Asian Banking

UNIVERSITY OF MUMBAI

ACADEMIC YEAR 2006-2007

SHRI CHINAI COLLEGE OF COMMERCE AND ECONOMICS ANDHERI (EAST), MUMBAI: 400091

PROJECT REPORT ON

ASIAN BANKS (Emerging Developments in Growth, Structure and Efficiency)

PROJECT GUIDE

PROF.EKNATH BIRARI

SUBMITTED BY

SAVIO DCOSTA T.Y.B.COM (BANKING AND INSURANCE) SEMESTER-V

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Asian Banking

Acknowledgement

It gives me an enormous pleasure in submitting the project of

Asian Banking-Emerging Developments in Growth, Structure and

Efficiency.

I would like to take this opportunity to sincerely thank Prof.

Eknath Birari my project guide, for extending their support,

guidance and co-operation which helped me in completing this

project successfully. I would also like to thank Prof. Nishikant Jha

for their kindly support and encouragement throughout my project

to complete the project in time.

I am also thankful to our college as well as our college

librarian for availing me the required books on Asian Banking who

have made my efforts into success by giving me all the possible

help and support in my project. I am also thankful to Sachin sir for

availing me the computer lab whenever needed regarding my

project.

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Asian Banking

DECLARATION

I, SAVIO DCOSTA student Of T.Y.B.Com (Banking &

Insurance) Shri Chinai College of Commerce &

Economics (semester V th ) hereby declare that I have

completed this project on ASIAN BANKS in the

academic year 2006-2007 .The information submitted

is true and original to the best of my knowledge.

Signature of the student(SAVIO DCOSTA)

CERTIFICATE

I, Prof.EKNATH BIRARI hereby certify that SAVIO

DOSTA student of T.Y.B.Com (Banking & Insurance)

Shri Chinai College of Commerce & Economics

(Semester V th ) has completed project ASIAN BANKS in

the academic year 2006-2007.The information

submitted is true and original to the best of my

knowledge.

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Asian Banking

Signature of Project guide

Executive Summary

“Asian Banks have a good track of services and well developed facilities which has lead to tremendous growth, structure and efficiency of the banks through their performance and their potential to handle the risks”.

Objective

My prime objective was to know about the dynamics of Asian banking sectors and the emerging developments in growth, structure and the efficiency of the Asian banks.

Sub-Objective

To learn the Asian banking more particularly from the point of view of one of the Indian bank operating in Asia Like ICICI which got the award for the “Best Managed Bank in Asia”, in a poll by Euro money for their excellence performance.

Secondary Data:

Books – Global Banking – Asia-Pacific Region - By Kasturi Rao

–Asian Banking Crisis - By ICFAI UNIVERSITY

Journals – Reports on the banks performance in Asia (ICICI Bank)

ICICI – Articles

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Asian Banking

Findings

Studying the Asian Banking and more particularly its growth, structure and efficiency one can say that the Asian banks are also emerging as strong banks in all their prospects in order to gain international standard through which they can give very tough competition to the international banks.

Learning

Asian banks are on growing phase and they are trying to develop their banking system so well to operate their functions globally also. Few years from now these banks are going to operate all over the world through their well developed technology and efficiency in their banking functions.

Index

Sr. No. Topics Page No.

SESSION-I

1 Asian Banking - Part I 1Introduction 2

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Asian Banking

Domestic Credit provided by Banking in Asia 4

Non Performing to Total Loans Banks in Asia 10

Emerging Issues in Asian Banks 12

Growth of Personal Banking in Asia 13

SESSION-II

2 Asian Banking - Part II 15Growth of Online Banking in Asia 16

Consolidation 17

The Pace of Bank Consolidation in Asia 18

Issues and Imperatives 18

Steps taken to Restrict Banking Crisis 21

SESSION-III

3 East Asian Banking Restructuring and

Regulation Industrial Policy

23

Introduction 24

Facts/Changes in East Asian banking 27

History of banking in Japan 29

History of banking in Korea 34

Asian Financial Crisis in 1997 39

Comparison between Japan and Korea 41

SESSION-IV

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4 Chinese Banks: On the Reforms Path 43Introduction 43

Banking Reforms 44

Interest Rate Policy 45

Behest Lending 46

Non-performing loans 47

Monetary policies of the Central Bank 49

SESSION-V

5 Bank Of China 52

Introduction 53

A Watershed Year, 2001 53

Treasury Operations 55

Investment Banking 56

Risk Management 57

Corporate Governance 57

The Business Strategy and Performance 58

6 Case Study 59

7 Conclusion 66

8 Annexure 68

9 List of acronyms 69

10 Bibliography 70

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List of Tables

Sr. Topic Page

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No. No.

1 Country Domestic Credit provided by Banking in Asia 6

2 Country Domestic Credit provided by Banking in Asia 9

3 Asian Banks: Emerging Issues in Asian Banks 13

4 Facts / Changes in East Asian banking 27

5 Brief history of banking in Japan 32

6 Brief history of banking in Korea 37

7 Asian Financial Crisis in 1997 40

8 Behest Lending 47

9 Non-performing loans 48

10 Treasury Operations 55

11 As Island of High Wage Earners 63

12 Priority Sector Credit 64

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Asian Banking

Asian Banking - Part I

Introduction

Country Domestic Credit provided by

Banking in Asia

Non Performing Loans to Total Loans:

Banks in Asia

Emerging Issues in Asian Banks

Growth of Personal Banking in Asia

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Asian Banking

Introduction

Among the emerging economies, Asian banking is the most energetic

and expanding one. In the aftermath of the Asian economic crisis, banks in

South East Asia were the worst to get affected, but they are clawing back

with aggressive pace, quite often strongly supported by their governments.

Despite impressive growth of capital markets in the Asian region, banking

remains a strong anchor supporting economic growth.

There are three major aspects of Asian banking. I.e. Growth, Structure

and Efficiency. Growth depicts the growth of banking activity in the region;

Structure describes features such as who owns banking and Efficiency

profiles the recent operational performance of banks across the Asian region.

In all these aspects suitable comparisons with banking systems in other

emerging economies is also done.

Asia has a strong banking presence. Banking industry is spread across

the major regions in the world. In the emerging economies, Asia has the

largest number of deposits taking institutions and banks, despite closure of a

fairly large number of institutions following the 1997 economic crisis. The

size of banking assets in Asia is more than the double that of Latin America

and several times larger than that of central Europe. Its capital ratios are

fairly higher.

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Asian Banking

In emerging economies, banking sector is the single most important

source of finance for corporate in the private sector. During the five year

period, 1997-2001, of the total corporate domestic funding for the private

sector in major emerging markets, a large chunk (63%) came from bank

loans, though the share of domestic bonds (22%) has been growing more

rapidly than the equities (15%). In respect of international funding too, bank

lending (41%) dominates bonds (37%) and equities (22%). This trend is also

evident in the private sector domestic funding in the Asia Region where

bank loans are the prominent source (78%) of funding but the share of

equities (12%) are more than bonds (10%). In international funding for Asia

region, all these three are proportionally represented in respect of the public

sector funding.

However, it is the bonds that are most prominent both in domestic

(91%) and international (73%) sources as compared to other regions, bank

loans, as a source of funding in the Asian region is more than other regions.

For both the sectors bonds have contributed significantly in funding to the

extent of 69%, followed by bank loans with 26% and equities 5%. Another

evidence to show that the growth of banking is more stronger in Asia than

the capital market could be evidenced from the fact that domestic private

credit as a ‘%’ of GDP in Asia grew from 90.6% in 1996 to 113.7% in

2002, where as equity market capitalization inched from 64.8% to 71.9%

and total bonds outstanding from 31.4% to 48.7%. More than 40% of the

world’s population still lives in countries in which the majority of bank

assets are in majority-owned state banks. Government ownership tends to be

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Asian Banking

greater in poor countries. Total assets of banking system is about one third

of all countries is smaller than $1 billion; another third have banking

systems smaller than $10 billion.

Asian banking showed significant growth in the last three decades.

Domestic credit provided by banking as a percent of GDP, reflects the

significance of the banking sector in the economy. It is evident that Asian

economies has showed the largest growth in this ratio, and always growing

in contrast to the banking systems in other emerging economies. Bank Credit

and GDP ratio growth was much faster and spectacular in East and South

East Asia as compared to South Asia, as most of the countries in South Asia,

namely India and Sri-Lanka have only made marginal gains in this ratio

during the decade of the 90’s where as in the countries like Pakistan this

ratio was actually failed and Bangladesh perhaps scored well in the South

Asian region in this regard. Despite several economic crisis that plagued the

entire East Asian region, this ratio remained high. This was an evident in the

growth of the banking system as well.

Country Domestic Credit provided by Banking in Asia

More than 40% of the world’s population still lives in countries,

which the majority of bank assets are in majority owned state banks.

Government ownership tends to be greater in poorer countries; Arguments in

favor of state control are-

(a) Better allocation of capital.

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Asian Banking

(b) Private ownership may restrict access to banking sectors for many parts

of the society.

(c) Private banking is more crisis prone.

Achievements of the goals of the state ownership have been elusive.

Greater ownership of banks to associate with higher interest rate spreads,

less private credit, less activity on the stock exchange, and less non-blank

credit, even after controlling for many other factors. One study revealed that

countries that had greater state ownership of banks in 1970s tended to grow

more slowly since then with lower productivity, especially in poor countries.

Asian banking is significantly either state owned or family owned.

This is also one of the biggest challenges facing the Asian banking system in

the background of globalization and financial liberalization which envisages

holding of greater share of banking assets by foreign entities. In the last two

decades, ownership of the banks in China has been predominantly state-

owned barely changed. Even in India, where both public and private sector

co-exist, a large chunk of it is owned by the former.

While state-ownership is predominant in some countries, family

ownership is sizeable in some others. State and family ownership are not particularly

viewed favorably from the point of view of emerging international financial policy that

puts greater thrust on promoting private sector with greater responsibilities on corporate

governance in terms of transparency and disclosure. A great deal of pressure is being

mounted on this type of ownership by international and domestic policy to transform into

a more responsible and accountable. This is explained with the help of following table.

Family Country Bank Stake(%)

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The Koo family(Koos Group)

Taiwan China trust 10

The Tsai family(Fubon Group)

Taiwan Fubon Commercial Bank

15

The Wu family(Shing Knog Group)

Taiwan Taishin International Bank

15

The Fung family Hong Kong

Wing Hang Bank 32

The Wu family Hong Kong

Wing Lung Bank 43

The Wong family Hong Kong

Dah Sing Bank 38

The Li family Hong Kong

Bank of East Asia 40

The Wee family Singapore United Overseas Bank 32.1The Lee family Singapore Overseas-Chinese

Banking Corporation22.7

The Lien family Singapore Overseas Union Bank 15.7Azman Hashim Malaysia Arab-Malaysian

Merchant Bank8.4

The Kwek family (Hong Kong Group)

Malaysia Hong Leong Credit 71.7

The Hong Piow Malaysia Public Bank 28Rashid Hussain Malaysia RHB Bank 23.9Tan Teong Hean Malaysia Southern Bank 22Sophonpanich family Thailand Bangkok Bank 15Lamsam family Thailand Thai Farmers Bank 10

One of the views that were put increasingly by international financial

policy as a better option to reduce the state and family ownership to

encourage ownership of financial institutions by foreign entities. Since many

of the foreign banks taking state in domestic banking systems comes from

the mature economies with fairly standardized and stringent regulatory

norms, it is envisaged that the greater share of foreign ownership will bring

in greater transparency and efficiency in the domestic banking systems.

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Asian Banking

There are however serious concerns in many emerging economies on the

entry and expansion of foreign banks. Arguments against foreign banks have

destabilized the local financial system and has putted local financial out of

business etc., However there is no hard evidence of local presence of foreign

banks in this regard. 1990s have been remarkable in enhancing the presence

of foreign banks.

For instance in Central Europe, the proportion of bank assets

controlled by foreign owned banks rose from 8% in 1994 to 56% in 1999. In

some Latin American countries, almost one-half of the total bank assets are

now controlled by foreign institutions.

Major factors inducing the growing pace of foreign ownership of

banks are; globalization of financial services, lower costs of information and

communication that lead to greater economies of scale to expand

internationally, surges in telephone and internet banking in which foreign

banks are already market savvy. Using bank level data for 80 countries for

1988-1995, Claessens, Demirguc-Kunt, and Huizinga of the World Bank,

have examined the extent of foreign ownership in national banking markets

on the basis of net interest margins, overhead, taxes paid, and profitability of

foreign and domestic banks. It is found that in developing countries foreign

banks tends to have greater profits, higher interest margins, and higher tax

payments than domestic banks. Increase in the foreign share of bank

ownership has reduced the profitability and overhead expenses in

domestically owned banks. Local bank competition gets affected more on

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Asian Banking

the entry of foreign banks rather than after gaining a substantial stake.

Foreign control of domestic banks in Asia has not been that particularly

easy. Attempt to sell Seoul Bank to HSBC failed, In Malaysia in 1950s the

foreign banks had controlled of assets to the tune of 94 %, which is

drastically reduced now. Prior to the financial crisis of 1997, Thailand has

been relatively closed to foreign banks but this situation is gradually

changing. China has withdrawn the sale of Shenzhen Bank, which is almost

finalized to a foreign private capital group. Though Thailand increased the

limit of foreign ownership from 25% to 100% and several others made

significant relaxations in foreign.

Despite a series of liberalization measures on most of the Asian

countries the share of foreign ownership in banks is rather limited. In India

post-liberalization the number of foreign banks expanded rapidly.

An interesting perspective of Indian banking provides that with the

positive intervention of the State, turnaround in banking sector could be

gradual but more concerted, though how far this strategy will be sustainable

is a big question. Bank wise shares of total assets in India for the year ended

March 2002 showed that Nationalized banks account for 46% of assets and

42% of net profits, State Bank Group accounts for 29.3% of assets and

29.8% of net profits, Old Private Sector banks account for 6.1% of assets

and 8.7% of net profit where foreign banks account for 7.2% of assets and

12.9% of net profit where as new private sector banks account for 11.4% of

assets but only 6.7% of net profit. This is explained with the help of

following table.

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*All years figures are in PercentagesCountry 1997* 1998* 1999* 2000* 2001* 2002*

India 0.7 0.8 0.5 0.7 0.6 0.8

Indonesia ___ -19.9 -9.1 0.1 0.8 1.8

Korea -0.9 -3.3 -1.3 -0.6 0.8 0.8

Malaysia ___ ___ 1.1 1.1 0.8 ___

Pakistan -1.2 0.5 -0.2 -0.2 0.5 ___

Philippines 1.7 0.8 0.4 0.4 0.4 0.7

Thailand -0.8 -5.1 -5.4 -1.6 -0.2 0.7

Memorandum Items

United States 1.3 1.1 1.3 1.2 1.1 1.4

Japan 0.0 -0.6 -0.5 0.2 0.0 -0.4

Canada 0.7 0.5 0.7 0.7 0.6 0.5

United Kingdom 0.9 0.8 1.0 0.9 0.6 0.7

The data published by the International Monetary Fund, for the year

2002, shows that the median ROA is highest in Central Europe(1.4%),

followed by Latin America(1.3%) and Asia(0.8%). Asia showed sizeable

recovery since 1997, when its ROA was -0.8% that fell further in the next

year to -1.4%, but has been gradually recovered since then to reach 0.8% by

the year 2002. The Differences in the ROA of banks in Asian economies are

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Asian Banking

measured by the standard deviation which was at 8% in 1998 gradually

declined to 0.5% by 2002. India has been maintaining a ROA of about

0.5% to 0.8% throughout the six year where as Indonesia showed rapid

improvement in the last two years. Korea, Malaysia, Philippines and

Thailand too showed gradual recovery in the ROA in the last two years.

Recovery of bank revenues is evident across the region. If the SAARS does

not continue to be a major problem threatening China and East Asia, with

the growth prospects currently foresee, banking industry in Asia could see

further growth in the immediate term. However, Risk management will be

very crucial to realize and sustain gains. Median levels of Non Performing

Assets of Asian Banks in 2002 remained more or less similar what it was six

years ago. It does not mean that bad-debts stopped growing in these banks,

but they have managed to bring down from about a median level of 20% that

they have reached in 1998. The latest data puts bad-debts of Asian banks at

10.3% of the assets, similar to Latin America but 2% points than Eastern

Europe.

Non Performing Loans to Total Loans: Banks in Asia

Non Banks in Emerging economies have always been prone to crisis.

From 1980 to 1995 more than three-quarters of the members of the

International Monetary Fund have experienced a serious and costly banking

crisis. In 69 of these countries, losses exhausted the net worth of the entire

banking systems. The cost of saving the banking system was around

10% to 50% of the GDP. The experience of the last three decades shows that

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Asian Banking

banking systems are prone to crisis, and these could happen in both rich and

poor countries. But the ability of the emerging countries in swinging back to

the strength and sustainability is an issue that continuously bothers

international finance regulation from the point of view of stability and

sustainability. Poverty rates rose faster from about 25% to 40% in Indonesia,

from 15% to 25% in Korea and 10% to 15% in Thailand in the aftermath of

the financial crisis. Most of the Asian economies in the late 1990s have

experienced several and intense crisis in the banking sector along with

currency crisis and major imperative emerging from this experience are that

banks should be particularly careful in not only managing risk but also

strategies for overcoming and combating the effect of contagion. Banking

crisis in some countries not only wiped off their entire net worth but also

cost the governments almost the size of the GDP to put them back in the

business.

One encouraging feature is that the banking systems across all the

regions in emerging economies possess capital adequacy levels that are

considered safe and sound. The median levels of capital adequacy levels in

banks in Asia, Latin and Central Europe are around 10% and these have

been consistently showing improvement. Korea in the Asian region tops the

regulatory capital as a percent to risk weighted assets, a trend which is

evident in most of the countries, in particular Philippines, Malaysia etc..,

Capital adequacy levels in Asian countries are much higher even compared

to the banking systems in the matured economies. Indonesia, Philippines,

Thailand, Pakistan remain at higher levels, the problem of which could be

further compounded by any setbacks in the economy either owing to the

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developments in the domestic sector or international economy. In India in

the last six years this capital adequacy ratio hovered around 10% to 11% and

given the subdued growth of assets, which remained pretty significant.

Despite the overall improvement in various aspects of operational

efficiency, the financial strength of banking systems remains a matter of

great concern. The median level Moody’s financial strength index for Asia

in 2002 stood at 16.7% as against 30.2% for Eastern Europe, 20.9% for

Latin America. The position of India is much above the Asian average but as

compared to the banking systems in mature economies (excepting Japan), it

is far lower.

Asian Banks: Emerging Issues in Asian Banks

Recent trends in banking across the world, which is evident in Asian

banking, are-

(a) Growth of personal banking and credit.

(b)Corporate increasing accessing bond markets for their resource

requirements increasing use of technology and growth of online banking.

(c) Shifts in revenue stream from being interest income based to fee based

and a greater degree of consolidation to achieve economies of scale. A

brief discussion on each of these is given below.

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Country 2001(%) 2002(%)

India 25.8 27.5

Indonesia 1.7 5.4

Korea 14.2 16.7

Malaysia 30.4 31.7

Pakistan 2.1 5.0

Philippines 17.5 20.4

Thailand 15.8 15.8

Memorandum Items

United States 77.1 75.0

Japan 16.7 12.9

Canada 77.1 75.0

United Kingdom 83.8 83.8

Growth of Personal Banking

Asian banks have experienced enormous growth in personal banking

in the recent period fuelled by expansion in household credit, online

banking, credit cards etc., In Korea, household credit now accounts for about

half of the total outstanding bank loans and this trend was evident in several

other Asian economies. In China as per the recent report of the Lehman

Brothers, mortgage and consumer credit in China grew by 70% in 2001 and

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already reached 10% of the total bank loan outstanding. Korea, Thailand,

Malaysia, Taiwan and Philippines experienced growth in credit cards in the

range of 20% in 2002 and China’s credit card market is expected to grow

around 75% to 100% in the next three years. In Korea value of credit debt

now accounts for about 16% of the total household borrowing and about

11% of the total private credit outstanding. In 2002, Value of credit card

debt outstanding has registered a growth of 47% in Korea, 34% in

Philippines, 30% in Thailand, 28% in Taiwan, 21% in Malaysia and as a

percentage of total domestic credit, it ranges from 3% in Malaysia to 11% in

Korea.

Growth in the household credit/personal loans was further accentuated

by a number of relief measures announced by the governments to promote

housing loans, use of credit cards and supplemented by additional measures

announced by banks such as fee waivers, higher credit limits etc., With the

growth of personal banking and household credit, banks are transforming

from a ‘transaction-based activities to process based activities’ that

requires sophistication in risk management. While growth of personal loans

is expanding consumerism in many Asian economies, which is fine for the

regional economies.

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Asian Banking - Part II

Growth of Online Banking in Asia

Consolidation

The Pace of Bank Consolidation in Asia

Issues and Imperatives

Steps taken by Asian banks to Restrict

Banking Crisis

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Growth of Online Banking

Online banking is expanding at rapid rate in Asian economies.

According to the recent report released by AC Nielsen Online. Active online

banking population in the five major Asian economies of South Korea, Hong

Kong, Singapore, China and Taiwan, grew 63% in 2001 taking the regional

total from 6.5 million to 10.6 million during 2000-2001. The report also

shows that 38% of regular internet users across now use online banking

services, compared to 29% a year ago and 16% two years ago. South Korea

tops online banking population with 5.3 million, followed by China

2.6 million, Taiwan 1.7 million. Of the top 20 internet banks, South Korea

has 12, China 5. Levels of the customer satisfaction are found to be higher

among the customers of Internet banking. The percentage of internet users in

favor of switching over to internet banking is high thought the region from

76% in Taiwan to 93% in China and 65% in Korea. In countries such as

United States, online banking adoption will rise from 22% in 2002 to about

38% by 2010. In the 1990s banks laid great thrust on Internet banking

drawing from the estimates of very lower cost of transactions in Internet

banking.

An interesting development in the growth of Internet banking is that it

could promote more of brick and mortar banking as well. A recent report of

the Nielsen/Net Ratings observed, “In virtually every market, it is the

traditional, established brick and mortal banks that are attracting the

biggest audiences. A large majority of online customers are most likely

also customers of the in-person bank branches”. A recent report in the

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Business Week magazine said that in the height of Internet boom, big banks

declared bank branching dead and were aggressively investigating in

technology instead. They hoped to win over customers through their new

electronic systems and cut back on expensive bricks and mortar. So they

spent heavily on call centers and website and also opened less costly mini

branches in grocery and discount stores.

Despite a growing array of online options, customers continue to

open 80% of new checking and savings accounts at branches. After a decade

of slow growth in deposits, banks are now benefiting from the stock market

slump as customers slash money from their banks. Multi product offerings

are hoped that will enable branches sustainability. WaMu Bank opened

144 branches last year and is planning 230 this year. ATMs in the early

1980s and Internet in the late 1990s. This trend could flow to the Asian

banking systems too soon.

Consolidation

Asian economic crisis brought in several changes in the banking

landscape. The prudential regulation was not only stepped up but also the

consolidation of banks to be followed in order to bring greater efficiencies

and financial stability. While bank mergers in the mature economies were

more market induced and to gain greater synergies between different

markets segments (such as Citibank/travelers) in the emerging economies,

policies too supported the consolidation of the banking industries to enhance

strength of the banking system and its sustainability. This trend was evident

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in many of the emerging economies. Though not much progress took place

in foreign acquisitions of domestic banks in Asia, consolidation within the

domestic banking institutions is significant and sizeable.

The Pace of Bank Consolidation in Asia

Consolidation is taking place at a rapid pace in Asia and the most

targeted banks for acquisition are the family owned banks. The size and

strength of banking systems in Asia is vastly varied. In the top 330 Asian

Banks, as compiled by Asia Week 500 (excluding Japan, Australia and New

Zealand) China’s 25 banks account for 42% of the bank assets, where as

Taiwan’s 48 banks account for 15% of the bank assets. India with 55 banks

represented in the top league accounts for just less than 6% of the bank

assets. Bank consolidation in South Asia has been relatively at a slow pace

as compared to South East Asia.

Issues and Imperatives

Major aspects are that banking in Asia is expanding and diversifying-

In ‘Operations’, banks continue to be major forces in financial

intermediation, though the recent period witnessed a sharp growth in

consumer credit, as corporate sector are moving more towards bonds and

equities for their financing. Online banking is rapidly growing across all

countries in the region and so as the credit card business. Growth of personal

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credit is also considered responsible for reviving domestic economic growth

in some economies. But already concerns about growth of personal debt are

increasing in many countries. Financial Service Authority of UK discussed

about the length of various issues involved in the growth of personal debt in

Korea, which witnesses sharp surge in household credit recently announced

several measures to reduce the rate of its growth In June 2002, Korean

authorities increased the loan loss provisioning requirement for consumer

loans, lenders are advised to share the customer information on borrowers

with large credit limits and outstanding, reduced loan to value ratios for

housing loans, increased risk weight age for home loan mortgages etc.,

Growth of personal banking gives scope to new types of risk that banks

should be well handled to assess and monitor.

In ‘Efficiency’, banks are slowly returning to healthy rates of return

and containing bad debts though, Asian banks have yet to go a long way to

reach the desired and established standards that are evident in stronger

banking systems. South East Asia had addressed to the issue of resolution of

non-performing assets in a much more focused manner and creating suitable

asset reconstruction mechanisms. Most of the banking systems are now

suitably capitalized which should not be a major constraint for the

continuation of banking growth. In view of the rapid decline of the interest

rates in the recent period, there could be some pressure on the margins, but

more of consumer credit would mitigate this problem to certain extent as

long as the risks are managed. These changes move banks more towards the

fee based earnings online with the trends evident in developed banking

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systems, but the transformation from transaction based to process based

activity will give rise to new types of risks which banks should ready to

assess and cope up with.

In ‘Structure’, significant consolidation is taking place, though the

growth of foreign ownership is not sizeable. With continued pace of

international coordination on creating strong and sustained financial

architecture, initiatives for giving more access to foreign ownership and

consolidation within the domestic institutions could gain speed. Already

in much of the Asia family owned banks are increasingly targeted for

acquisition. More or less the pace of globalization and removal of controls

and barriers which could gain further momentum could also give rise to

large regional banks.

A World Bank report on Finance for Growth observes, “It is obvious

that advanced economies have sophisticated financial systems’’. What is not

obvious, but is borne out by the evidence, is that the services delivered by

these financial systems have contributed in an important way to the

prosperity of these countries. They promote growth and reduce volatility,

helping the poor. Getting the financial systems of developing countries to

function more effectively in providing the full range of financial services-

including monitoring of managers and reducing risk is a task that will be

well rewarded with economic growth. At the same time, it is the banking

systems that have the evidence of becoming most vulnerable at the first

signs of opening up or financial liberalization. The World Bank report sums

up “If finance in fragile, banking is its most fragile part”. The most

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important aspect of managing better banking is through responsibility of

major constituents of the banking systems, right type of regulation and

quality of response in a crisis. The last two decades of financial

liberalization, equipped banks with enormous experience and expertise in

dealing with a wide range of challenges and crisis. This hopefully would be

handy for them in charting new areas of growth in the background of next

generation reforms. Then banking could generate and sustain long-term

prosperity.

Steps taken by Asian banks to Restrict Banking Crisis

Screen out imprudent, incompetent, dishonest bank owners: Fit and

Proper Tests that bank owners and managers must pass to quality for

banking license. Prudential Supervision that covers leverage and asset

quality Capital adequacy, risk management, restrictions on connecting

lending etc.

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Termination of Authority in case of excessive insolvency, exposure

Regulation and disposition of bank before it exhausts its net worth and

causes losses to depositors. To protect depositors from loss and remove the

incentive for depositors to run from other banks thought to be jeopardy

‘Lender of the Last Resort’ to enable solvent institutions to meet the claims

of liability holders by Borrowing against assets rather than selling illiquid

assets at fire sale prices Protection of Monetary Authority from Cumulative

Collapse by neutralizing any shifts in the public demand for cash thus

protecting the Volume of bank reserves.

31

Asian Banking

East Asian Banking

Restructuring

&

Regulation

Industrial Policy

32

Asian Banking

Introduction

Facts/Changes in East Asian banking

History of banking in Japan

History of banking in Korea

Asian Financial Crisis in 1997

Comparison between Japan and Korea

Introduction

The impact of transition from a price-cap regulation (deposit/loan rate

control) to a rate-of-return regulation on banking industry structure. A

simple theoretical model of banking competition suggests that the relative

dominance of the two objective functions are influenced by industrial policy

via preferential rates and relaxing price-cap regulation reduces the

equilibrium number of banks. The result is supported by empirical evidence

from Japan and Korea, which have undergone a substantial consolidation.

The analysis is applied to a unique data set of the entire commercial banking

sector in Japan and Korea, which covers both pre and post banking crisis

periods. The evolution of the banking structure is based on the Structure-

Performance relationship.

Throughout the last decade, the East Asian banking industry has

adopted a more concentrated market structure. In particular, the Japanese

and Korean banks have made a radical move towards consolidation to deal

with their respective economic crisis. East Asian banks were simply

33

Asian Banking

regarded as a means of supporting the real sector in the process of pursuing

economic development; the economic crisis triggered the restructuring

process in the banking sector. Hence, the recent financial crisis in Asia

renewed recognition of the significance of the banking industry and its

regulation for the overall economy of the region. Previous bank structure has

primarily focused on the impact of exogenous change in regulation and the

subsequent change in competition environment. However, the industrial

policy in East Asia dominated the banking sector regulation and competition

prior to the crisis. Banking regulation has been nothing new in Japan and

Korea in terms of entry barriers, branching restrictions, and deposit rate

ceilings. East Asian banking regulation was designed to facilitate the

development of strategic industries. The deposit rate regulation, Allowed the

banks to have access to cheap funding. With cheap funding and with the

help of government subsidies, the strategic industries could grow fast

generating supernormal profits and remained as high quality customers to

banks. This kind of growth pattern continued in East Asia until they faced

economic crisis recently. Not only Japan and Korea have led the economic

growth in East Asia, but also some other East Asian countries which have

replicated many of the development patterns set by Japan and Korea

Moreover, the two countries have similarities in their industrial

structure due to their strong trade networks. Since the modern banking

system in Korea was established during the Japanese occupation, it seems

natural that Korea followed the Japanese type of banking establishments

when they had much in common in the structure of the real sector. However,

there is some evidence of divergence in terms of recent restructuring of the

34

Asian Banking

banking sector. World Bank data categorizes Japan, Korea, China, Hong

Kong, Indonesia, Malaysia, Philippines, Singapore and Thailand as East

Asia. However, Japan and Korea have dominated the regional economy and

its growth representing 78% to 90% of East Asian GNP over the period

1960-1997. Their Contribution to the regional growth has been more than

80%, which fell down to 50% to 60% in the 1990s.

It is important to note that the banking industry has some special

attributes due to its nature of service industry and hence an industry-specific

approach is inevitable.

First, the role of East Asian banks in industrialization is analyzed by

comparing the evolution of the banking system with the country’s

macroeconomic position. The uniqueness of this approach lies in the sense

of inter-industry comparison between financial and non-financial industries

using an industrial organizational framework. It is important to note that

financial and non-financial industries have different attributes and therefore,

it is interesting to investigate how they evolved together. Second, a

theoratical model of banking competition is based on the circular model. The

two objective functions of banks: a revenue maximizing bank under

regulation and a profit maximizing bank under deregulation. The relative

dominance of the two objective functions is influenced by industrial policy,

thus by regulation which has an impact on the market structure in terms of

equilibrium number of banks in the market.

35

Asian Banking

Finally, it empirically investigates the consequences of the regulation

and deregulation on entry, branching and deposit rates. The different types

of regulation and deregulation are defined and separately analyzed from the

country specific perspectives. The relationship between concentration

(Structure) and the degree of competition (Conduct) in Japan and Korea is

examined. The effects of deregulation on the structure of the banking

industry and the profitability (Performance) of the banks are tested. The

evolution of banking industry in the two countries is compared and which

shows the evidence of divergence in the restructuring process of the banking

sector between Japan and Korea.

Facts/Changes in East Asian banking

In the post war period, East Asian governments actively promoted

heavy and chemical industries and certain academics like Cho (1994) and

Castle (1999) argued that the financial sector was lagging behind the fast-

developing real sector. Moreover, the pattern of fast growth in the real sector

and the lagging financial sector was common for all East Asian countries. In

particular, the similarities between Japan and Korea were significant due to

their strong trade networks. Thus, it is fair to say that the Korean

industrialization process followed that of Japanese with a time lag of almost

a decade. This overlapping transfer of industrial structures from Japan to

Korea was explained by the Japanese relocation process, which was started

in the late 1960s. This is explained with help of following table.

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Asian Banking

Japan and Korea: changes in industrial structures

Period Japan Korea

1950 Light industries (textiles) Primary products(food

products)

1960 Heavy industries(steel & ships) Light

industries(textiles)

1970 Knowledge industries & heavy

industries

Heavy industries(steels,

chemicals, electronics

& ships)

1980 Knowledge-intensive(high-

tech) industries

Heavy industries

1990 High-tech & service industries Knowledge-intensive

industries

Source: Castle (1999), Korea’s Economic Miracle

Ishii (1997) claimed the reason for the high growth rate in East Asia is

its high rate of savings. Even in the 1980s the rate of savings of the

household economy in Japan was around 17% which was twice as much as

those in the advanced Western countries. It is true that the high rate of

savings in East Asia is one of the common factors for its fast growth.

However, the role of banks in the process of allocating the funds into

appropriate industries and enterprises should not be overlooked. As Ishii

(1997) pointed out for Japan, the main part of the funds for industrialization

in East Asia was not procured directly from the capital market but supplied

indirectly through various kinds of banks, and the respective central banks

provided these banks with funds if necessary.

37

Asian Banking

Cho (1994) explains that the East Asian governments were heavily

involved in the direction of savings fund to achieve development goals in the

real sector. Industrialization in East Asia has not only meant for a

transformation of an agrarian economy into an industrial economy, but it

also means a more focused industrial development in strategic industries

such as heavy industries. Thus, the financial sector has never developed

independently of the real sector in East Asia. More importantly, the

industrial policy dominated financial sector developments leaving the

banking sector subordinate to the real sector.

Brief history of banking in Japan

It is worth looking at the formation of modern banking system in

Japan as it set a prototype for the region. The Meiji restoration in 1868

provided a ground for the modern banking system in Japan. A structural

framework including, operating principles and regulatory issues started to

form and continued to develop from 1868 up to the mid 1990s. The

development phases of Japanese banking reflects three distinctive periods,

the period from the Restoration through World War II and the Allied

occupation, the high growth era of the 1950s to the 1970s, and the quarter

century since the oil shock of 1973.

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Asian Banking

WWII-1868

A modern banking system was built by adopting a variety of Western

models on top of a legacy of indigenous financial practices between 1868

and World War I. The main institutional feature of the banking evolution in

Japan was characterized under the Bank Act 1890, which took effect in

1893. National banks began to change to ordinary banks in substantial

numbers from the end of 1896, when the charters started to expire and by

1899 no national banks remained. This amalgamated three classes of

banking institutions – National, Private, and Quasi-bank into one.

Interestingly, the new bank law did not set any minimum bank size in favor

of free competition. As a result, unit banking was predominant in Japan until

World War I. With the development of Zaibatsu (former enterprise type of

Keiretsu), the Mitsubishi and Sumitomo Zaibatsu transformed their finance

department into banks in 1895. This made the monetary crisis more several

because these banks were suspected to failure during recessions.

The Big Five banks (Mitsui, First, Mitsubishi, Sumitomo, Yasuda)

dominated the sector until World War I. Special banks started to emerge

during this period as well, such as the Tokohama Special Bank (established

in 1880) to finance foreign trade. Within the five year period between 1897

& 1902, the government founded the Hypothec Bank of Japan (Nippon

Kangyo Ginko), 46 affiliated prefectural Agricultural and Industrial Banks,

the Hokkaido Colonial Bank and the Industrial Bank of Japan (Nippon

Kogyo Ginko). Most of these banks were designed to finance the transition

from an agrarian economy to an industrial economy. During the 1920s and

39

Asian Banking

1930s, Japanese banking underwent with considerable adjustment in terms

of the relationship between private institutions and state regulators. The

trigger to this legislative reform was the Banking Crisis in 1927 caused by

the post World War I recession. With the intensification of official

regulation, concentration in commercial banking has increased. However,

public and private interactions were dynamic and complex and the

bureaucracy could not simply dictate policy to the banks. Zaibatsu banks

continued to be the leading institutions in the system while a new Hugh

(1999) well documented the Japanese banking system in historical

perspectives in Banking in Japan (1999) edited by Tsutsui.

WWII-1973

There were some institutional changes in the banking sector after the

WWII as post-war reorganization of the financial system was carried out by

dissolving wartime institutions and establishing private long-term credit

institutions and financial institutions for small and medium sized firms and

agriculture. During high growth era between 1952 and 1973, Japanese

banking established the uniqueness of the system. The predominant pattern

of banking activities was over-loan and over- borrowing in indirect

financing in order to facilitate the investment led growth.

40

Asian Banking

Post 1973

Japan tried to reform the banking industry once again to cope up with

the difficulties in the real sector and the driving force of the reform was from

market liberalization with various deregulation measures. The main focus of

liberalization was on lifting interest rate regulation starting with short-term

rates. Branching restriction and cross-financial sector entry restriction started

to relax later. In the 1980s, banks were allowed to diversify their financial

products and services. Enactment of the Financial System Reform Act of

1993 enabled banks and securities firms to enter each other’s fields.

One of the most significant liberalization measures in recent Japanese

banking history, was “Big-Bang programmed” initiated in 1996 by the

then Prime Minister Hashimoto. Various reforms were scheduled to be

implemented based upon the three guiding principles of ‘Freedom’,

‘Fairness’, and ‘Globalization’, so that the Tokyo financial market could

attain a status on par with New York and London by 2005. Restructuring has

accelerated following the Asian crisis in 1997. The bank-on-bank holding

companies created a new environment for financial institutions so that they

can form alliances. This can be explained with the help of following table.

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Asian Banking

Japanese Banking Liberalization: Post-1978

Liberalization measure Date effective

Short-term interest rates liberalized 1978

Issuance of CD started May 1979

FX control eased by amending the

Law

Dec 1980

Regulation on conversion of foreign

currency into the yen abolished

Jun 1984

Money market certificate created Apr 1985

Investment business law enacted Nov 1986

Financial System Reform Act

allowed banks to enter securities

business

Apr 1993

Interest rates of Time deposits

liberalized completely

Jun 1993

Interest rate on demand deposits

liberalized (ex. current account)

Oct 1994

Restrictions on the number of a

bank’s new branches removed

Jun 1995

Regulation on deposit products

relaxed

Oct. 1995

‘Big Bang’ reform announced – PM Nov 1996

42

Asian Banking

Hashimoto’s idea of-

1/freedom

2/fairness

3/globalisation

Ban on financial holding companies

lifted

Dec 1997

Amended FX and Foreign Trade

Law making FX transactions free

from

governmental authorization

Apr 1998

Bank allowed to sell investment trust

over-the-counter

Dec 1998

Restriction on trust bank

subsidiaries/securities company

subsidiaries

Oct 1999

Abolished Bank allowed to issue

straight bonds

Oct 1999

Banks, securities companies to be

allowed to enter insurance business

End 2000

A new Financial Services Law to be

enacted

Source: Japanese Banks 2000 (Zenginkyo, 2000)

Brief history of banking in Korea

43

Asian Banking

The Korean banking system seems to replicate the Japanese system as

the introduction of a modern banking system into Korea dates back to the

beginning of Japanese domination over the country.

WWII-1878

In 1878, the First National Bank (a Japanese bank) opened in Pusan

and this was followed by Korean banks openings. However, most Korean

banks only existed for See Japanese Banks 2000 (2000), Japanese Bankers

Association (JBA). In May 2001, Sony Corp. filed a formal application for a

bank in cooperation with Sakura Bank and JP Morgan that utilizes the

internet. In 1909, the Old Bank of Korea was founded and was renamed the

‘Bank of Chosun’ in 1910.

During the early 1900s, numerous banks were established including

Chosun Industrial Bank, Chosun Commercial Bank (later renamed the

Commercial Bank of Korea), Cho Hung Bank, Korea First Bank (1929) and

Hanil Bank (1932). In 1959, Bank of Seoul was established and became

nation wide in 1962. Since the government had owned commercial banks

until government owned stocks were sold in the late 1950’s, these banks

exercised very little autonomy.

WWII – 1982

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Asian Banking

The establishment of the new banking system followed the liberation

from Japan in 1945 and the inauguration of the Republic of Korea in 1948.

At that time, The Korean banking system was reorganized for the purpose of

financing the five years Economic Development Plan more efficiently. The

Bank of Korea Act was amended in 1962 and various specialized banks

were introduced to facilitate financial support for underdeveloped or

strategically important industries such as Small and Medium Industry Bank,

Citizens National Bank, Korea Exchange Bank and The Korea Housing

Bank.

Post 1982

The General Banking Act was revised in 1982 and commercial banks

started to be privatized. These included Hanil Bank, Korea First Bank, Bank

of Seoul and Trust, Chohung Bank. One of the main reasons was the shift

from direct credit controls through credit ceilings on individual banks to

indirect controls through management of bank reserves. In 1984, the

preferential rates on policy loans by commercial banks were abolished and

band system in loan rates was introduced, in which banks are allowed to

charge different rates. The ceilings on various rates (inter-bank call rates and

issuing rates of unsecured corporate bonds) were also lifted. As a measure to

provide a more competitive environment in banking, Shinhan Bank and

Koram Bank opened in 1982 and 1983 respectively. It is important to note

that Shinhan Bank was the first banking establishment financed by private

capital only.

45

Asian Banking

In the 1980s, to encourage the domestic banks to improve their

banking practices and managerial skills, numerous foreign bank branches

were allowed to open. In 1988, interest rates were extensively deregulated to

increase banking competition in the process of financial liberalization. Entry

barriers were further lowered in 1989, adding 3 new commercial banks -

Dongwha Bank, Dongnam Bank and Daedong Bank. Also, Korea Exchange

Bank changed its status from a specialized bank to a nation-wide

commercial bank. Between 1991 and 1997, a four-stage plan for interest

rates deregulation was completed. The main focus of liberalization was on

lifting interest rate regulation starting with short-term rates while branching

restriction and cross-financial sector entry restriction has not been fully

relaxed. Further deregulation is in the process of being implemented in the

aftermath of the Asian financial crisis of 1997. This can be explained with

the help of following table.

Korean Banking Liberalization: post-1990

Liberalization measure Date effective

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Asian Banking

Short-term interest rates and interest

rates on time deposits with maturity

over 3 years liberalized

Nov 1991

Liberalized interest rates on time

deposits with maturity over 2 years

Nov 1993

Rates on strategic loans (BOK

induced) were partially liberalized as

the band of preferred rates for this

category was guided by the

government

Dec 1994

Liberalized interest rates on time

deposits with maturity over 1 years

Dec 1994

Liberalized interest rates on time

deposits with maturity over 6 months

Jul 1995

Liberalized interest rates on time

deposits with maturity below 6

months (completed 4 stage

deregulation on interest rates:1991-

1997, earlier

than planned)

Nov 1995

Branching restriction still remains 2000

Source: Korean Financial System (Bank Of Korea, 1998)

As one of the most significant changes of banking regulation in

Korea, the restriction on foreign ownership of domestic commercial banks

47

Asian Banking

has been lifted and now there is virtually no restriction on foreign

ownership. The current changes within the Korean banking structure are

being propelled by the recent financial crisis, as government officials

realized that Korean banks were not competitive enough to survive. To

improve the banking standards, ‘Financial Supervisory Service’ (FSS)

enforced the new accounting standards in accordance with internationally

accepted standards. Changes in the management structure, in particular with

the presence of foreign management, will definitely affect the structure of

the Korean banking industry.

However, Asian banks showed evidence of maximizing lending

during the regulated period as their interest margins were protected by the

deposit rate ceilings and the guaranteed minimum lending rate for strategic

industries. Asian banks started to focus more on profit maximization as their

objectives following market deregulation. Thus, recent transformation in the

Asian bank objectives is in part due to the increasing non-performing loans

following the economic crisis. The banks realized that revenue maximizing

does not protect them from losses due to non-performing loans considering

lending as equivalent to revenues of non-financial firms.

Asian Financial Crisis in 1997

In order to test the predictions of ‘SCP’ paradigm with modification

for feedback, a set of variables for Structure (concentration), Conduct

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Asian Banking

(branching and pricing) and Performance (profitability) were chosen and the

relevant indices computed with respect to the strategic variable and deposits.

The number of branches per bank measured the size of the branch network.

Finally, three variables were used to capture the effect of various types of

deregulation.

The sample consists of 16 city banks and 64 regional banks in Japan

(80 banks) and 17 city banks and 10 regional banks in Korea (27 banks) over

the period of 1976 to 1999. For both countries, the data for all banks were

aggregated. The econometric model is tested on commercial banks (i.e.

nation-wide city banks and regional banks), as foreign bank branches and

specialized banks do not participate in the majority of competitive activities

given the prevailing regulation. Moreover, city and regional banks represent

nearly 50% of the deposit market and they are the ones that compete in the

more realistic sense. This can be explained with the help of following table.

Evolution of the number of commercial banks

Dec-

1976

M&A R T A Peak Dec-

2002

Japanese

Banks

Dec

1985

Nation-

Wide

13 -3 -1 0 0 13 8

Regional 63 0 0 0 1 64 64

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Asian Banking

Korean

Banks

Dec

1987

Nation-

Wide

5 -6 0 3 9 16 8

Regional 10 -4 0 0 0 10 6

Source: Japanese Banks- Principles Financial Institutions By Zenginkyo, & Korean Bank

Management.

Where, M-Mergers & Acquisitions, R-Revocation, T-Transformation, A-Authorization of

new entities

4.3 Comparison between Japan and Korea

Many economists showed similarities between Japan and Korea during the

industrialization period after World War II, very few people tried to explain

differences between the two countries. Despite the close interdependency

with respect to trade and industrial structure, the banking sector has shown

some evidence that they were taking fundamentally different steps towards

restructuring. Japan seemed to have taken a prolonged plan for restructuring,

as banks cannot truly compete in interest rates as they are bounded around

zero. By contrast, Korea seemed to move much faster towards restructuring,

growth and efficiency.

50

Asian Banking

51

Asian Banking

Chinese Banks: On the

Reforms Path

Introduction

Banking Reforms

Interest Rate Policy

Behest Lending

Non-performing loans

Monetary policies of the Central Bank

52

Asian Banking

Chinese Banks: On the Reforms Path

Introduction

With the china’s entry into the WTO-fold, Chinese banks have to gear

up, to face competition from foreign banks, which will be entering china

shortly.

China is a very fast growing major economy in the world, with a

strong domestic demand and substantial foreign direct investment. It has

joined WTO during December, 2001. But its banking system is in a crisis

with a very high level of NPA’s and behest lending to state-managed

enterprises, which have been faring very poorly. With the entry into WTO-

fold, foreign banks will get the green signal to carry out business in foreign

currency with their domestic clients. Within two years, they will also be

allowed to conduct wholesale banking business in local currency & within

five years, they will be permitted to do retail business with the Chinese

population. So, obviously there is an urgent need for the unsophisticated &

ailing Chinese banks to perform better and been in the competition with the

foreign banks.

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Asian Banking

Banking Reforms

Chinese banking reforms were initiated during 1978, a clear 14 years

ahead of Indian economic reforms of 1992. The PBOC which functioned

both as a central bank has been split to form four specialized banks and one

central bank, which retained the name of PBOC. The four specialized banks

are the Agricultural Bank of China (ABC), the China Construction Bank

(CCB), The Bank of China (BOC) & The Industrial & Commercial Bank of

China (ICBC). These four banks were also known as Policy Banks, as they

were charged with the responsibility of implementation of the government

plans and policies relating to agriculture, construction, foreign exchange,

urban commercial and industrial development. However, by 1994 they shed

the ‘Policy Banks’ tag to become commercial banks. However, the policy

execution functions have been entrusted to three state-run banks namely,

China Development Bank (CDB), Export Import Bank of China (XIB) and

Agricultural Bank of China (ABC). But as these new banks lacked network

of branches, the separation of policy banks from the commercial banks was

not very well-defined and effective.

Presently there are four wholly state-owned commercial banks (the

Big Four Banks), 10 joint equity commercial banks and 90 city commercial

banks. The four largest banks in china account for about 70% of assets,

deposits and loans of the entire banking system, thereby depicting the

dominance of the big four banks.

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Asian Banking

Interest Rate Policy

PBOC follows a regulated interest rate policy, which means the big

four government banks virtually face no competition either in loan pricing or

deposit interest rates, thereby according a monopoly status. The Central

Bank Authority (PBOC), however, claims that interest rates, though not

deregulated, are tending to be market-determined.

Behest Lending

The big four banks undertake substantial behest lending to state-

owned enterprises. It is no surprise that these banks are gradually loosing

their position of prominence in profitability, thanks to the poor performance

of SOE’s and mounting NPA’s of the banks.

Explicit guarantees by the central government for the deposits placed

with the big four provided them with abundance of deposits, a source used to

finance the SOE’s. While SOEs are the chief contributors to the employment

sector, pension funds and housing, their dismal performance has been a big

drag on the performance of the big four banks. There are about 1.7lakh

state-owned enterprises, which are the social legacy of China. These SOE’s

never had profit focus and were notorious for inefficiency. The fourth

generation of leaders, to whom political power has been transferred during

October, 2002, has now realized that it is better to commercialize SOE’s

55

Asian Banking

rather then wholesale privatization. In fact, reforms are in place for the better

management of these establishments in the form of ownership

transformation and commercialization, so that both public and private

ownership could co-exist. Radical efforts to reduce staff and curtail wastage

are also showing better results. One paradoxical situation that the Chinese

authorities have faced is that many of these SOE’s may have to be declared

bankrupt if stringent bankruptcy laws which are on the avail are to be

implemented. In such a case, the financing banks will obviously take a

bigger hit on the NPA’s front. This can be explained with the help of

following table (Table-8)

China: Surges Ahead

1998 1999 2000 2001 2002

Growth Rates(%,y-y)

GDP 7.8 7.1 8.0 7.3 8.0

Merchandise exports 0.5 6.1 27.8 6.8 22.3

Merchandise imports -1.5 18.2 35.8 8.2 21.2

Ratios(% of GDP)

Current account balance 3.4 2.1 1.9 1.5 1.7

Government debt 17.8 20.9 22.8 24.5 25.3

Levels(US$)

Foreign exchange reserves

(billions)

145.0 154.7 165.6 212.2 286.4

Net FDI inflow (billions) 41.1 37.0 37.5 37.4 41.8

Income per capita 740.0 780.0 840.0 890.0 940.0

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Asian Banking

China has concentrated both on macroeconomic stability and improving the

performance of the banks, especially the state-owned banks.

Non-Performing Loans

There was a need to recapitalize the banks with the help of NPA

(Non-Performing Asset) levels. In 1998, an amount of US $ 33billion has

been recapitalized, through a special bond issue, so as to make the

transaction ‘fund flow neutral’. In 1999, four AMC’s have been started to

acquire the NPA’s of the big four. Chinese banks have adopted the five

classification loan structure (pass loans, special mention loans, substandard,

doubtful & loss loans). The AMC’s were to exchange their bonds, in a

phased manner, over a period of 10 years, with the NPL’s of the big four.

These bonds carry the guarantee of the central government. So far, the

AMCs have taken about US $170 billion NPL accounts from the big four

banks.

However, the NPL’s problem has acquired crisis proportions, with

over 25% level for the big four (2001), showing only a 3% fall from the

previous years level. It is worth recording here that analysis placed the

NPL’s figure for the big four as high as 35-50%. At the targeted level of 3%

reduction every year, (either through recoveries, write-offs or sale to

AMC’s), it will take 12 to 16 years to bring down their level to an acceptable

percentage. This is explained with the help of following table (Table-9).

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Asian Banking

Recovery Rate in NPL Sales(%)as of End of Year 2001

AMCs Oriental Great Wall Huarong Cinda

2001 24.2 7 32.5 35

Monetary policies of the Central Bank

The PBOC has been designated as the central banking authority, in the

year 1995. It charged with the main function of formulating and

implementing monetary policy and supervision of the financial services

sector. In its report for the fiscal 2002, it claims that it has encouraged

commercial banks to strengthen loan marketing, improve financial services,

and intensify financial support to economic growth, besides creating a

favorable condition for the sustained, rapid and healthy development of the

economy. It also stated that monetary and credit supply was basically

commensurate with the trend of economic growth. The central banking

authority appears to be taking conscious steps to reduce the significance of

cash as an intermediate monetary target by facilitating the growth of

settlement instruments such as commercial bills and credit cards.

There is significant increase in Renminbi loans and foreign currency

loans by 17% in total for the year 2002. Wholly-owned state banks, and joint

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Asian Banking

stock commercial banks besides policy banks, as usual, contributed to this

rise. The growth in deposits was also significant. PBOC has declared that for

the year 2003, monetary policy instruments of various kinds will be flexibly

used to keep appropriate increase of money supply. The interest rate and

exchange rate policy will be kept stable, in the process of market based

interest rate reform. Credit policy will be applied to support economic

restructuring.

China’s monetary policy was fairly successful in keeping interest rates

and inflation very low. What is more, it did not allow the economy to fall

into a deflationary spiral, through a sound monetary policy, coupled with the

proactive fiscal policy of the government.. Other features of the monetary

policy are preserving the exchange rate stability & improving the monetary

policy transmission mechanism. PBOC has counseled the SME’s, starved of

bank credit, to attempt for enterprise restructuring, so as to improve

creditworthiness. Banks have also been advised to aggressively market

credit to eligible SME’s sector borrower.

59

Asian Banking

60

Asian Banking

Bank of China

Introduction

A Watershed Year, 2001

Treasury Operations

Investment Banking

Risk Management

Corporate Governance

The Business Strategy & Performance

61

Asian Banking

Introduction

Bank of China is a major government bank with strong foreign

exchange operations. It proposes to strengthen its operations in insurance,

investment banking and foreign exchange business to become an

international bank. It has been strengthening risk management and corporate

governance functions, besides computerization level. BOC was established

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Asian Banking

90 years ago, and is one of the major government banks in china, popularly

known for its foreign exchange operations. It is ranked 8th among 300 Asian

banks, with respect to net profit.

A Watershed Year, 2001

For BOC, 2001 signifies radical changes. The entire bank was focused

on the development of its core activities, as a matter of priority. During this

year, the bank has continued to build a robust decision-making system. It has

also fine-tuned risk management through a due diligence process and a

system of follow up evaluation. Asset disposition review committee and

procurement review committee have also been established.

The bank has also followed prudent accounting principles with a view

to improve transparency. It has also adopted the five-tier approach in loan

classification with a view to provide transparency. It has also adopted the

five-tier approach in loan classification with a view to provide transparency

and clarity about asset quality. It is during 2001, that the bank, in

compliance with the prudent accounting principles has undertaken massive

write-off of bad-debts, besides providing substantially, for substandard and

doubtful debts. It has even reversed uncollected overdue interest. Three

years of restructuring efforts have resulted into better standards of risk

management & transparency.

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Asian Banking

In the credit area for 2002, it has added US $ 103 billion by May 2002

to the retail lending sector, to take the total exposure over US $ 250 billion.

The areas-of retail lending includes consumer loans, auto loans, travel and

personal loans.

BOC has significant overseas presence with 585 branches in 26

countries. Thirty seven percent of Chinas international trade is routed

through this bank. BOC has put in place, performance-based reward and

disciplinary processes. The evaluation results are linked to bonuses,

promotions, training, job assignment etc.

Treasury Operations

The bank provides market information and option for risk

management through the hedging services for assets and liabilities, the bank

garners impassive revenues.

Sector Structure of the Loans

Sector December 31,2001 December 31,2000

Manufacturing 3,36,965 3,13,541

Commerce 1,29,062 1,18,856

Real Estate 1,67,140 1,98,810

Others 9,53,770 8,73,838

Total 15,86,937 15,05,045

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Source: Bank of China, 2001 Annual Report.

The bank is very strong in foreign exchange services, with a volume

of US $ 160 billion (2001). It is a lending player in foreign currency clearing

business in domestic market. During 2002, the foreign exchange business

was amounted to US $196 billion.

For corporate clients with global operations, an innovative product is

called as ‘Global Credit Line’ which has been introduced during 2001, to

facilitate overseas development of Chinese enterprises. It also introduced

factoring & forfeiting services and cash management solutions. Credit to the

sales outlets of the multinationals is provided through two new products

namely, ‘Distribution Passport’ and ‘Startup winners’. By the end of 2002,

corporate deposits had been increased US $963 billion, a growth of 11%

over the previous year.

In the credit cards area, the bank issues two types of cards namely, the

Great Wall International Card and the Great Wall Electronic Debit Card, this

is the domestic card. In 2001, the issue of domestic cards reached a level of

4.6 million, recording a growth of 13%. The international cards totaled to

110,000, with a growth rate of 112%. At the end of 2002, the number of

Great Wall Cards in issue was 5.25 million. The number of international

cards has swelled to 23,000.

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Investment Banking

The bank participated in the IPO’s of eight enterprises in 2001. Total

capital raised by these enterprises accounted for over 70% of the amount of

capital raised in the Hong Kong Stock Market in 2001. The bank acted as the

joint global coordinator, joint book runner, joint sponsor and joint lead

underwriter for the biggest IPO project in Hong Kong in 2001, China

National Offshore Oil Corporation (CNOOC). In 2002, it remained the

number one arranger of IPO’s.

Risk Management

The banks risk management system reflects the principles of segregation of duties

between risk management and business operational roles. Cross-departmental Risk

Management Committee, Asset and Liability Management and Budget Committee

functions under the direct control of the top management, while individual departments

take care of the credit, market and liquidity risk. The bank is trying to implement Basel

capital accord norms while managing the various risks.

Corporate Governance

The bank plans to attain international standards in corporate

governance within three to five years. As a first step, the bank has focused

on the following six key areas: Clear strategy for business expansion, sound

decision-making mechanism and strengthened financial risk control, prudent

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accounting principles and increased transparency, strategically linked

performance evaluation, human resource development and establishment of

a truly accountable board.

During 2001, the bank has been adjudged the best bank of china by

Euro money, the Best Domestic Bank in china by Asset, and the Best Retail

Bank in China by the Asian Banker. The bank hopes to acquire the status of

a leading universal international bank very soon, by foraying into insurance

and securities through strategic alliances. It proposes to concentrate on

commercial banking, investment banking and insurance.

The Business Strategy

The bank has paid special attention to improving the penetration of

information technology besides focusing on corporate and retail banking.

The bank has further strengthened its risk management and internal control

infrastructure.

Performance Highlights for 2002

The bank has principal exposures in manufacturing commerce, real

estate and other sectors.

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At the end of 2002, domestic retail loans reached US $155.5 billion,

an increase of US $73.1 billion, the highest growth rate in the Chinese

banking industry.

Number one in cards business in china.

Top 50 arranger of European syndicated lending.

The asset quality of Bank of China improved considerably in 2002. At

the year-end, the non-performing assets ratio of Bank of China group was

22.5%, down 5% points from the previous year. In the banks domestic

operations, non-performing assets of US $59.6 billion have been

resolved, resulting in cash recoveries of US $34.7 billion.

Number one arranger of IPO’s in Hong Kong.

30% growth in insurance income.

Case-Study

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ICICI Bank

ICICI Bank has been a consistent performer. It has occupied the first

place among the private sector banks & second place among over all the

banks on the basis of its assets. This tech-savvy bank always follows well-

defined business strategies. Its present emphasis is on retail banking. While

it has many strengths and opportunities, it is likely to face challenges in the

form of higher incidence of NPA’s, unfavorable funding composition and

the needs to comply with the 40% priority sector norms in the coming years.

ICICI Bank has become the largest private sector bank and the second

largest bank in India. As a universal bank, ICICI Bank has transformed itself

from the role of mere financial intermediary into a provider of a wide range

of services, in addition to an originator of credit. The product range is

impressive: Home Loans, Car Loans, Consumer Loans, Credit Cards, Debit

Cards, Smart Cards, E-Cheques, Private Banking, Demat Services, NRI

Services, all these in retail banking, driven by branches, ATMs, internet and

call centers. Being a tech-savvy bank, it has taken full advantage of a

liberalized economy and availability of superior technology. Its retail

distribution and services are truly technology-driven.

Well-defined Strategies

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ICICI Bank has adopted a well-defined, carefully planned strategy for

development. The key elements of its strategy have been capitalization of

new business opportunities; build up of a strong brand and distribution

capability, leveraging technology, establishment of robust systems and

human capital.

Strategic Initiatives-Retail Banking

The banks retail assets continued 49% of advances and 42% of

customer assets as on December 31, 2003. The bank continued to focus on

securitization of its customer assets. During April to December 2003 the

total sell-down/securitization of assets was Rs.7, 900 cr. The bank has base

of over 6, 50,000 credit cards at the end of fiscal 2002. Most of the Indian

banks do not appear to be successful in profitability conducting credit card’s

business. It is not known whether ICICI Bank is earning profits from this

retail business. The bank has issued 6, 00,000 debit cards as well. The bank

has been aggressively marketing retail deposits as well, with a view to

reduce the cost of funds besides creating a stable funding base. Its retail

clientele, as a consequence has increased from 3.2 million to over 5 million

during 2001-2002. The average cost of funds has come down to 5.30%

during fiscal 2003.

Other retail initiatives include electronic trading on the stock

exchanges, called “ICICI Direct”. The bank produces digitally signed

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contract notes, allowing customer to view and print contract notes online. Its

multi-channel distribution strategy is fairly successful. The branches now

account for about one-third of the transactions, the rest being done through

one thousand ATM’s, and internet banking accounts. It has over 10,00,000

retail internet banking accounts. It offers internet-based inter bank funds

transfer facility in eight cities through e-cheques. Its call centers can be

accessed by customers in 100 cities, providing a single point of contract for

customers across all products, besides self-service options and personalized

communication with customer service officers.

Corporate Banking Strategy

The bank adopts the strategy of customized financial solutions to

clients. It follows risk-based pricing and proactive portfolio management. It

has been actively partaking in the ongoing public sector disinvestment

process through structuring and advisory services. The bank has created a

market for securitized debt. It is a dominant player in project finance, loan

syndication and international business in the form of ethnic banking services

to NRIs. It also leverages its home country links for capturing market shares

in select international markets.

As Island of High Wage Earners

The bank pays high salaries to its executive cadre staff and very high

level salaries for other officers. A general manager’s salary is easily in the

range of Rs.25, 00,000 to Rs.50, 00,000 gross per annum, depending on the

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performance. CEO, managing director, joint managing directors, and

executive directors clear more than a cr. of rupees annually. It has

introduced Employee Stock Option Scheme (ESOS), two years ago to

enable its employees participate in the future growth and profits of the bank.

Public Recognition

During fiscal 2003, the bank received several prestigious awards in

recognition of its business strategies, customer service levels, technology

focus and human resource practices, linking:

“Bank of the Year 2002, in India” by The Banker magazine of UK;

“Bank of the Year from the emerging markets” by The Banker

magazine of UK;

“Best Bank in India” by Global Finance;

“Best Consumer Internet Bank in India” by Global Finance;

“Best Foreign Exchange Bank in India” by Global Finance;

“India’s Most Admired Bank 2002” in the BB-TN Sofres Mode Poll;

“Best Managed Bank in Asia”, in a poll by Euro money;

“India’s Top 5 most respected companies” Business World magazine;

“Excellence in Retail Banking” award by Asian Banker journal;

Source: ICICI Bank Annual Report, 2003.

Priority Sector Credit

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The level of priority sector credit is less than 7% (2001-02),

consequent to the reverse. This percentage has gone up to 17% by March 31,

2003. The bank would have to deploy an additional 10%, over and above the

requirement of 40%, on the residual portion of its advances to reach the level

of 40% of the net bank credit. This acts as a constraint for the present

lending strategy of the bank, which is oriented towards high net worth

individuals and corporate sector. Augmenting priority credit involves putting

money in sectors like agriculture, SSI, professional and self-employed, retail

trade small business and road transport. The entire retail credit segment of

the bank cannot be classified as priority credit as it includes consumer

finance, shares, advances etc. Housing loans up to Rs.10,00,000 only qualify

for priority sector tag. In such a situation the bank has to alter its business

model towards weaker section segment. Thus, the expansion of SSI

advances, which attracts the medium and large industry segment borrowers

of the bank.

Other Key Highlights

Continued shift in liability profile

Repayment of Rs.11, 000 cr. Of ICICI borrowings.

Deposits constitute 60% of funding.

Wholesale banking product and channel innovation

ICICI e-business, multilingual SME portal.

Roaming current account.

Increase in government relationships; wider product coverage for corporate

with increase in volumes.

Focus on recoveries

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Progress of international initiatives

Increase in NRI deposits and remittances.

Source: ICICI Bank’s Annual Report 2004

Thus, the ICICI Banks toughness has its strengths, faces formidable

challenges. It has to run faster to stay where it is.

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Conclusion

The Asian banking has grown through their performance,

restructuring policy and their efficiency in providing the large amount of

services which helps the banks in their growth, structure and efficiency.

In Asian Banking, the concentration rises when deposit market size

increases as a consequence of deregulation process in banking industry. The

convincing pattern, innovation of new technology and the use of highly

advanced and sophisticated technology which is being used by almost all the

Asian Banks in order to perform their banking functions more efficiently,

effectively and in a proper manner . Thus due to convincing pattern and

latest use of technology which leads to the growth, structure and efficiency

in Asian Banking in a very smooth and convincing manner and which also

helps in increasing the banks profitability and their customers. The evolution

of banking concentration has been non-monotonic in Asia.

It is also important to note that the Asian banks are using

unambiguous entry deterrent tactics when they face new entrants following

the deregulation on cross-sector entry within the banking industry. However

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the Asian banks are growing tremendously which is concluded after the

testing of econometric model which suggests that more or less Asian banks

like Japan and Korea are going through the same path in terms of banking

restructuring and efficiency.

It has been investigated that what has already happened with respect

to the structure of banking in Asia is worth having a closer look at the

on-going process of growth, structure and efficiency to predict the future

banking structure in Asia.

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Annexure

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List of Acronyms

GDP-Gross Domestic ProductROA- Return on Assets.NNP-Net National Product.GNP-Gross National Product.JBA-Japanese Bankers Association.SCP-Structure, Conduct and Performance.FSS-Financial Supervisory Services.IRD-Interest Rate on Deposits.IRL-Interest Rate on Loans.PBOC-Peoples Bank of China.ABC-Agricultural Bank of China.CCB- China Construction Bank.BOC- Bank of China.ICBC-Industrial and Commercial Bank of China.CDB-China Development Bank.XIB-Export Import Bank of China.AMC’s-Asset Management Companies.ADBIT-Asian Development Bank Institution of Tokyo.WTO-World Trade Organization.SOE’s-State-Owned Enterprises.SME’s-Small and Medium Enterprises.NPA’s-Non-Performing Assets.NPL’s-Non-Performing Liabilities.

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Bibliography

www.Asianbanking.org

www.PBOC.org

www.adb.org

www.ICFAIpress.org

www.malaysianbank.com

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