Saturday, November 9, 2013

ChanYanChong-Commentary 08.11.2013- China’s Banking Industry Likely To Undergo A Major Transformation

 08 NOVEMBER 2013
China’s Banking Industry Likely To Undergo A Major Transformation
By Dr Chan Yan Chong

The US Federal Reserve (Fed) has announced its decision to maintain status quo at its latest round of meeting. It will keep interest rates at super low levels, and continue to buy US$85 billion worth of US government bonds every month. On the day this news was released, US stocks went into correction after hitting a record high, which is a normal reaction of investors cashing out on the back of the good news. Prior to the announcement, the stock market had already gone through a rally, indicating that the decision is within market expectations.

Since the Fed warned of impending tapering in May, Wall Street had gone through a period of turbulence, complete with three significant downturns. The first plunge was in mid-June, the second in end-August, and the third in early October. Even though the Fed has decided not to taper this time round, it will have to do so sooner or later. For this reason, I believe Wall Street will experience a few more rounds of the roller-coaster ride in the future as it continues to be spooked by the tapering spectre. In the short-term, US stocks will move independently according to the performance of individual listed companies and relevant economic data releases.

The US Department of Labour recently announced that there were only 148,000 new non-agriculture jobs created in September, a figure that is far worse than market expectations. Investors, though, are happy with this news, for that meant the Fed will not start tapering so early yet. However, I have been warning everyone repeatedly that I am most concerned about how the People’s Bank of China (PBOC) is playing against the Fed. It is abundantly apparent from history that when the PBOC tightened up, interbank rates would rise and China’s stock market would fall across the board.

Over in Hong Kong, the short-term foci of investors should be on the Third Plenary Session of the CPC and the People’s Bank’s monetary control measures. With the Session convening very soon on November 9, the cacophony of speculations a while back on the possible ideologies to be raised at the meeting has all but died down, leaving behind a palpable sense of anticipation. This round of the Session will focus on reformation and the bid to address some of unresolved major issues and those that the CPC has yet to come to a consensus on. With reforms come uncertainty, which spells bad news for the stock market. However, reforms are always for the better, so in the long run, they will have a positive impact on the stock market.

The Third Plenary Session should be a meeting on economic reforms, rather than an economic planning meeting. I believe that the new leadership under Xi Jinping and Li Keqiang will lean towards a market economy rather than a planned economy. Therefore, we can expect to see a relaxation in many of those industries in which the central government exercises price control, as well as the liberalisation of some industries that are currently monopolised by state-owned enterprises, such as the banking industry. Some would worry that the four existing state-owned banks will lose their oligopoly once competition is opened, which would erode away their share prices. In the long run, however, these four major banks will surely find ways to survive and thrive. In my opinion, liberalising the banking sector to make it more market-oriented is a good thing, because by introducing competition, it will definitely benefit everyone.

Today, almost every city in China would have its own local bank. With increased competition, these small-scale local banks will need to go through reorganisation and integration in the future in order to stay competitive. Call it a coincidence or planned move, but just as Chongqing Bank (listed in Hong Kong on November 6) and Huishang Bank (due to be listed in Hong Kong on November 12) are getting ready to be listed, the PBOC did a reverse repos (repurchase of securities to inject funds into the market). Bank stocks rose across the board in response, which had the effect of highlighting the fact that shares of these two soon-to-be-listed banks are priced relatively cheaply. Chongqing Bank and Huishang Bank are local banks, which mean they inherit the one glaring disadvantage of local banks, which is the difficulty of venturing beyond their geographical boundaries. On the other hand, they enjoy the home-turf advantage and are more willing to lend to small-medium enterprises in exchange for higher interest incomes. This means they can yield higher returns than large state-owned banks. Of course, with high returns come high risks. The key to running local banks then is to spread out the risks intelligently.

Investing in local banks is another form of investing in the future development of the local economy. I am more optimistic about the development in Anhui Province. China’s economic development model is to start with the coastal provinces and cities, and then extend inland gradually. To date, coastal centres like Shanghai, Jiangsu and Zhejiang are already fully developed. As factories begin to move westwards, these regions are moving gradually towards developing their service industries. Anhui is poised for major growth as it is next-in-line to inherit these west-bound industries from Shanghai, Jiangsu and Zhejiang.

In the future, banks large and small will define their own positions and compete with different strategies. Conservative investors could look into diversifying their investment portfolios by adding some medium-sized local banks to supplement the usual staple of large state-owned banks. This is also one reason why I have decided to take up the IPO offer of Huishang Bank. In one way, this is to test how investing in local banks would work out, and also my bid to compare the competitiveness of local banks against relatively large national banks. I also believe that the coming year will see a large number of local banks listing in Hong Kong, which would give investors a bumper load of choices.

The banking sector is the mother of all sectors. When Hu Jintao and Wen Jiabao came to power 10 years ago, one of the first things they did was to push large state-owned banks to go public, so that they would grow in the process. Now that the leadership baton has been passed to Xi Jinping and Li Keqiang, I believe they will carry on with this strategy.

Guangzhou government-owned Yuexiu Group announced recently its acquisition of Chong Hing Bank at twice its price-to-book (PB) value. Rumours are rift that Singapore’s Oversea-Chinese Banking Corporation will acquire Hong Kong’s Wing Hang Bank. If you recall, DBS Group Holdings acquired Dao Heng Bank some time back at three times its PB value. It seems that the multitude of small banks in Hong Kong will become acquisition targets in the long run.

Looking on the bright side, encouraging competition and privatisation of state-owned companies would always result in an enlarged pie to fight over. In the competitive process, the market shares of some businesses may fall, but with a bigger pie, a smaller market share could still translate to decent results. The casinos in Macau are the best example. More than a decade ago, there was only one single casino in the whole of Macau – SJM Holdings. Now that the gaming market has been liberalised, SJM’s market share has declined, but with a significant increase in the gaming industry’s total turnover and net profit, SJM Holdings’ share price has since risen drastically.

Neptune Orient Lines (NOL) recently ended its losing streak with a decent turnaround. The rise and fall of the shipping industry often reflects the health of the global economy. With NOL’s recovery, this means that the global economy is recovering, which bodes well for the global stock market.

Publish date: 08/11/13

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