Finance in Asia
Pots and kettles
May 15th 2008
http://www.economist.com/finance/displaystory.cfm?story_id=11376444
SHANGHAI
From The Economist print edition
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 Sato**** Kambaya****
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 im****tant, 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 im****tant 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 in 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: "****".
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 op****tunity 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 entrepreneur****p.
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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