50 China & World Economy / 50-61, Vol. 12, No.

1, 2004

Foreign Banks in China: What Impact

Would They Bring about?

He Liping *

Ａｂｓｔｒａｃｔ
After a long absence, foreign banks are coming back to China as the country becomes
increasingly open and its economic and financial systems become more liberalized. The
entry of foreign banks will bring significant impacts on China’s economic and financial
development in the future. A most notable impact will be their catalyst role in facilitating the
rationalization of the country’s banking and financial regulation system. In addition, a
greater role played by foreign banks will necessarily pose serious challenges to China’s
macroeconomic stability management in the long run.

Foreign banks are coming to China. Since China became a member of the World Trade
Organization (WTO) in 2001, a number of foreign-banking institutions have announced
their intent to enter the Chinese market. Several foreign banks bought stakes in Chinese
banks, while others expanded their branch networks in major Chinese cities to prepare for
local currency banking businesses, which have been made possible only recently.
The wave of foreign banks entering China today may have vast and profound
implications for the future of Chinese economy and finance. Compared to the huge amount
of total assets held by domestic Chinese banks which is about US$1 trillion and
approximately equivalent to China’s gross domestic product (GDP) in one year today
foreign banks in China only own a tiny proportion of it (4 percent at most). Yet, foreign
banks stand out as a serious competitor to domestic Chinese banks and the new challengers
to China’s existing banking system, which has been characterized by state ownership,
government intervention and immunity to international market fluctuations. Given the fact

* He Liping, professor, Department of Finance, School of Economics and Business Administration,

Beijing Normal University. lphe@bnu.edu.cn.
 Foreign Banks in China: What Impact Would They Bring about? 51

that many foreign banks are currently seeking a union with Chinese banks, which are also
flirting with foreign suitors, it would be interesting to know what impact foreign banks
would bring to China’s economy and finance in the future.
This paper will first of all provide a brief review on what foreign banks had been
doing in China until the time China joined the WTO in 2001. In Section II the pattern of
foreign bank entry into China and their businesses will be analyzed with regard to their
integration with China’s economy and finance. Section III will discuss the likely long-term
impact that foreign banks will have on the future development of China’s economy and
finance. Finally, Section IV will draw a conclusion.

I. Foreign Banks in China: A Brief Background

Historically, foreign banks were not a novelty to modern China. They first appeared in
China’s “treaty ports” where a few select coastal cities were opened to foreign businesses
under “unequal treaties” during the mid-19th century. In the early period, foreign banks
mainly served as international trade portals between China and the outside world. Toward
the end of the 19th century, a U.S. consul-general in Shanghai observed that while indigenous
Chinese banking firms lacked a clearly defined legislative and regulatory banking framework,
they had developed a well-functioning operational system in major aspects of modern
banking, such as issuing notes, accepting deposits, lending and clearances in some port
cities they even enjoyed certain competitive advantages over foreign banks (Jernigan,
1896,pp.546-567).
Yet the arrival and growth of foreign banks in China exerted a great impact on China
between the late-19th century and the 1930s. First of all, they inspired Chinese people to
create and develop a modern banking business in their own right. The first modern Chinese
bank was established in 1897 by a high ranking bureaucrat with extensive business experience
with foreign firms. Ten years later, the first private Chinese bank was formed by a group of
business people in Shanghai, some of whom had worked at foreign banks. Secondly, a
large congregation of foreign banks in Shanghai turned the city into a significant
international financial center in the “Far East,” foreshadowing the coming of its contemporary
peers like Hong Kong and Tokyo. Thirdly, the interplay between foreign banks and domestic
Chinese banks in Shanghai, together with other centripetal financial and non-financial
market forces, made the city an effective financial center for China during its heyday in the
1930s, remarkably facilitating the process of national economic integration that would
otherwise have remained very fragmented (For a detailed account of this background, see
52 He Liping / 50-61, Vol. 12, No. 1, 2004

Cheng, 2003; Ji, 2003).

In hindsight, however, one might wonder whether the accelerated financial link
between the country’s financial center and the rest of its regions had played a role in
accidentally destabilizing the monetary system at a conjuncture when China struggled with
a series of turbulent internal and external events. An episode documented in Friedman
(1994) occurred during the mid-1930s when China was compelled to abandon its previously-
prevailing silver standards in response to soaring international silver prices and a subsequent
money drain and adopted a fiduciary system that ultimately led to hyperinflation in the
1940s when the civil war occurred. Then, foreign banks in China might not have been held
responsible for the mischief, although the government responded to the situation by
establishing a banking structure dominated by state-owned national institutions and
imposing strict restrictions on foreign-exchange markets that were largely inherited (under
different names) in post-1949 China.
From a historical point of view, the new arrival of foreign banks in China, following
Deng Xiaoping’s reform and opening-up policy introduced in the late 1970s, may be
regarded as their re-entry. The absence of foreign banks in China between the 1950s
and 1970s had been coupled with the nationalization of the country’s banking sector,
shrinking of commercial and financial activity, and emphasized inward economic
development. It is the reform and opening-up policy that not only began to change
China’s economic landscape, but also ushered in a comeback of foreign banks to
China.
Between the early 1980s and late 1990s a number of foreign banks made their
presence known in the country by establishing Chinese branches (Figure 1). The business
of banking that these foreign banks were serving, however, was subjected to tight
restrictions and was very limited in scope (for more details, see He, 2002). First of all, most
of such branches were only allowed in geographical locations such as the “Special
Economic Zones” (SEZs). Secondly, they could only engage in foreign currency-
denominated banking businesses, i.e., not in the Renminbi. Thirdly, they could only deal
with foreign firms or expatriates in China, not with Chinese firms or ordinary residents.
And finally, it was stipulated that funding for foreign banks come entirely from abroad,
with no access to local finances. During this period there were several Sino-foreign
banking joint ventures where similar restrictions were applied. Due to the restrictive
measures, until recently, the main business of foreign banks was trade finance and money
transfers. As a result, foreign banks had little links with China’s domestic banking and
financial markets, although they may have provided necessary assistance to foreign
direct investment in China.
 Foreign Banks in China: What Impact Would They Bring about? 53

China’s WTO membership and accompanying commitments to opening up its domestic

banking market made changes to the policy environment for foreign banks. Encouraged by
policy relaxations and attracted by huge market potential, many foreign banks also began
to respond positively by shaping their new development strategy in China. Foreign bank
news even made headlines in recent China.

II. Foreign Banks in China Today: What They Are Doing?

Immediately after it was announced that the country had joined the WTO in November
2001, China’s financial authorities publicized the content and timetable for lifting restrictions
on foreign banks in China (People’s Bank of China, 2001). Basically, it was stipulated that,
first of all, geographical restrictions on foreign branches would be discarded; secondly,
foreign banks would be allowed to conduct banking businesses with Chinese firms, and
later with Chinese residents; and thirdly, foreign banks would be able to conduct businesses
either in foreign currency or Renminbi. The measures are expected to take full effect within
five years from 2001. In addition, not part of the new policy package announcement, another
policy will also allow foreign banks to participate in China’s interbanks and securities
markets. More significantly, financial regulators in China have repeatedly made it clear that,
foreign banks would be gradually treated on “equal footing” with domestic banks.
It is not difficult to see that the policy announcement has been more than an extension
of the olive branch. With the anticipation of more opening-up in China’s domestic banking
and financial markets, foreign banks have been remarkably active on the following fronts.
54 He Liping / 50-61, Vol. 12, No. 1, 2004

1. Opening more branches in more Chinese cities

In 1993, when the Chinese economy was heating up in light of Deng Xiaoping’s popular
talks in South China, rumors circulated that China could possibly open up its financial
markets very soon, and a large number of foreign banks came to set up offices in China. The
enthusiasm faded away shortly afterwards since the economy was not ready for an opening
up. But in 2002, a number of new foreign bank branches emerged, and the numbers are
expected to climb for years to come. Unlike the first half of the 1990s, new foreign bank
branches have opened up beyond traditional, coastal regions, such as Shanghai and
Shenzhen, and a number of inland Chinese cities have been chosen by foreign banks as the
locations for their new branches. This reflects their intent to conduct and expand local
business on the Chinese market.

2. Offering an increasing variety of banking

services to local customers
Several large international banks have made advances in China’s retail banking sector.
They began conducting or preparing for services in a wide range of fields, such as consumer
auto loans, housing mortgages, Internet banking, as well as debit-card and credit-card
operations. Retail banking is normally a sector where domestic or local banks have a
competitive edge over foreign players, requiring a great deal of socio-cultural input. The
fact that foreign banks, as newcomers on Chinese markets, intend to enter this sector may
have reflected their perception that not only is this a niche with huge potential, but also
where they can apply expertise obtained elsewhere.

3. Developing corporate banking and preparing

for money centers
Shortly after China’s WTO membership was announced at the end of 2001, a large
international bank successfully persuaded a large international manufacturer in China to
switch to a foreign bank. One of the lures was that the factoring services provided by the
former were not applicable to the Chinese bank or any other contemporary Chinese
institution. This case suggests that foreign banks are promoting their competitive products
in China’s corporate banking markets and undercutting Chinese competitors, especially in
certain corporate client categories. In another development, foreign banks will be permitted
to enter China’s interbank market, although, at present, this privilege only exists on a
limited scale. With more international investment funds entering China’s securities markets
and capital flowing across Chinese borders, the role of foreign banks on China’s currency
markets is expected to grow steadily.
 Foreign Banks in China: What Impact Would They Bring about? 55

4. Acquiring stakes in domestic Chinese banks

Since December 2001, several Chinese banks were reported to have sold their stocks to
foreign banks. The new foreign-bank owners included large international banks based in
Hong Kong and Singapore, as well as some foreign non-bank financial institutions and
investors. Targeted Chinese banks were city-focused commercial banks (“small banks” in
the Chinese sense) and share-holding commercial banks (“medium-sized banks”, sometimes
called “regional banks” in China). In any case, no foreign banks have acquired controlling
stakes in targeted Chinese banks, but the new shareholders usually have a seat on the
board. Geographically, this kind of stake acquisition has occurred in several provincial
capital cities. It is likely that acquiring a stake in Chinese banks by foreign banks has been
an ongoing process to be continued in the near future. An immediate motivation for stake
acquisitions may have been to obtain access to China’s vast retail banking markets, which
may also serve the involved foreign banks in accumulating knowledge and human capital
for their long-term development on China’s banking markets.
It is clear that foreign banks are expanding in China, and they are doing some
serious business on China’s domestic markets. Perhaps there are only a couple of things
they are not doing, nor would they do in the foreseeable future: large-scale deposits from
the public and credit lending to a large pool of domestic money users. Several large
international banks have already begun accepting deposits from the public (although at
present this is limited to foreign currencies), but it seems that it is not in their intent to
establish dense geographical branch coverage to attract ordinary Chinese depositors.
Perhaps also due to regulatory requirements for a large capital base, foreign banks usually

2
Chen (2003) and Shirai (2002) provide a detailed account of institutional characteristic of Chinese
banks under transition. Barth et al (2000, pp.119-251) provide a general reference of international
experience that may be viewed in comparison with Chinese banks.
56 He Liping / 50-61, Vol. 12, No. 1, 2004

have had a higher lending-deposit ratio than Chinese banks (Figure 2). Observers also note
that credit lending by foreign banks has been highly selective and restrictive, partly reflecting
their strict standards of credit-risk control and their unfamiliarity with local markets.
Comparing domestic Chinese banks to foreign banks is a huge endeavor. Suffice it to
note that there are obviously wide and deep differences in ownership structures, corporate
governance, management styles, marketing practices, and so forth, between the two2. In
terms of similarities, both are subject to current Chinese regulations, such as separating
commercial banking from investment banking, interest rate ceilings and the Renminbi’s
inconvertibility. If there is deregulation in these areas in future, foreign banks may possibly
show an additional competitive edge over Chinese players. On the other hand, in the
context of China’s domestic markets, it is Chinese banks that may face a unique, somehow
dilemmatic situation of benefiting and suffering from their close relations with governments.

III. Foreign Banks in China Tomorrow:

What Impact Will They Bring About?

It is reasonable to expect that foreign banks will become an increasingly important player in
China’s domestic financial market. Further deregulation will take place in accordance with
the implementation of government policy that has been formulated with China’s accession
to the WTO. There will be a liberalization in things like interest rate control and currency
convertibility in general, and offering more freedom in conducting business for foreign
banks in particular. At present, foreign banks as a whole have had a tiny share in China’s
domestic banking market, and this share is expected to grow steadily over time when
deregulation takes effect and foreign banks are actively expanding their business in China.
Understandably, there will be certain that an increased presence of foreign banks in
China will make a difference to the country’s economic and financial development in the
foreseeable future. It is almost immediately clear that foreign banks will at least bring about
the impact described below.

1. Foreign banks will further facilitate economic

and financial links between China and the world
Foreign banks in China have already had the tradition of serving foreign investment flows
and related trade activities. For many years the work was done by foreign banks using their
own capital resources. When they become accessible to China’s huge domestic deposit
markets, the role is likely to continue to increase.
 Foreign Banks in China: What Impact Would They Bring about? 57

By the end of 2001, foreign direct investment-related exports accounted for more
than one-half of China’s total exports, and exports for more than 20 percent of China’s GDP.
Through such measures, China has already served as a highly internationalized economy.
With enhanced help from foreign banks these ratios will continue to rise over time.

2. Foreign banks will bring more competition

and inspire the Chinese banking system
Since China still lacks effective private commercial banks and financial institutions of
significant scale, foreign banks stand out as significant commercial players that are largely
independent from government intervention and economically successful at the same time.
From a historical point of view, exemplary roles that foreign banks once played would,
perhaps once again resurface in China. And new, indigenous Chinese banks would emerge.
Existing Chinese banks would possibly diverge into fast and slow learners with contrary
results in performance. There will be an increased number of Chinese banks conducting
business in the same way as foreign banks. In other words, for the most part, Chinese
banks will react positively to increased foreign presence, helping improve their managerial
and operational efficiency.
But what if most Chinese banks will behave like foreign banks, keeping in mind that
the foreign banks known to China are mostly large, international banks. One possibility is
an increase in the number of Chinese banks that are restructuring their businesses and
moving away from their traditional clientele, possibly leaving certain potential domestic
customers without services or without adequate services. Should this occur, it should be
viewed as the result of existing Chinese banks responding to foreign presence by shifting
their attention to similar customer groups. In particular, the small business sector and
people living in rural or urban-peripheral areas are likely to become the victims of this
transition. In this case, the true culprit should be the institutional rigidity of China’s financial
system since diversification in banking institutions and banking services have not been
adequately provided for or promoted by an existing regulatory framework. The foreign
function in this regard is perhaps a “centrifugal” one, which would not have become
centrifugal under different circumstances.

3. Foreign banks will help large Chinese cities, such as Shanghai,

to re-emerge as international financial centers
Due to the tight control on the number of new banks, there are now more foreign than
domestic banks in several large Chinese cities. For instance, by the end of 2001, there were
45 foreign banks in Shanghai, but only 15 Chinese banks (of which four were large, national,
58 He Liping / 50-61, Vol. 12, No. 1, 2004

State-owned banks; 10 were regional, share-holding banks; and one was a local bank). Of
course, Chinese banks usually have a far larger number of branches than foreign banks do.
This situation highlights a pattern of congregating foreign banks in contrast to domestic
banks in some large Chinese cities.
The large, concentrated presence of foreign banks will become a catalyst for Chinese
cities to develop into international financial centers. In a sense, the goal for Chinese cities
to become international financial centers, is only two steps away. The first is the deregulation
of China’s foreign exchanges markets, i.e., the currency market is so deregulated that it is
almost completely open to foreign banks and non-bank financial institutions, as well as
Chinese players. The second step involves having large international banks and non-bank
financial institutions relocate their Asian-Pacific regional headquarters to the Chinese cities
where they can conduct wholesale financial transactions in large quantities and frequencies.
Obviously, the above processes will not happen overnight. However, constant efforts are
being made by provincial and city governments to push towards the goal of becoming an
international financial center.
In summary, it is clear that foreign banks will play significant roles in accelerating
the internationalization of the Chinese economy and finance. It is known that the Chinese
economy is already tremendously internationalized in terms of its high trade to GDP ratio.
In the past, foreign banks have helped vast, foreign direct investment flow into China, and
they will continue to provide necessary services in the process. This time, however, foreign
banks would be in a better position to serve foreign direct investment and related activities
by making use of China’s domestic financial resources which were not previously available
to them. Moreover, via large international banks and their activities, financial flow into
China and across its borders would become increasingly integrated.
A few further questions can be raised concerning the impact of foreign banks on
China in the near future. With regard to China’s existing banking system, one may ponder
whether the presence of foreign banks will help transform Chinese banks from traditional
government-controlled banking units into independent, commercially viable business
entities. Likewise, one may also wonder whether foreign banks will pose a challenge to
China’s macroeconomic stability management in the future. While these two questions are
complex, the summary below can be used as a starting point for further discussion.
Regarding the role of foreign banks in transforming the Chinese banking system, it
has been noted that as new, completely independent players, foreign banks would
undoubtedly provide a good example for Chinese banks to seek development in a similar
way. Success stories about foreign banks in China and elsewhere will also inspire Chinese
entrepreneurs to become more innovative in China’s banking service industry. Foreign
 Foreign Banks in China: What Impact Would They Bring about? 59

stake holdings in Chinese banks minority holdings mainly by foreign banks –　will certainly
bring fresh ideas and contacts for Chinese bankers, and also possibly instil a little more
distance from their previously dominating owner the State. However, existing regulations
on bank ownership seems not to allow any fundamental changes to the current basic
structure. This may reflect a policy intention that not only contains potential foreign
influence on the institutional structure of Chinese banking organizations, but also provides
a necessary, continued base for governments to exert their interventional roles over Chinese
banks. Given this background, it is difficult to imagine that the institutional characteristic of
the Chinese banking system would be reformed significantly in a short period simply due to
the entry of foreign banks or their minority stake holdings in Chinese banks.
So, does it make sense for foreign banks to seek minority holdings in Chinese
banks? It makes sense in the sense that it could provide a channel for foreign banks to
communicate with China’s domestic banking markets, a role that would be of diminishing
significance as foreign banks expand their own branch networks in China. Perhaps some
foreign banks have adopted a strategy combining minority-holding in Chinese bank networks
with their self-owned branch networks. Should this be the case, one can expect that the
marriage between foreign and Chinese banks through stake acquisitions will continue for a
long time.
The most significant impact brought about by foreign banks would be that on
China’s financial regulatory system. To date, China’s financial regulatory system has been
emphatic in controlling market entry for both domestic and foreign players and interest
rates at both macro and micro levels. With more foreign banks obtaining access to China’s
banking markets, there will be an increased demand for financial authorities to open up
market entry to domestic players　 be they government-related agencies or private
institutions. Meanwhile, as banking and financial services and products become increasingly
diversified, it will be more difficult for authorities to maintain control over interest rates at
service and product levels. Regulators have to withdraw direct control of interest rates and
rely on indirect means. In other words, when foreign banks begin to play a role, China’s
banking regulatory system has to make changes in response to the new player　 one that
is independent and must be treated fairly. When this principle is established and embedded
in China’s new regulatory system, China’s domestic players may also benefit. This is not to
say that China’s banking regulatory system will be revolutionized simply because of the
entry of foreign banks. What it means is that without active foreign participation, the pace,
or perhaps the direction of China’s banking regulatory system will be different since the
issue now rests between the government and independent players, not between the
government and its non-independent units.
60 He Liping / 50-61, Vol. 12, No. 1, 2004

The biggest challenge foreign banks will bring to China perhaps surrounds China’s
financial and macroeconomic stability in the long run. Ultimately, foreign banks will become
alternatives for Chinese money holders and become a channel of financial flow across
China’s borders. As discussed earlier, foreign banks will further facilitate China’s external
economic links, thus exposing China’s economy to external shock. This exposure would
not become too big of a problem to manage if the economy had a large and strong domestic
base. But as the economy continued to move along the export-led growth path, its domestic
base could possibly become relatively small and weak. At some point, the economy and its
financial system would both become vulnerable to external shock. Moreover, when this
concurs with the liberalization of capital flow, a small shock could more easily be amplified
into a serious consequence due to a faster shift in resources and financial contagion
effects under a more open economic and financial system. Furthermore, if by then domestic
banks and financial institutions still had significant, unsolved problems of non-performing
loans, the banking and financial systems would be more susceptible to external or internal
shock.

IV. Conclusion

The entry of foreign banks is not new to China. Yet, it is a new concept in some ways. First
of all, foreign banks were permitted to conduct business with Chinese customers after
China joined the WT O in 2001. Secondly, from now on, foreign banks can enter China’s
inland regions. Thirdly, foreign banks can also hold stakes in Chinese banks to form new
partnerships. Finally, foreign banks are entering China as its banking sector is undergoing
some fundamental changes and challenges, and as the country’s financial system is moving
towards external liberalization.
To date, foreign banks have shown great interest in assuming a stockholding
partnership with Chinese banks. Does this suggest foreign banks are more likely to be allies
rather than rivals? Both could be the case. Foreign banks, as a whole, will become a new
competitive force on China’s domestic market and play an increasingly important role in
China’s financial and economic development. The domestic market has not been fully open
to the players yet, and, as such, they will rationalize their approaches to entering the
Chinese market.
Impacts brought about by foreign banks in China will be profound and varied.
Firstly, foreign banks will continue to play an important, supportive role in China’s external
development, helping bridge foreign direct investment in China and China’s trade with the
 Foreign Banks in China: What Impact Would They Bring about? 61

outside world. Secondly, foreign banks will help modernize the Chinese banking system by
providing a competitive, stimulating and exemplary role to domestic Chinese banks. Thirdly,
in the near future, foreign banks in China are likely to pose challenges to China’s financial
regulatory system and macroeconomic stability management.

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