Chinese Banking Reform: Long March to Conquer
Yongyuan Qiao
Oct 20th, 2006
Intro
WILL a rotten apple turn out to be a golden one after you give it to someone else? Only when he is the god. The mess domestic and foreign investors are the “GOD”, because people, at least some believe that going public is one of the best ways to promote the competitiveness of Chinese banks. Recently going public fever is the evidence.
Is going public an efficient way promoting bank governance?
Going public means to sell part of the firm’s share to the public, on the contrary, selling shares to a group of target investors is named private offerings, but not going public. Private offerings was used previously in Industrial and Commercial Bank of China’s (ICBC here after) case to introduce Goldman Sachs and Allianz.
For a public offering, the shares are constituted by two parts. One part is the shares held by the original shareholders of the firm. The other part is the shares freshly issued by the firm. Afterall, the firm needs money.
From ICBC’s IPO prospectus, we can see the money raised by the IPO is used to top up the capital adequacy rate. By investigating ICBC’s capital structure, however, I found that ICBC’s core capital adequacy rate is 8% while the requirement rate is only 4%. Comparing with the contemporary banks, such as 3.15% for Shenzhen Development Bank(SDB here after), ICBC’s core capital adequacy rate is far more from enough.
The firm’s aims might be various by going public, such as introducing strategic investor to promote the firm governance, bringing in shareholders from upper stream firms to build business network and obtaining investors’ evaluation from public traded share prices. The first aim is the most frequently mentioned in ICBC’s case. But if look into ICBC’s case, we will realize that the aim is not fully realistic. ICBC introduced some strategic investor before IPO, after which China National Security Fund(CNSF here after) obtained 4.99% of ICBC’s total shares and Goldman Sachs obtained 5.75%. Although ICBC’s IPO in the near future is forecasted as the biggest ever IPO in the world, H shares for sale are only 10.80% of the total shares and A shares for sale are much less, 3.97% only. Given millions of investors are applying for the share allocation, we can’t imagine that any institutional investor is able to obtain one tenth of the total shares. Even though some one does get one tenth, the shares he will get is just 1%, which doesn’t mean he is unable to act his duty as a strategic investor with such limited voting right.
To sum up, going public can rather bring cash than any additional profit by improving the state owned banks’ governance. However, it seems that banks don’t need money at present. My conclusion here is going public per se isn’t an effective way of improving banks quality.
An optimal way of go public?
Even though that the banks do lack of money, and going public is the best way of going public, I have to point out their ways of going public are not smart.
Firstly, selling stories are now a fashion in IPOs for Chinese banks and it seems that good stories are the admissions for successful IPOs. Years ago, when Bank of Communications (BC here after) went public to bring in strategic investors, its story was “Smaller size, good merge opportunities.” The following China Construction Bank’s (CCB here after) IPO emphasized that it was the “Most profitable bank in China”, by incorporating a fund previously from the government. Bank of China (BoC here after) used the story “most stable growing bank”.
When selling story is a habit for IPO and the word “MOST” is the guarantee for successful IPO, the only reasonable expectation of ICBC’s IPO is some story with the initial word “MOST”. One of the stories ICBC’s selling is “The biggest ever IPO”. The biggest IPO brings a huge impact on the supple side which implies the discount of the shares will be much more severe. The “biggest IPO” brings the scenario to my mind when a magician claimed he would make the Great Wall disappear to promote his performance, but investors are not investing for a magic show.
We should still remember CCB used the word “biggest IPO” in its prospectus when it went public. It does be the biggest IPO in previous five years world wide, but not in the history. No wonder the bible says, “Nothing new under the sun.”
Most mess don’t agree that the National Department of Finance should pay for the loss of the big four banks by injecting huge amount of money, however, I prefer to interpret that as a compensation for the loss of the banks during national economic reform, which is mainly raised by government but not the banks themselves. The thing now I don’t agree with is the timing of going public.
Great pressure will be made for the supple of capital by offering the same kind of shares during a short period. The Chinese banks are now going public at almost the same time, which will be the reason for the more severe competition and a larger cost of capital. The first day profit could be used as a measure of the cost of capital. Recalling the doc-com bubble in U.S., the first day profit is about 20% to 30% for the internet firms while normally this should be less than 10%. For CCB’s offering before the bank fever, the first day profit is 0. However, during the fever, BoC’s first day profit is 15% for H shares and 23% for A shares. This gathering seems like a government behavior but not business.
The last issue is the “Equal Price” between A and H shares. ICBC is the first firm going public in Shanghai and Hong Kong at the same time. In ICBC’s prospectus, they claimed that the price for A shares and H share would be equal subject to the exchange rate. This equalization should work in text books rather than in reality, since no equalization has ever found in the real world for the same share traded in different markets. It’s reported that for most countries with a domestic currency traded market and a foreign currency traded market, the difference in price is significantly existed. In most cases, the same share might be more expensive in foreign currency used market than in domestic currency used market. For Chinese case, I found that BoC’s H share price is normally 3% more than A shares, and China Merchant Bank’s (CMB here after) H share price is 13% higher than A shares. If ICBC issue it’s A and H shares at the same price, the only thing is going to happen is the demand for the shares is too high while on the other market is too low.
End up
Although it’s not perfect for Chinese banks’ IPO, going public is still very important for the banks. Before going public, the banks had to investigate themselves thoroughly. The CEO of CCB, Jianqing JIANG, said that this was the first time we knew ourselves ever. By going public and consequent reforms, the quality of the banks will be promoted and the bank governance will be better in a long run.
As long as the shareholders, especially the nation, can effectively act their right, the bank governance will not rely on going public and other strategic investors. Improving the bank’s service, increasing the understanding of the bank’s customers and clients are the only way to save the banks. Without any foreign strategic investor and going public, the banker Muhammad Yunus in Bangladesh not only issue debts with no mortgage, keeping the loan recovery rate high as 95% till 1998, but also won the Nobel Peace Price in 2006.
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