Banking in Asia: Acquiring a Profit Mindset

A treasure of analysis and statistics from McKinsey consultants.

This book has it all: well-chosen statistics, excellent analysis and, last but not least, conciseness. The book is suitable for any commercial banker working in Asia or interested in Asia, as well as for anybody who wants to understand such a fundamental aspect of the region's economic development.

The book, written by a team of Asia-based McKinsey consultants, is divided up into country reports covering the whole of north and south-east Asia in the first part. The second part is arranged thematically, with chapters covering personal financial services, corporate banking, and cross-border M&A.

Jeffrey Wong's chapter on China is especially good. In 30 pages he gives a concise and highly informative analysis of what most observers perceive as the black hole at the heart of the Chinese financial system.

His approach is clever and sympathetic. He draws attention to the numerous balancing acts the Chinese government has to follow, such as propping up state-owned enterprises while guiding the banks towards more profitability as well as exposing the local banks to foreign competition while preventing them from being annihilated.

It's important investors understand the strains the government is under in order to understand why contradictory regulations can appear.

More unique is the way he opens up the promising panoply of business areas that Chinese banks can go into. Despite their huge legacy problems, the encouraging news is that with 'a return to banking basics' Chinese banks can prosper.

Wong points out that state banks, which have the bulk of financial assets in China, could make large profits from the booming small-to-medium enterprise sector as well as consumer finance. In consumer finance, for instance, Wong expects China's economic boom to lead to China becoming the third-biggest market in Asia for mortgages, credit cards and auto financing.

Wealth in the banking sector is astonishingly concentrated, with under 1% of the urban population controlling over half the banking assets. That makes the approach followed by China Merchants Bank, where 20% of the customers have annual incomes of at least $20,000, so apt: focusing on high income customers and providing them with innovative services such as internet banking and all-in-one ATM and debit cards.

Wong doesn't see the problem as being a lack of opportunities, given the boom in home mortgages and the demand for credit cards. Rather, he sees it as the mindset problem of the Chinese bankers.

Thus, they are reluctant to move powerfully into the lucrative credit card area or car financing (only 12% of cars are financed through banks in China) because they don't possess the skill sets. In fact, banks have moved into these areas, but have been badly burnt.

This pushes banks into doing silly things, such as underwriting whole construction projects in order to gain a lock on selling all the mortgages in the finished project. The upside is that they don't have to come up with attractive packaging and services; the downside is the huge risk they are taking on.

Another example is bank assurance. Bank managers were rewarded for selling insurance to customers, but what wasn't taken into account was that the insurance companies would take the premiums paid by policy holders and deposit them back at the bank. The far higher interest rate the banks had to pay on corporate deposits compared to retail deposits easily exceeded the fees the bank gained from insurance companies for selling their products

Speaking of deposits, Wong makes the crucial point that the state banks, though technically insolvent, are a long way from collapse. That's because their loan to deposit ratio is only around 70%, creating enough liquidity to defeat even the severest run on the banks. That fact is just as important as the implicit government guarantee.

The other chapters on Greater China, covering Singapore, Hong Kong and Taiwan are also good. While far better than the mainland banks, Taiwan's institutions are plagued by an inability to move into carefully targeted personal financial services. As on the mainland, and despite attempts to change direction, the focus in on the fiercely competitive corporate banking area. Under this model, retail deposits are seen as cheap funds to lend on to companies and branches tend to be old and not geared to providing customers with better services.

Bankers need to replace this model by focusing on their retail customers, and using data mining to maximize their returns. The banks which do this correctly, for example targeting a credit card at a younger demographic with lower interest rates, tend to do very well. Mainly, however, the banks engage in copycat activities, thus driving down margins. It's this fundamental inability to manage information and hence risk, which is causing banks to miss out on opportunities to lend to the ubiquitous SMEs and to make unsecured loans.

Of the biggest revolution in Taiwan's recent history, the legislation to permit financial holding companies, chapter author Greg Gibb says that while highly unlikely to be panacea, the reorganization of the banking landscape has given bankers the opportunity to think very carefully about where they stand and what they want to do.

Given the overbanking in Taiwan, it's obvious that China should be a target - but for political reasons this is out of the question. Instead, Chinese banks are setting up 'Taiwan desks' to service Taiwanese SME customers.

Hong Kong, despite having the strongest banking system, also suffers from information analysis, as the rocketing credit card default shows.

Trapped in the post handover depression, and with local businesses pouring over the border into China, Hong Kong banks saw their cartel blown open in 2000 and the launch of really serious competition. The competition got so cut throat, with spreads on mortgages shrinking by 300 basis points between 1995 and 2001, that Citibank exited the mortgage market. Other banks dropped out of the much hyped provision of the mandatory pension services. Credit cards were thought to be the answer, and unsecured lending grew 20% per year from 1995-2000. But even in Hong Kong the lack of a credit bureau and shared information systems between banks led to charge-offs of 13% of total balances in 2002, one of the highest rates anywhere in the world.

Wong expects Hong Kong banks to eventually learn how to manage information profitably. In addition, Hong Kong banks have the advantage of being able to move easily into China to follow their customers. But it's highly likely Hong Kong banks will have to consolidate.

The authors conclude that despite the decades of booming Asian growth, the banking system is poised to explode. But this book shows very well how difficult taking proper advantage of the process will be.

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