Risk Management in China

Synopsis
How to develop the China market

General Background
Economic

Demographic

Cultural

People’s Bank of China – Central Bank

 Started functioning as a central bank in Sep 1983.
 Management
Governor – Zhou Xiaochuan

Deputy Governor – Su Ning

  PBC Main Responsibilities
o Issuing and enforcing relevant orders and regulations
o Formulating and implementing monetary policy
o Issuing Renminbi and administering its circulation
o Regulating inter-bank lending market and inter-bank bond market
o Administering foreign exchange and regulating inter-bank foreign exchange market
o Regulating gold market
o Holding and managing official foreign exchange and gold reserves
o Managing the State treasury
o Maintaining normal operation of the payment and settlement system
o Guiding and organizing the anti-money laundering work of the financial sector and
monitoring relevant fund flows
o Conducting financial statistics, surveys, analysis and forecasts
o Participating in international financial activities in the capacity of the central bank
o Performing other functions specified by the State Council
 Other Comments

Regulatory Commissions
China Banking Regulatory Commission (CBRC)
 Launched in Apr 2003
 Management
Chairman – Liu Mingkang
 o Took office as Chairman of the CBRC in March 2003. Currently also serves as Chairman
of the International Advisory Council of the CBRC, a member of the Monetary Policy
Committee of the People’s Bank of China, and a member of the 17th Central Committee
of the Communist Party of China
o Acts as a guest professor at quite a few reputable universities
o Serves as a senior fellow of Hong Kong Institute of Bankers, a member of the
Governance Body of the Basel Committee on Banking Supervision (BCBS), and a director
of the Board of International Center for Leadership in Finance (ICLIF), Bank Negara
Malaysia.
o Received the MBA degree and the honorary doctorate both from the City University of
London.

 Main functions
o Formulate supervisory rules and regulations governing the banking institutions
o Authorize the establishment, changes, termination and business scope of the banking
institutions
o Conduct on-site examination and off-site surveillance of the banking institutions, and
take enforcement actions against rule-breaking behaviors
o Conduct fit-and-proper tests on the senior managerial personnel of the banking
institutions
o Compile and publish statistics and reports of the overall banking industry in accordance
with relevant regulations
o Provide proposals on the resolution of problem deposit-taking institutions in
consultation with relevant regulatory authorities
o Responsible for the administration of the supervisory boards of the major State-owned
banking institutions
o Other functions delegated by the State Council
 Supervisory focuses
 o Conduct consolidated supervision to assess, monitor and mitigate the overall risks of
each banking institution as a legal entity
 Stay focused on risk-based supervision and improvement of supervisory process and methods
o Urge banks to put in place and maintain a system of internal controls
o Enhance supervisory transparency in line with international standards and practices

China Securities Regulatory Commission (CSRC)

 The equivalent of SEC in China

 Management

Chairman – Shang Fulin

o He holds a Ph.D. in finance from Southwestern University of Finance and Economics,

Chengdu, China. Dr. Shang has been the Chairman of CSRC and a member of Monetary
Policy Committee of the People’s Bank of China since December 2002.

o Started banking career in 1973. Has had a successful and prominent career in China's
central bank and commercial bank for many years before presiding over CSRC.

o Had been focusing his attention on theoretical research and practice in monetary policy
and related areas.

 Basic Functions

o To establish a centralized supervisory system for securities and futures markets and to
assume direct leadership over securities and futures market supervisory bodies.
 o To strengthen the supervision over securities and futures business, stock and futures
exchange markets, the listed companies, fund management companies investing in the
securities, securities and futures investment consulting firms, and other intermediaries
involved in the securities and futures business. To raise the standard of information
disclosure.

o To increase the abilities to prevent and handle financial crisis.

o To organize the drafting of laws and regulations for securities markets. To study and
formulate the principles, policies and rules related to securities markets. To formulate
development plans and annual plans for securities markets. To direct, co-ordinate,
supervise and examine matters related to securities in various regions and relevant
departments. To direct, plan and co-ordinate test operations of futures market.

o To exercise centralized supervision of securities business.

China Insurance Regulatory Commission (CIRC)

 Founded in Nov 1998.
 Supervises and manages the insurance market and maintains the legal and stable operation of
insurance companies in the country
 Management
Chairman – Wu Dingfu

o Appointed Chairman of CIRC in Mar 2003.

 Main Responsibilities
o Formulates guidelines and policies for developing insurance business, to draw up
development strategies and plans for the industry; to formulate laws, rules and
regulations for insurance supervision; and to introduce rules and regulations for the
insurance industry;
o To examine and approve the establishment of insurance companies and their
subsidiaries, insurance group companies, and insurance holding companies; together
with other departments concerned, to examine and approve the establishment of
insurance assets management companies; to examine and approve the setup of
representative offices of overseas insurance institutions in China, insurance
intermediary institutions such as insurance agencies, broker companies, appraisal
companies and their subsidiaries; to examine and approve insurance agencies to be
established overseas by Chinese insurance and non-insurance institutions; to examine
and approve the merger, split, change and dissolving of insurance institutions, to decide
whether to take over or reallocate assets; to be involved and organize the bankruptcy
and clearance of insurance companies;
o To examine and approve the qualifications of senior managers of various types of
insurance institutions; to formulate basic standards for the qualifications of staff
engaged in insurance;
o To examine and approve the categories of insurance schemes related to public interests,
to impose insurance articles and rates of premium for compulsory insurance schemes
and newly developed life insurance schemes, and to accept filing for the record of
articles and premium rates of other insurance schemes according to law;
o To supervise the payment ability and market conduct of insurance companies; to be in
charge of the management of insurance guarantee fund, supervise insurance deposit; to
formulate regulations according to law and state policies in regard to the operation of
insurance funds and to supervise the operation of funds of insurance companies
according to law;
o To supervise policy-oriented insurance and compulsory insurance operations; to
supervise such organizational forms and business operations as special self-insurance
and mutual insurance. To oversee such organizations as insurance trade associations
and societies;
o To investigate and mete out punishment against unfair competition and illegal conduct
of insurance institutions and individuals as well as the operations of non-insurance
institutions and disguised insurance operations;
o To supervise and oversee organizations stationed overseas by domestic insurance and
non-insurance institutions according to law;
o To draw up information standard for the insurance industry; to establish insurance risk
appraisal, forecast and supervision systems, to trace, monitor and forecast operations in
the insurance market, to take charge of compiling data and statements of the national
insurance industry, copy them to the People's Bank of China and promulgate according
to relevant regulations of the state; and
Brief Overview of Key Industries
Banking
There are four major state-owned commercial banks known as the “Big Four”: the Bank of China (BOC),
the China Construction Bank (CCB), the Agricultural Bank of China (ABC) and the largest of the four the
Industrial and Commercial Bank of China (ICBC).

 ICBC is 2nd in foreign exchange business, 1st in RMB clearing business and is the largest in total
assets, consumers and employees
 BOC specializes in foreign-exchange transactions and trade finance
 CCB specializes in moderate to long-term term credit for specific long-term projects, e.g.
schools, housing developments, transportation and communication systems
 ABC specializes in financing China’s agriculture sector and provides banking services for
township and village enterprises known as TVEs.
 A Brief Comparison (@USD/CNY 6.82820 on 24 Sep 2009)
Rank by Total Assets

(in USD Market Net Income

Total Assets Deposits Total Equity P/E Ratio
millions) Cap. (31-Dec-2008)
ICBC 247,983 1,430,112 1,205,254 88,404 16.09 15,937
CBC 206,004 1,107,351 934,474 68,293 15.7 13,323
ABC 1,027,262
(Private N.A. (as of 31-Dec- 892,977 N.A N.A. 7,535
incorporated) 2006)
BOC 157,231 1,018,860 747,781 68,043 12.99 9,260

ICBC
 Shareholding structure
o State-owned shares, shares held by other domestic investors and shares held by foreign
investors are restricted on sales
  Profitability

 Financial indicators

2008 2007 2006

Return on average total assets 1.21 1.02 0.71
Return on weighted average equity 19.43 16.23 15.37

Non-performing Loans ratio 2.29 2.74 3.79

Allowance to NPL ratio 130.15 103.5 70.56
Allowance to total loans ratio 2.97 2.84 2.68

Core capital adequacy ratio 10.75 10.99 12.23

Capital adequacy ratio 13.06 13.09 14.05
Total equity to total assets ratio 6.22 6.26 6.27

 Loan Quality Analysis

o NPL dropped by RMB 7,292 million (USD 1,068 million)
o NPL ratio decreased by 0.45 percentage points to 2.29%
o NPL balance and NPL ratio have declined for 9 consecutive years.
o Allowance to NPL ratio increased to 130.15, enhancing the bank’s ability to resists risks.
 o The bank has combined different measures to enhance the collection and disposal of
NPLs in 2008.
o Has become the first bank to build and put into use a special asset management system
which includes the NPL Management Information System, Personal NPL Management
Information System and Suspended Asset Management System. The systems improved
the efficiency of disposal of NPLs.
o
 Risk Management System

ICBC has a comprehensive risk management system.

o Plan for Implementation of the New Basel Capital Accord was formulated in 2008
o Internal Rating-based Approach on credit risk
o Internal Models Approach on market risk
o Advanced Measurement Approach on operational risk
 Recent News

CBC
 Shareholding structure
State-owned shares and shares held by foreign investors are restricted to sales.
  Profitability
 Financial Indicators

2008 2007 2006 2005 2004

Return on average total assets 1.31 1.15 0.92 1.1 1.31
Return on weighted average equity 20.68 19.5 15.0 21.75 22.99

Non-performing Loans ratio 2.21 2.6 3.29 3.84 3.92

Allowance to NPL ratio 131.58 104.41 82.24 66.78 61.64
Allowance to total loans ratio 2.91 2.72 2.7 2.57 2.42

Core capital adequacy ratio 10.17 10.37 9.92 11.08 8.6

Capital adequacy ratio 12.16 12.58 12.11 13.49 11.32
Total equity to total assets ratio 6.19 6.4 6.06 6.27 5.0

 Loan Quality Analysis

o NPL ratio continues to drop on a year-on-year basis. It dropped by 0.39 percentage
points to 2.21%.
o Overseas operations developed soundly, however, the NPL ratio for overseas operation
increased slightly, due to the global financial crisis.
  Risk Management System

 Recent news

ABC
 Shareholding Structure
  Profitability

 Financial Indicators

 Loan Quality Analysis

 Risk Management System

 Recent news

BOC
 Shareholding Structure

 Profitability

 Financial Indicators

 Loan Quality Analysis

 Risk Management System

 Recent news

List of Other Banks

Recent News
25 Sep 2009: Market News International

The volume of new loans extended in Sep by Chinese banks has exceeded August’s CNY 410.4 billion
(approximately USD 60 billion).

Chinese banks extended a record CNY 8.15 trillion (USD 1.2 trillion) during the first 8 months of 2009,
including an average CNY1.2 trillion (USD 175 million) lent out each month during the first half.

Securities
Stock exchanges
Transaction volume

Insurance

Real Estate
House price index: (show the graph)
26 Sep 2009, China Daily

In PBOC’s 3rd quarter survey, more than 65% of urban residents from fell housing prices were “high and
unacceptable”, up 2.8% from the 2 nd quarter.

However, respondent’s willingness to buy houses and cars were buoyant, at 17.1% and 12.8%
respectively, up 1.3% and 0.6% compared to 2 nd quarter.

It is a tradition in China that parents will help newly married couple with home purchase by paying the
down payment. However, it is still common that working adults see themselves as “house slaves” as
more than half of their salary goes to pay mortgage. The monthly installment is so high and has have
lowered their life quality. This predicament is not only restricted to top-tier cities like Beijing and
Shanghai, but exists in other cities as well.

The property market in china is expected to continue a booming trend in the 4 th quarter of 2009, due to:

 Loose monetary policies is expected because the economic recovery is not yet stable

 Supply falls short of demand because many developers have cut construction plans last year due
to the economic downturn.

Recent Development
Regulations
CBRC issued Commercial Banks Operational Risk Management Guidance in 2007 (comment?)

CBRC issued Notice on Reinforcement of Risk Management by Financial Institutions Dealing with
Institutional Clients on Derivatives in 2009

New Derivative Trading Rule

According to the announcement by PBOC and State Administration of Foreign Exchange lately, starting
from Sep 16 2009, banks are only allowed to trade financial derivate products in China with peers that
they have signed a master agreement with.

Foreign-invested banks are now confronted with the stringent regulation that has made it very difficult
for them to stand in the fast-growing financial derivatives trading market. This is because:

1. Few of the big players, such as the Big Four” banks have inked such agreement with their foreign
peers. These banks are major players in the interbank financial derivative product trading,
supplying 30% to 40% of the market liquidity. That is to say, a majority of the foreign banks will
have to suspend trading with the major force in the market.

2. On the other hand, some domestic banks come up with conditions that are difficult for foreign
banks to comply with. E.g
 1) Some seek credit guarantee from foreign bank’s overseas parent before signing the
agreement

2) Some insist that the parent companies of their peers should take responsibility for possible
default.

The Stimulus Package

GDP slid to 9% in 2008, first time in 9 years.

The 4-trillion-yuan (USD 585.8 billion @ USD/CNY 6.82820 on 24 Sep 2009) stimulus package is:

o Introduced late 2008 following the fallout of the US financial crisis, and revised in Feb
2009
o Aimed to boost the slowing Chinese economy by spurring domestic spending and
demand (China GDP growth slid to 9% in 2008 for the first time in years)

The latest revised spending falls under seven broad areas:

1) Public infrastructure development – 1.5 trillion yuan (USD 220 billion), 38% of total.
Projects include railway, road, irrigation, and airport construction
2) Post-quake reconstruction – 1 trillion yuan (USD 146 billion), 25% of total
It is allocated for the reconstruction works in Sichuan regions hit by earthquake last May
3) Social welfare plans – 400 billion yuan (USD 59 billion), 10% of total
Plans include the construction of low-cost housing, rehabilitation of slumps, and other social
safety net projects.
4) Rural development – 370 billion yuan (USD 51 billion), 9%
Projects include building public amenities, resetting nomads, supporting agriculture works, and
providing safe drinking water
5) Technology advance programs – 370 billion yuan (USD 51 billion), 9%
These programs are mainly targeted at upgrading the industrial sector – gearing towards high-
end production to move away from the current export-oriented and labor-intensive mode of
growth. This is in line with the government’s latest blueprint for revitalizing 10 selected
industries.

Industry/ Measures Comments

Sector
Machinery,  Increase export rebates for textile producers to 15% from  Aimed to reduce
Textile 14% reliance on
industry  Special textile-industry fund for structural adjustment and imported parts.
technological upgrading
  Scrap of tariff exemption for imported machinery parts
that China could produce on its own (proposed)
Shipbuilding  Increase credit support by an unspecified amount for ship  Support for the
industry buyers shipbuilding
 Extend the existing financial support policies for industry also help
oceangoing vessels until 2012, e.g. tax rebates other sectors,
 Construction of new docks and expansion of slipways such as steel,
would be suspended for three years to facilitate industry chemicals,
restructuring textiles, light
 Investment in R&D in high-tech ships and maritime industry,
engineering equipment equipment
manufacturing
Auto & Steel  Lower the purchase tax on cars under 1.6 liters from 10%  This is to
sectors to 5% stimulate sales
 5 billion yuan (USD 730 million) is allocated to provide one-
off allowances to farmers to upgrade their three-wheeled
vehicles
 Increase subsidies for people to scrap old cars
 Cancel regulations that restrict car purchases
 M&As among automakers and part makers are encouraged
to optimize resources and improve their competitiveness
 In the next three years, 10 billion yuan will be provided as
a special fund to support auto companies to upgrade
technology, and develop new engines that use alternative
energies
 Government is to offer financial support to promoting the
use of energy-saving autos and those fueled by new
energies
 Government is to support automakers to develop
independent brands and build auto & auto parts export
bases
 Urges improvements in the credit system for car purchase
loans – currently, more than 93% of Chinese vehicles are
sold in the domestic market, but less than 10% are
purchased on credits
Electronics and  Government is to boost innovation, increase financial input  The plan to
Information and promote the use of IT in various fields in the next boost domestic
Industry three years demand is
 Investment will focus on boosting the progress of 3G implemented in
mobile communication services and promoting the use of a bid to offset
digital TVs weakening
 Adjustment of recognition standards for high-tech global demand
enterprises and tax rebates for electronics and information
product export will be also be given
Light industry  Lift trade restrictions on some labor-intensive, technology-
& intensive, energy-efficient and environmental-friendly
Petrochemical products
 sector  Raise export rebates of some light industrial products
 Extend fiscal and credit support to SMEs within the sector
 Add microwave ovens and induction cookers to the list of
home appliances that come with a government subsidy for
rural buyers
 Act to expand urban and rural consumption and to
increase supply of light industrial products on the domestic
market
 Improve foreign trade services and maintain export
volume
 Speed up technological upgrades, with focuses on
independent development of equipment and
industrialization of key technologies
 Strive to boost demand for petrochemical products in
order to maintain the stable development of the sector
 Policy support to the petrochemical sector, such as
accelerating the building of finished oil product reserves,
better tax policies and more credit access for firms
Nonferrous  Promote company restructuring and will offer subsidized The logistics
Metals & loans to support technical innovations within in the industry is a service
Logistics nonferrous metals sector that could
industry  Export rebate for nonferrous products will be increased give a major boost
 Eliminate technically undeveloped producers and avoid the to production and
increase of excessive output capacity consumption, as
 Nine key projects are decided to boost the logistics sector, well as providing job
including supplying necessary equipment as well as opportunities
promoting an industry standard and an information
platform
 A special district for logistics development is to be built to
boos urban delivery, wholesale and rural logistics
 Encourage M&As between companies in order to nurture
large and modern logistics companies which could
compete in the international market

6) Sustainable development – 210 billion yuan (USD 31 billion), 5%

This portion is allocated for promoting energy saving and poison gas emission cuts, and
environmental engineering projects
7) Educational, cultural projects – 150 billion yuan (USD 22 billion), 4%

The stimulus investments require cost-sharing between the central government, local governments and
private sectors. In total, the central government will only provide 1.18 trillion yuan of funds.
 Source: National Development and Reform Commission, China

Recent News
25 Sep 2009: SinoCast Macro & Breaking Economic News Beat

Macro-economic confidence index of bankers hit 55.4% in china in the 3 rd quarter of 2009, rallying 15.4
percentage points over previous quarter, according to surveys issued by the PBOC.

Bankers predicted that macro-economy would continue turning better in the fourth quarter of the year.

Macro-economic climate index of entrepreneurs hit 39.9% in the 3 rd quarter, up 5.3 percentage points
over the figure in the 2nd quarter, a rise for two consecutive quarters following a bottom in the 1 st
quarter of 2009.

According to another general survey by PBOC:

 65% says homes were not affordable

 41.5% predicted that the prices would rise during the 4 th quarter

 44.6% chose “I can hardly accept the inflation rate”, 1.3 percentage points higher than in 2 nd
quarter

 51.8% thought goods prices were affordable, 1.4 percentage lower

  43.1% favored putting money at bank (down from record high of 47% in last quarter), 15.3%
spent more, and 41.6% invested more.

17 Sep 2009: SinoCast Macro & Breaking Economic News Beat

PBOC is taking a cautious attitude on the use of renminbi international concept, says Guo Qingping,
governor assistant of the central bank.

Internationalization of a currency should be decided by the market, at least three factors:

1) The nation that backed the currency must have enough competitiveness in economy

2) The financial market that supported the currency must be developed, and the currency ought to
be available for convertibility

3) The environment where the current operates should keep stable continuously.

The status of renminbi is seen as had risen on the global market, but it has not attained full
convertibility.

By the end of the previous week, cross-border trade renminbi settlement had arrived at CNY 70 million
(USD 10 million).

17 Sep 2009: SinoCast Macro & Breaking Economic News Beat

China had had six-month-overdue credit card debts of CNY 5.773 billion (USD 845 million) in total by the
end of 2nd quarter of 2009, rising 16.2% or CNY 803 million (USD 117 million) as compared to the figure
in the 1st quarter, suring 131.3% on a year-on-year basis.

Opportunities
From the three sectors:

Other sectors: Real Estate

Problems
Banking industry
 Weak risk culture.
 No effective communication and reporting channels on risk issues
 Ignorance of operational risk
 Lack of competence and risk management talents
 Room for improvement in Risk Management methodology
 Lack of risk management information makes it difficult to quantify risk
 Corruption – non-transparency of credit policy, who to lend to? Why?
Securities

Insurance industry
 Significant regulatory risk from CIRC
 Incompetent insurance agents, cases of fraud and customer complaints is common

Article – China Economic Weekly