Three keys to Chinese banking reform – and what it might mean for Australia

" The signs are China’s ongoing structural reforms are heading in the right direction."
Shayne Elliott, CEO, ANZ

ANZ remains confident in China’s economic transition. China - and Asia more broadly - are integral markets for a bank such as ours with its history of financing trade and investment in the region.

But I’m no blind optimist and, like many observers, can see risks as well as opportunity. China’s transition to a modern, more consumption-based economy is progressing but not surprisingly this is not a smooth process – and nor should we expect it to be in the future. But that doesn’t mean it is not happening.

I’ve had many fascinating and insightful conversations about the transition and here are some of the key themes.

STRUCTURAL REFORM

The signs are China’s ongoing structural reforms are heading in the right direction. Continuing to create a vibrant and sophisticated banking sector is an important part of this work.

This, in my view, requires the sector to be open and internationally competitive. Indeed, it is an argument we made at length in our insight report, Caged Tiger: The Transformation of the Asian Financial System.

I would offer three observations about structural reform of China’s banking sector.

First, China would benefit from further developing the role of bond and equity markets. Bank loans currently represent almost 70 per cent of corporate funding. This creates structurally-induced high leverage problems for the corporate sector. I note the Loan-Deposit Ratio of 75 per cent is no longer a mandatory compliance ratio but will now be used to monitor liquidity.

Second, China will benefit from continuing to pursue financial liberalisation and capital account liberalisation, allowing cross border portfolio flows. An established interest rate market is important to support foreign exchange and interest rate hedging of both corporate and financial institutions. Putting in place these arbitrage conditions represent the gold standard in financial markets.

And third, China could encourage greater participation of foreign financial institutions in the onshore market. Foreign banks comprise less than 2 per cent of market share.

Creating a level playing field for foreign banks could be expected to lift the quality of the banking industry and would be an important step towards the objective of making Shanghai an international financial centre by 2020.

Foreign banks currently face different regulatory standards to domestic banks. For example:

• Market entry requirements for certain licenses are still quite restrictive for foreign banks;

• There is a 20 per cent cap on foreign investment in Chinese domestic banks and foreigners can invest in no more than two domestic banks; and

• Foreign debt quotas are an impediment for foreign banks which are less able to fund onshore than domestic banks.

CLOSER FINANCIAL TIES AND OPPORTUNITIES FOR AUSTRALIA

More broadly, our longer term optimism about China rests on some fundamentals:

China’s target to increase urbanisation from 56 to 60 per cent of the population ensures there will be a continuing demand for infrastructure and services, as well as iron ore and other resources.

We also see opportunities for Australian financial services companies to provide infrastructure and project financing for overseas projects by Chinese companies.

Direct convertibility between Renminbi and the Australian dollar has helped lower currency conversion costs, facilitate the use of RMB and Australian dollars in bilateral trade and investment, and promote economic and financial ties between our two countries.

It has also created major new opportunities for the Australian financial services sector as Asia’s growth and the RMB’s internationalisation drives financial depth in the region. There is no doubt the continuing rise of the RMB will bring major benefits for Australian businesses trading with China.

INVESTMENT IN AUSTRALIA

Australia’s economic involvement with China is not one way. In Australia, the banking and financial services sector is open and diverse. There is an increasing presence from Chinese firms and a broadening of services they offer.

In addition to loans, Chinese banks offer trade finance, transactional and securities and investment banking services. And there has been an extension of the customer base beyond the mining sector.

GREATER ENGAGEMENT

For some years now, China has been Australia’s largest two-way trade and services partner and historically we know investment follows trade.

We don’t see any reason for that to be different in this developing relationship. The impediments are self-imposed, whether that be regulation of the banking sector in China or sensitivity over foreign investment in Australia.

These are issues but we are confident the opportunity for both countries is enormous and I want ANZ to play an integral role in supporting the economic and business relationship.

I think we are seeing positive signs and in my time here in Beijing several key themes have been evident.

• China’s rising middle class will increase demand for services and high-end consumer goods from cars to education to medical services and premium food .

• That demand will fuel direct exports and Chinese investment in healthcare, pharmaceuticals, education and agriculture;

• China is increasing its export of capital (underpinned by the “Going Out” policy).

• The ongoing infrastructure demand as China aims to lift urbanisation from 56 per cent to 60 per cent by 2020. Demand for hard commodities will remain resilient given continued urbanisation and demand from Chinese companies operating offshore or in other countries.

Challenges, yes, but great opportunity and ANZ wants to be part of it.

Shayne Elliott is CEO at ANZ