Details of policies for restructuring and transformation yet to be announced

China will allow the establishment of private banks and other financial institutions funded by private investment on a trial basis.

The government made the announcement after the State Council formulated policies to support economic restructuring, transformation and upgrading.

Shanghai Securities News reported that the China Banking Regulatory Commission has asked provincial governments to make plans for the establishment of private banks and submit their plans to the commission.

Insiders say a proposal made by a province in eastern China suggested minimum deposits of 500,000 yuan ($82,000; 59,750 euros) from high net-worth individuals or companies. The suggestion could protect deposits from potentially high risks, but may also discourage private enterprises from opening banks because they will not have access to small deposits.

On Sept 16, Zhou Xiaochuan, governor of the People's Bank of China, published an article in Qiushi journal calling on the government to relax restrictions on private investment entering the financial market, and to support the establishment of private banks.

Zhou also emphasized the importance of introducing an insurance system for deposits to create a fair competitive environment for financial institutions.

Yang Tao, a researcher at the Institute of Finance and Banking at the Chinese Academy of Social Sciences, says: "The government should adopt the following principles on the development of private banks: In terms of ownership, private investment must hold a controlling interest in the banks; in terms of management, the banks must build their internal power structures independently, operate independently, and assume full responsibility for their profits and losses. In other words, only privately owned and managed banks are real private banks."

By Yang's definition, the number of private banks in China is limited. Despite years of market-oriented reforms, only China Minsheng Banking Corp has the basic features of a private bank. Moreover, only a small number of city and rural commercial banks are privately controlled and have broken away from local government intervention, Yang says.

Although the China Banking Regulatory Commission has yet to issue detailed regulations for private banks, China Business News recently reported that one unnamed local government had already provided the commission with a draft document on the supervision of the pilot private banks. According to the draft, the founders of a private bank must have 500 million yuan to 1 billion yuan as registered capital and the number of shareholders should not exceed 20. In addition, the largest shareholder and related parties will only be allowed to hold shares equivalent to no more than 20 percent of the bank's total share capital.

Shares surge

By late September, 27 listed companies or their major shareholders had submitted applications to establish private banks, or had revealed plans to do so, and the number of applications continues to rise. Since the start of the year, the State Administration for Industry and Commerce has approved at least nine names for prospective private banks, including Suning Bank, according to China National Radio.

In a statement released on Aug 23, the home appliance retailer Suning Commerce Group said it had submitted an initial plan to establish a private bank, but is still awaiting operational details and government approval. The market obviously sees potential in the idea. Shares in the Shenzhen-listed company have surged 81.9 percent in less than three months, from 7.53 yuan on the day before the announcement to 13.7 yuan on Oct 14.

Banking-related shares have also risen sharply during the last two months and are expected to continue advancing over the short term. Shares of Guangzhou KingTeller Technology Co, which manufactures ATMs, surged by the daily 10 percent limit on Oct 8, as investors reacted to news that the company plans to establish a private bank in collaboration with other Guangzhou-based enterprises.

The media and social networking sites have been inundated with speculation that a number of well-known companies, including the e-commerce giant Alibaba Group, and Tencent Holdings Ltd, one of China's biggest Internet companies, had joined the competition to establish their own private banks.

Tencent confirmed that, as a minority shareholder in a financial group seeking a banking license, it will use its online platform and user interface to supplement the group's financial services. However, the company denied that it is planning to apply directly for a banking license, for the time being at least. Alibaba insiders refuted reports that the group has submitted an application to run a private bank.

"Many companies are interested in setting up banks, mainly because they want to make loans to themselves and their suppliers. The move has a similar effect to getting listed. The only difference is that the companies will raise money by taking deposits rather than issuing shares," says Jin Gang, a former account manager at a joint-stock bank in Guangdong province.

And, of course, the high profits in the banking industry are another major attraction for companies. The four biggest state-owned banks occupied the first four positions in a list of China's 40 most profitable companies in 2013, according to a list released by Fortune China. Industrial and Commercial Bank of China was ranked first with profits of 238.53 billion yuan.

In 2012, the nation's banks realized combined post-tax profits of 1.51 trillion yuan, an increase of 20.7 percent year-on-year. Nearly 65 percent of the Chinese banking industry's income came from net interest, according to the China Banking Regulatory Commission.

The net interest margin - the difference between the interest rates for savings and loans - of Chinese banks is 3 to 3.5 percent for state-owned enterprises and local governments, approximately 10 times higher than the international rate. The margin is even wider for private enterprises, more than 7 percent, according to Larry H.P. Lang, emeritus professor of finance at the Chinese University of Hong Kong.

Black market capital

"The central government has urged large banks to support small and medium-sized enterprises for many years, but has achieved minimal results. In the end, the government has no choice but to support private banks," Jin says.

"Today, as the Chinese economy continues to slow, banks do not lack customers. As long as the banks have low-risk, high-profit projects associated with the government, there is no reason for them to invest in small and medium-sized enterprises that are likely to bring problems," he says.

Even if some state-owned and state-held banks are willing to provide loans to SMEs, they usually set the bar higher. China Everbright Bank, for example, defines SMEs as companies with registered capital of at least 5 million yuan and annual sales in excess of 20 million yuan.

According to those criteria, only 3 percent of 100,000 private enterprises in the Nanhai district of Foshan, Guangdong province, are qualified to apply for a loan from China Everbright. And only 10 to 15 percent of those 3,000 companies will eventually obtain the loans they seek, Lang says.

As a result, more than 90 percent of China's private businesses are forced to rely on black market capital, at usurious rates of interest, even though 80 percent of new jobs are created by private companies, he says.

A central bank investigation found that private lending had hit 3.38 trillion yuan nationwide by May 2011, and the average interest rate was 15.6 percent.

In Wenzhou, a world leader in light manufacturing, in Zhejiang province, private lending totaled 110 billion yuan by July 2011, with an annual interest rate of 24.4 percent. Around 59 percent of businesses and 89 percent of families and individuals in the city were involved in private lending in some capacity, according to the local branch of the People's Bank of China.

"If the bar is too high for private capital to enter the financial market, it will find other ways to invest and will fall outside government supervision. But private banks would bring these underground financial activities out into the sunlight by providing a legal channel for investment. That would also strengthen risk prevention," says Lei Wei, a financial researcher with the Development Research Center of the State Council.

The growth of small and medium-sized banks, especially private banks, lags far behind the growing demand. By the end of 2012, China had more than 1,400 small and medium-sized banks, including city commercial banks and village banks, but their assets accounted for just 15 percent of total bank assets nationwide, wrote Ji Zhihong, director of the central bank's research bureau, in an article published in Caijing Magazine on June 20.

According to Yang of CASS, "promoting the development of private banks will increase competition in the financial market and improve the overall quality of financial services. Private banks have significant advantages over their state-owned counterparts in terms of market efficiency, management systems, property rights arrangements, transaction costs and ability to innovate. Accelerating the entry of private capital into the banking industry will spur continual reform of state-held financial institutions."

Wu Qing, a financial researcher with the State Council's Development Research Center, said: "By setting up private banks, China will introduce a new type of institution to the financial system. We hope they will have a different way of doing business and offer different financial products and services.

"For example, Suning's rich retail experience means that it understands the types of financial services retailers require far better than any bank. If the government gives it a banking license, the company will provide good services for itself and similar businesses," he says.

"However, the government is only conducting an experiment. Private banks will only account for a tiny proportion of the Chinese banking system. We can't expect them to challenge the existing system or change the banking industry overnight. China's banking industry will not achieve overall progress until the government loosens the regulations so that all the banks compete in the provision of new services."

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