Citigroup in China, an Argument Against

Chinese regulations have historically limited the operations of foreign banks, but with the entry of China into the World Trade Organization (WTO), that is all slated to change- in theory. Geographic limitations for foreign banks are to be lifted by December 2006, along with a host of other restrictions that have retarded the growth of Western banks and the Chinese banking sector as a whole. Progress on these liberalizations has been slow, however, and Chinese regulators have even put other limitations in place that will hurt competition in the long run

This is far from the only problem facing the Chinese banking sector. Decades of policy lending have saddled the four state-owned banks with an unhealthy level of nonperforming loans from state-owned enterprises. Asset management companies have been created to manage these nonperforming loans, but the situation is far from stable. A lack of corporate governance has also created an environment where management of banks is opaque and corruption widespread. The risks inherent in this industry are great.

Midway through 2005, Citibank faced significant barriers to growth in China. It had worked hard to become the dominant foreign bank in the country in expectation that the country's banking sector would be opened to all competition in late 2006. The changes mandated by the WTO have been slow in coming. The Chinese government removed some of the legal barriers to entry in some areas, but had erected new ones elsewhere, including raising reserve requirements to unprecedented levels. In addition to regulatory problems, Citibank is facing serious problems in its own approach to strategy in China. It had initially been aggressive in pursuing every opportunity to buy into Chinese domestic firms as a way to gain an advantage on its foreign competitors. This strategy hadn't produced the results that had been expected.

While the Chinese economy is booming at the moment, it is far from stable. Any economy that experiences growth like China has will be more vulnerable to global economic conditions, and the developing nature of China's market means this is even more of a truth. Questions about the long-term stability and viability of the Communist regime will always top the list of risks of doing business in China, but there are specific problems with the banking sector that concern Citibank. The legacy of policy banking has created an environment that lacks a culture of lending accountability. Currently Citigroup is not doing well in dealing with the following issues.

* Non-performing loans- The Communist system of awarding loans to state owned enterprises, whether they are profitable or not, has lasted until the present day and has saddled these banks with an unwieldy percentage of nonperforming loans. It is impossible to provide an accurate percentage of nonperforming loans among the total number of Chinese bank loans, but even after an enormous government injection of $157 billion into Chinese bank coffers in 2000, the most optimistic estimate of Chinese nonperforming loans stood at 30% of all outstanding loans. Modern banking theory contends that if this percentage stands higher than 5%, warning signals should be sounded (Chang, 2001). This places Citigroup, and indeed the entire Chinese economy, in a precarious position.

* Term structure of foreign banks loans- As mentioned above, if a large number of bank loans are issued in foreign currencies and in maturities of one year or less, it leaves a national banking system at risk of a quick fund pullout in case of a crisis. Due to a lack of lenders issuing loans in renminbi (In Chinese "Renminbi" means "People's Currency"), corporations have been forced to borrow in foreign currencies and in terms of less than one year in order to lower their cost of capital. If there is devaluation in the value of the renminbi, companies may be unable to repay their short-term loans. In this case, Citigroup would have to rely on the huge amount of personal savings that they have accumulated from the public to remain afloat. It is logical to think that a bank rush would result from a devaluation of the Yuan, however, and these savings would also disappear, leaving the bank without the means to continue operations.

* Profitability of banks: An annual system wide return on assets of less than 1% for retail banks and/or an annual net interest margin of less than 2% are often signs of a crisis. As a result of the high number of nonperforming loans,