By November 2005, 18 foreign institutions had invested in 16 Chinese banks, with investment volume amounting to about $13bn. Western institutions such as Royal Bank of Scotland and Bank of America have paid $3.1bn and $2.5bn respectively for stakes of about 10% in big Chinese banks. While some have suggested they may have paid too much, others take a more positive long-term perspective and see the huge potential in the entire Chinese market, especially in the small and medium-sized enterprise (SME) and retail sectors.

The potential in these relatively new sectors is a strong cause for optimism, and while there are obvious concerns over credit quality in such virgin territory, the size of the virtually untapped consumer sector in a country of 1.2 billion people is breathtaking. Bank of China (BoC) forecasts retail deposits in China to grow overall by more than 70% in the three years to 2008 to reach Rmb22.200bn ($2747bn).

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In what McKinsey forecasts will be the second largest banking system in the world by 2014, profound changes have taken place in the past two years. Bank of Communications (BoCom) and China Construction Bank (CCB) have both successfully completed their listings in Hong Kong, raising $1.89bn and a record $9.2bn respectively. This follows the government’s $45bn capital injection into BoCom and CCB in 2003 and $15bn into Industrial and Commercial Bank of China (ICBC) last April.

Although analysts such as Joe Studwell, editor of China Economic Quarterly, criticise China’s reforms, lack of bankruptcy infrastructure and ability to price capital, investors have taken to the two bank initial public offerings (IPOs) in 2005. Kevin Watts, chairman of Merrill Lynch International, estimates that the four major bank IPOs forecast for the next year or so could raise up to $25bn. These are BoC ($5-$8bn), ICBC ($5-$10bn), Agricultural Bank of China ($5bn) and China Merchants Bank ($1.5bn); all are set for 2006, except AgBank (2007/08).

The China Banking Regulatory Commission’s efforts to strengthen the banking sector in the past three years have brought significant results. There is still a long way to go; IPOs, the retail revolution and improved profitability are yet to become a reality or spread through the banking sector. But a credible new framework is in place and banks are in the process of a genuine restructuring with foreign investors acting as catalysts.

Stephen Timewell