and Beijing opens the door. Last year, regulators cleared the way for foreigners to completely absorb local banks. Then outsiders were allowed to control asset management firms, as well as pension fund managers and brokers. In April of this year, restrictions on foreign ownership were lifted from insurance companies. Elite financial managers are teaming up with local employees or creating branches in the hope of getting a piece of the Chinese financial services market, which amounts to $ 45 trillion. “Every week, some of the top 15 players knock on our door,” says Greg Gibb of Lufax, a Chinese financial asset management firm.
To gain a foothold on this soil will not be easy. People already working there 25 years ago began to create branch networks and establish contacts throughout the vast territory of China. Often they use investment banking in order to offer additional services to local companies, so they can gain an advantage over outsiders at prices. Attempts to liberalize are not particularly promising – in 2007, when Beijing first allowed foreign banks to work in the country, it hindered competition by forcing them to work in rather strange places. Today their market share is 1.5%.
New players say it would be crazy not to try. However, many fear that they will be crushed before they become big enough to make money. “We do not expect short-term commercial success,” says the head of an American firm. Another financial manager associated with a local company believes that the flow of information moves in only one direction. Existing managers can hope for more efficient markets and a certain transfer of knowledge. Many have established joint ventures with several foreign firms to cover all sites. “China is opening up because it is self-confident,” says a former senior official at the Bank of China. He compares the country’s financial industry with the automotive sector, in which China also lifted its ownership restrictions last year. One example of this kind of merger speaks of possible dangers for foreign firms. In 2007, Geely, not the best-known Chinese company, entered into a partnership with LTI (London Taxis International), a manufacturer of London black cabs. In 2013, she already completely bought this business. Today, the Geely company is already filling Britain with electric taxis, and in terms of the “green” indicator, it is able to get ahead of the Uber company.
Contact us: [email protected]