Finance In Asia: Pots And Kettles

Finance In Asia: Pots And Kettles

From The Economist Print Edition | 22 May 2008

The credit crisis has cooled Asia's ardour towards Western banks.
But the region stands to gain even more from opening up
than Wall Street does.

Illustration by Satoshi Kambayashi

SHANGHAI— When China's three leading state-run banks finally felt confident enough to list their shares in 2006 and 2007, after years of losses from bad lending practices, the initial public offerings contained two common elements: big Western banks acting first as underwriters and second as strategic investors. What the government most wanted was an endorsement of quality that it felt could come only from the cream of global banking. It was prepared to offer the lucky few the chance to make billions of dollars, in exchange for sharing what it thought was their invaluable risk-management expertise.

The offer of minority stakes was accompanied by a slight crack in the Great Wall that China has built around its highly sensitive securities markets. Last year Credit Suisse, Citigroup and Morgan Stanley all received enough encouragement from regulators to announce agreements with domestic securities firms for some form of tie-up. Meanwhile, China's new sovereign-wealth fund spent $3 billion on a stake in the Blackstone Group, an American buy-out fund, hoping to learn lessons in finance from a master of the craft.

All of this came before the credit crisis sideswiped the big Western financial firms, costing hundreds of billions of dollars in losses, the jobs of senior executives (not to mention those of thousands of more junior employees) and, most important, their reputations for prudent risk management. Optimists in Europe and America say that acknowledging these losses is all part of the healing process. But in parts of Asia there is a chillier interpretation. There you can find the belief that Western banks have failed an important test of soundness and that their regulatory model is not to be trusted either.

As a result, Western bankers say they are greeted more coolly than they were a year ago— not just in China, but in Japan and South Korea too. They point to Seoul's reluctance to endorse HSBC's acquisition of Korea Exchange Bank as one sign of frostiness. In China attitudes are hardening publicly. Credit Suisse, Citi and Morgan Stanley have not yet had their deals approved, and other banks that had hoped to be next now wonder if the approval process has been quietly shelved.

Unlike many developed markets where government decisions are clearly explained, a rejection in China often comes in the maddening form of absolute silence. But strong hints are emerging. A senior Chinese regulator recently described to this newspaper his view of big global investment banks in one unusually graphic word: "shit".

There is particular scepticism about whether large Western banks, or their regulators, truly understand the risks associated with the mountain of derivatives on their balance sheets. Liu Mingkang, chairman of the China Banking Regulatory Commission (and a leading reformer), makes no attempt to conceal his doubts about bank regulation in America— and how flat-footed it was. "After the death, the doctor came," he observes dryly. As a result, he indicates, China is likely to open up to international banks even more slowly than it has already.

Even as Western financial firms have fallen into disrepute, banks in emerging markets are treated as paragons of probity. Jiang Jianqing, chairman of Industrial and Commercial Bank of China, the world's most valuable bank, recently talked down the merits of investment in American bonds and banks. His bank has refused invitations to invest in global firms. Instead it has bought a large part of Standard Bank of South Africa and controlling shares in banks in Macau and Indonesia.

Some of the reaction is an understandable response to genuine failures. China's sovereign-wealth fund has lost plenty of money on its year-old Blackstone stake and on its investment in Morgan Stanley. But rather than viewing this as an education in the way an unrigged market works, or an opportunity to buy more at a lower price, it considers the investments an embarrassment. So far this year, China has not invested in any stricken Western banks; just in time, Citic, China's leading securities firm, slipped out of a billion-dollar investment in Bear Stearns before it fell into the arms of JPMorgan Chase.

In many ways, these are nerve-racking moments for institutions that have put great store by China. The potential spoils are huge. According to Matthew Austen of Oliver Wyman, a consultancy, the Chinese banking and securities market generates $225 billion in revenues; he reckons that Western firms receive no more than 7% of this (and less than 1% if shareholdings in Chinese companies are excluded). The global firms would like to manage funds, raise capital and trade securities, including shares, debt and derivatives. All these activities are still heavily restricted.

They are not the only ones likely to be hurt by rising protectionism, however. Hank Paulson, America's treasury secretary, was not just talking America's book when he said that opening the Chinese financial system is "absolutely necessary" for China's own long-term economic success. It would not only provide greater equilibrium to global capital flows, but would also bring more efficiency to China's industry. Already, manufacturing firms in southern China are struggling to cope with the rising yuan, because there is no currency-futures market for hedging.

Similarly, Chinese firms are forced into inefficient financing arrangements. They can borrow from state-controlled banks at rising rates that may have little to do with their own creditworthiness, let alone what they plan to do with the money. Alternatively, they can join a long, bureaucratic queue to issue shares. Even the largest ones still rely on the state for permission to raise capital: Ping An, the second-largest insurer, recently pulled a vast secondary share offering after what was believed to be a quiet word from the authorities.

A state-driven financial market means state firms tend to do best. Financing for start-ups remains largely informal— loans from friends outside the financial (and tax) system— which stifles entrepreneurship. Worst of all, today's system provides a truly rotten deal for Chinese citizens trying to put away money for retirement, for their children's education, or other personal needs. They are given a bleak choice of subsidising the financial system through deposits yielding less than inflation or speculating on highly volatile shares.

China's financial firms are by no means model institutions either. A banking crisis, which began in the late 1990s and is still not fully resolved, cost $428 billion, according to the World Bank. In addition, billions of dollars were lost by state-controlled securities firms through unfunded "guaranteed" investment products and inept proprietary trading funded by money absconded from client accounts. China has never revealed the full cost of this disaster. Whatever the collective figure, it gives some perspective to the $335 billion or so of write-downs and credit losses thus far from the subprime crisis.

Clearly, Western banks have every reason to regret their losses. That may be one of the reasons they are not defending their methods more vigorously. Even in the West, where there is plenty of talk of regulation, they are keeping a low profile. Having got so far with China, however, bankers will be remiss if they let the misapprehensions fester. Western finance may be prone to cyclical excess, they can argue, but the state-sponsored model is even more so. At least when troubles hit Western banks, the recognition— and the healing— come far quicker.

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Normxxx    
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