Citigroup more equal than others
By Sue Anne Tay and Mark Cabana
WASHINGTON - A consortium led by Citigroup has offered an unprecedented bid of
US$2.93 billion for 85% of
Guangdong Development Bank (GDB). On
Thursday, media reports said the deal had been approved by Chinese regulators
and the Guangdong provincial government. If successfully consummated, the deal
would give Citigroup a stake of 45% in GDB, the Carlyle Group 9%, and the
remainder distributed among a few Chinese state-owned companies.
However, trailing the bid are burning questions that remain unanswered because
of corporate secrecy and the frequent
opacity of Chinese policymaking. How is it that Citigroup was able to negotiate
such a deal, which apparently breached existing limits on foreign buy-ins to
Chinese financial institutions? What are the factors affecting a favorable
outcome? Does the sale mean the government will raise the caps on foreign
investment in Chinese banks, or is the Citigroup-GDB deal an exception? The
apparent delay by the State Council over its decision is indicative of the
weighty impact a revision of policy could have on the landscape of the Chinese
banking sector.
Currently, overall foreign investment in Chinese banks is restricted to 25%, of
which individual investors are allowed up to 19.9%. China is bound by World
Trade Organization stipulations to open its banking market fully by the end of
this year, subjecting the four state banks, joint-stock banks and city
commercial banks to foreign competition. Foreign investors have been scrambling
to establish themselves in anticipation of this event.
Citigroup has been aggressively playing catch-up with its counterparts,
including HSBC Holdings, which has the largest foreign banking presence in
mainland China. It abruptly pulled out of the bidding process for China
Construction Bank last year, and has not had any major partnerships with the
state banks. Led by chief executive officer Charles Prince and former US
Treasury secretary Robert Rubin, Citigroup has lobbied diligently to expand its
presence in China and the bid for GDB, Guangdong's second-largest lender with
more than 500 branches, is part of that strategy.
Citigroup has offered to pay three times the book value for GDB, while securing
protection against more bad loans after the transaction. It even surrendered
its status as the largest shareholder in
Shanghai Pudong Development Bank (SPDB),
China's second publicly traded lender, to be allowed to invest in GDB. Around
the time that Citigroup indicated an interest in increasing its stake in SPDB,
six of Pudong's shareholders announced they would sell their entire stake to
Shanghai International, a state-owned investment company, which would make it
the top investor instead of Citigroup. Some observers have speculated that this
was a move, possibly by Beijing, to prevent Citigroup from becoming too
dominant an investor in several Chinese banks.
Although reports have indicated a government preference for Citigroup over its
competitor, French bank Societe Generale, because of its larger bid, regulators
have good reasons for not wanting the deal to go through. Chinese banks and
regulators have come under fire for granting too much influence to foreign
investors and selling stakes too cheaply, especially after the Bank of America
share purchase from Chinese Construction Bank in 2005. The major concern for
regulators if the Citigroup-GDB deal is approved is that foreign investors with
existing stakes in Chinese banks will begin negotiating to increase their
stakes. HSBC's purchase of a 19.9% stake in the Bank of Communications was a
high-profile event, given that the latter was the country's fifth-largest
lender, and analysts have suggested they will be one of the first to
renegotiate. Lately, in general, Beijing has demonstrated great concern over
the impact the rapid pace of financial reform has had on its overall control of
the banking sector.
Nonetheless, there are equally strong reasons to believe Beijing will support
this particular deal. GDB's affairs as a lending firm are thought to be among
the worst for joint-stock banks. Guangzhou provincial authorities had to step
in early last month after GDB's failure to offload more than $4.2 billion in
non-performing loans (NPLs) to state-owned asset managers. As a result,
Guangdong Yuecai Investment Holdings, an entity controlled by the Guangzhou
government, relieved the bank of its problem loans just as a newly amended
Chinese law would not allow the GDB to use statutory capital reserves to
compensate for its historical losses.
The recent sale of loans to Yuecai was part of large-scale financial reforms
taking place in China through which GDB is trying to reduce its NPL ratio from
15% to below 5%. After pumping more than $45 billion to reduce heavily the NPL
ratios of the Bank of China and China Construction Bank, Beijing has other
onerously debt-laden state banks to worry about, including the Agricultural
Bank of China and its policy banks. It seems unlikely that Beijing will set an
unhealthy precedent by bailing out non-state banks.
However, Beijing is acutely aware of the poor performance of smaller banks.
Officials believe that next year when the banking sector is opened up to
foreign competition, it is unlikely they will be able to compete aggressively,
much less survive. Many of the smaller banks are in desperate need of foreign
expertise and capital injection. The central and local authorities are unable
to provide the former, and are hesitant to provide the latter.
Seen in this light, for Beijing, it would arguably make sense to concede the
weaker smaller banks to foreign investors rather than keep them afloat and risk
a banking crisis should the banks falter under intense competition. Xinhua
Financial Network quoted an industry source who said, "Once China opens up its
financial market there will be no place for [Guangdong Development Bank] ...
Selling the bank is really the only thing the government can do, plus it will
allow them to save face." Back in 1998, the State Council refused a bailout
package for
Hainan Development Bank and forced the island province's
largest bank to close down. The move shocked the banking industry, but
delivered a stern warning to other poorly performing banks.
As for provincial and local authorities, whose revenues and budgets are
stretched thin by other pressing expenditures, foreign investors with deep
pockets and the necessary expertise are just what the doctor ordered. More
important, the local government is able to recoup cash quickly from bank sales.
Since Guangdong as a province has always been more willing to test regulatory
boundaries given its historical position as a dynamic and open economy, boldly
establishing this precedent of allowing an 85% bid should not be too
surprising. In the case of a struggling bank like GDB, one could speculate that
Guangdong authorities must have pressured Beijing to consider the benefits of a
sale and later received a positive signal from the central government to take
large bids for majority foreign ownership.
Assuming that Citigroup gets the nod, the implications of the reform of GDB
will be far-reaching. If the consortium gets the 85% it is seeking, it could
usher in a new stage of foreign-investor involvement in Chinese banks. The GDB
case could establish a new precedent in which foreign investors partnering with
or buying shares of Chinese commercial or joint-stock banks would no longer be
limited by the old China Banking Regulatory Commission (CBRC) rules, which
restrict overall foreign ownership to 25%, of which individual investors are
allowed 19.9%. If this regulation were relaxed, foreign investors could freely
bid for stakes of majority-ownership control and have an active hand in the
redesign of the Chinese banking sector.
However, all of the above is contingent on whether the State Council and
banking regulators will officially change their policy. Beijing has made it
explicitly clear that state banks will remain under government control. From
Beijing's point of view, control of state banks remains vital, largely for
macroeconomic-control purposes. Since the government directly controls the
price of capital by repressing interest rates and absorbing bank losses, the
onus is on the government to monitor and control state banks' balance sheets
directly. As China is one of the most bank-dominated of all financial systems,
the health of its banking system remains a critical determinant of the
country's long-term economic performance. Hence, if there is any kind of major
easing of foreign-ownership restrictions, it will most probably apply to
non-state banks, ie provincial and regional joint-stock banks and city
commercial banks.
In the end, the sale of the majority stake in GDB may only be a test case by
the government to review foreign majority control. That said, one can imagine
different outcomes. The State Council may agree overall on the sale but
pressure Citigroup to lower its 85% bid. Societe Generale may pressure the
State Council to allow it to increase its bid for more ownership stakes,
protracting the decision-making process.
Regulating in China is cautious, slow and never static. Pressured by the pace
of rapid economic modernization, the government has always favored
experimentation of provisional policies as a way of guaranteeing political and
social stability before implementation. The government took this approach when
allowing strategic minority partnerships from foreign investors in commercial
banks, beginning in 2001 with a deal between HSBC and the Bank of Shanghai. It
later led to a proliferation of similar deals between multinational banks and
Chinese banks in 2004 and 2005. More than $16 billion of foreign investment has
poured into China's banking market so far.
Ultimately, the GDB deal could spell the end of certain types of regional
policy-lending and instead fuel greater domestic Chinese entrepreneurialism.
This entrepreneurialism, funded by capital from Western banks, would also be
held to Western business standards of accountability of transparency. Hence the
success of Citigroup's reforms with GDB will play a pivotal factor in the
further opening of the Chinese banking sector, but the precedent it will likely
set for the shape and direction of the Chinese financial sector will be just as
significant.
Sue Anne Tay is a researcher with Hills & Stern in Washington, DC,
focusing on Chinese politics, finance and economics. Mark Cabana is a
master's candidate at the Paul H Nitze School of Advanced International Studies
in Washington, DC.
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