China Domectic

1

• Neil Tait
• Special Advisor on Asia, BMO Financial Group

China Domestic International Banking Reforms
Presented at the Bankers Association for Finance
and Trades 83rd Annual Meeting A Global Focus
2

• Agenda
• Economic Overview Financial Services
• BMO / Harris Bank in China
• Chinas Domestic Banks
• Their Challenges Reform Measures
• Foreign Banks Pace of Reform
• Currency Revaluation ?

3
Why China really matters ?

• Chinas economic expansion has a voracious
  appetite for raw materials, natural resources,
  energy, food and infrastructure.
• Chinese demand accounts for 12 of the worlds
  supply of pulp, 7 of the worlds supply of oil,
  25 of the supply of aluminum and steel, 30 of
  iron ore and coal and an amazing 40 of available
  cement.
• China devoured nearly half of the aluminum,
  nickel, zinc and lead sold on international
  markets last year.
• With a population of 1.3 billion, roughly 100
  million are middle class with an annual savings
  rate consistently at around 45.
• Chinese acting like our Baby Boomers in their
  spending patterns, which underpin regional
  economic growth just as Americas baby boomers
  shaped the US economy from 1963 1999.
• Chinese natives with Silicon Valley executive
  experience and Ivy League educations are
  populating decision making at Chinese companies,
  leading to more comfort for foreign investors.

4
Strong Macro Economic PerformanceThe Chinese
economy is expected to grow at a sustainable 6-8
over the next 5 years
CAGR 9
CAGR 15
CAGR 12
CAGR 7
5
Fuelled Remarkable Growth in the Financial
Industry
CAGR 52
CAGR 110
CAGR 36
CAGR 35
of Funds 21 34
51 71 112
6
WTO Gradually Opens up China Market
Banking
Securities / Asset Management

• Foreign banks are now allowed to conduct foreign
  currency business without restriction.
• Since Dec 2003, foreign banks have been permitted
  to provide local currency service to Chinese
  enterprises, and from 2007, they will be
  permitted in the retail business.
• Major cities such as Shanghai, Shenzhen Beijing
  are already open to foreign banks, From 2007,
  there will be no geographic restrictions.
• Foreign ownership in Chinese banks is allowed up
  to 25 accumulatively or 20 for a single foreign
  institution.

• Foreign ownership within fund management industry
  is allowed up to 49
• Up to 33 foreign ownership in securities
  companies with A-share license (underwriting and
  trading of domestic securities)
• Foreign financial institutions are also allowed
  to participate in the Chinese domestic A-Share
  market through the QFII (Qualified Foreign
  Institutional Investor) program.
• QDII (Qualified Domestic Institutional Investor)
  program is currently under consideration for
  Chinese enterprises to participate in foreign
  securities market.

Insurance
Auto Finance

• Life Insurers to be allowed 50 ownership in JVs
  wholly owned subsidiaries allowed since 2004.
• Geographic restrictions to be removed.

• Non bank financial institutions allowed to
  provide auto financing oth no major restrictions.
• Volkswagen, Toyota and GM have secured licenses,
  and started operations in 2004.

7
BMO / Harris Bank in China
8
BMO / Harris China Profile
Hong Kong Subsidiary (1969) Branch
(1975) Beijing Rep (1982) Branch
(1996) Guangzhou Rep (1994) Branch
(1995) Shanghai Rep (2002) Taipei Rep
(1990)
Fulllgoal Fund Management Co. Ltd (2003) BMO
27.775 Equity (Haitong Securities, Shenyin
Wanguo, Shandong, ITIC)
CHINA
(Rep Office)
TAIPEI (Rep Office)
HONG KONG
9
BMO / Harris Offering in China Today
10
BMOs History in China

• 1818 First Transaction with China
• 1920s BMO Officers commence regular visits
• 1996 Beijing branch 8th Foreign Bank
• 1997 BMO Board meeting in China 1st outside
  North America
• President Jiang Zemin
• Premier Zhou Rongji
• Former PM Pierre Elliott Trudeau
• 1999 BMO CEO appointed member of Mayor of
  Beijings International Business Leaders
  Advisory Council
• 2003 Fullgoal Funds Management Co. Ltd

11
BMOs History in China(continued)

• 2002/4 BMO ranked 1 FX Bank in China
• (264 Foreign Bank branches)
• BMO ranked 7th largest trading bank in 2003
• (Domestic Foreign)
• BMO one of six foreign banks awarded
  Derivative License by CBRC
• BMO 1st foreign bank to link EBS electronic
  feeds to CFETS
• (China Foreign Exchange Trading System)
• April 2005 BMO and six foreign banks approved
  to trade in 8 currencies with BOC and CITIC
• EUR / USD AUD/USD GBP / USD USD / JPY
• USD / CAD ASD / CHF USD / HKD EUR / JPY
• Deutsche BK, HSBC, ABN AMRO, ING, RBS, Citibank
• June 2005 IMC Beijing

12
Chinas Domestic Banks
13
Five Main Categories of Banks
MKT Share by 2003 Assets

• 4 State Owned Commercial Banks
• 3 Policy Banks
• 10 Joint-Stock Commercial Banks
• Local Banks and Others
• Foreign Banks
• Four Groups
• Branches with RMB License
• Branches without RMB License
• Sino-foreign Joint Venture Banks
• Representative Offices

• 57
• 8
• 14
• 20
• 1

14
Sector GrowthDynamic Sector Growth driven by
broader economic growth, 40 savings rate and
banks focus on loan growth
Deposit CAGR 25.3 Loan CAGR 20.4
15
Challenges facing Chinese Commercial Banks

• Chinese Banking Market has great growth potential
  but high risk
• Transformation of planned economy to market
  driven mindset
• Resolving NPLs while controlling increase of new
  non-performing assets
• Excessive liquidity and change of investment
  structure
• The need to boost corporate governance efficiency

16
Broad-based Reforms Liberate the Chinese
Financial Market

• SOE Reform
• Regulatory Reform
• Capital Markets
• NPL Resolution
• Pension Reform

• Ongoing privatization through domestic and
  overseas capital markets
• Relaxation/removal of price controls
• Enforcement of bankruptcy laws
• Big Four set up time table of introducing
  strategic investors and IPO
• Adoption of international practices in areas such
  as accounting, credit appraisal, risk management
  and internal control
• Phase-out of stringent state credit allocation
• Reclassifying bank loans into 5 categories in
  line with international practices
• Listed Companies required to disclose differences
  between PRC GAAP and IAS
• Foreign enterprises in China being permitted to
  be listed in China
• Fostering international investors and
  facilitating institutional investment
• 4 AMCs created to absorb US 232 billion of NPL
  after US 33 billion recapitalization program
• US 22.5 billion each recap program for BOC and
  CCB, followed by more aggressive NPL resolution
  measures
• Auction of NPLs (foreign FIs participation
  permitted)
• Further transfers of NPLs to AMCs likely

17
Regulatory EnvironmentThere are four regulators
that have the most direct impact on the banking
sector in China

• CBRC China Banking Regulatory Commission
• Formulate regulatory rules governing the banking
  institutions
• Authorize the establishment, changes, termination
  and business scope of the banking institutions
• Monitor banks operation and take enforcement
  actions against offence activities
• Conduct fit-and-proper tests on the senior
  executives of the banking institutions
• PBOC Peoples Bank of China
• Central Bank of the PRC
• Initiate related laws and rules for financial
  institutions
• Formulate and implement monetary policy
• Supervise the inter-banks lending, debt market,
  foreign exchange and gold markets
• Formulate RMB policies circulate RMB
• MOF - Ministry of Finance
• Formulate and implement fiscal and taxation
  policies and rules
• Formulate PRC GAAP and supervise the deployment
  of accounting rules
• Manage central fiscal social security expenses
• SAFE State Administration of Foreign Exchange

18
Foreign Banks Pace of Reform
19
Foreign Banks business scopeForeign banks
commercial presence (excluding insurance and
securities) subject to Chinas WTO Accession
Schedule and phased on two limitations
currency denomination (FX vs. RMB) and client
type (corporate vs. retail)

• Current Permission
• Foreign currency business no limits can serve
  both corporate and institutional clients
  nationwide
• Local currency business can only serve
  corporate clients in 16 cities
• Shanghai, Shanzen, Tianjin, Dalian, Guangzhou,
  Zhuhai, Qingdao, Nanjing, Wuhan, Jinan, Fuzhou,
  Chengdu, Chongquing, Kunming, Beijing, Xiamen

• 2005 - 2006
• Local currency businesses by year-end 2005,
  additional 4 cities will be opened up Shantou,
  Ningbo, Shenyang and Xian
• RMB business limited to corporate clients until
  year end 2006, following which retail banking is
  permitted

• 2007 Thereafter
• 5 year after China WTO Accession year end 2006,
  no limits on foreign banks commercial presence

20
Major Foreign Banks presence(example)
21
Chinas NPLsForeign Banks participation

• NPL China Banks
• US 232 billion of NPLs after initial US 33
  billion recapitalization program
• 4 asset management companies created in 1999
  (HuaRong Orient China AMC Great Wall AMC)
• US 22.5 billion recap for BOC and CCB
• BOC and CCB target
• ICBC

NPL Foreign Bank Participation Buyer Seller De
al Size US Note
. Citigroup BOC 1.8 billion HK real estate
as collateral Morgan Stanley, Lehman
Bros HuaRong 1.3 billion Loan
packages Morgan Stanley, Deutsche BK Great
Wall 500 million Real Estate Citigroup Great
Wall 300 million Asset Package Citigroup,
JPM, GS, UBS, Morgan Stanley HuaRong 300
million Loans - Wuhan Note More NPL
disposals expected prior to IPO of SOCBs and
financial market fully open to foreign banks in
2007
22
Future trends ChallengesNext 10 years critical
for China Banking industry

• Control risks and change of business model
• Challenge of free market interest rate
• Improve IT platform
• Ownership reform / Improve Corporate Governance
• Move focus from being domestic to international
  banks

23
Currency Revaluation
24
Arguments for Revaluation

• Chinas trade surplus with the US
• Chinas 200 billion in annual FX reserves
  increased to 615 billion in 2004
• Due to peg, Yuan real trade weighted exchange
  rate fallen 13 since 2001

• Chinas overall trade surplus of 33 billion in
  2004 is smaller than in the late 1990s.
• US overall trade deficit was 665 billion in
  2004
• Chinas trade surplus with US was 162 billion in
  2004 offset within Asian deficit.
• Chinas aim is balanced overall trade, not
  balanced trade with the US.
• If US dropped technology restrictions US
  exports would narrow imbalance.
• China economics and restructuring imperative ,
  more important than the politics of dealing with
  US
• Much of increase in reserves short term capital
  (speculative investing)
• Between 1993 and 2001 it gained 30.
• During East Asian Crisis, China passed on chance
  to devalue like its neighbours.
• China accounts for 10 of US total trade. 10
  revaluation would reduce weighted trade value 1.
• Chinas exports have high import content.
• China closed Capital Account provides insulation
  to destabilizing fluctuations

25
Observations

• Performance of the US
• US Current Account Deficit
• Rise in cost of Oil
• Textile Industry hurting in US, Canada, EU and
  Chinas Asian neighbours

• China fixed exchange rate provides stability
• Lack of savings in US - not Yuan
• Could cause cutback in US consumer spending
  affecting Sino/US trade and economic stability
• Quotas eliminated end 2004 (WTO)
• Threat of possible sanctions against China by
  developed nations
• Asian developing nations could resent China for
  stealing market share vs. being their trade
  champion

26
Possible Outcomes

• China will revalue
• Widen the exchange rate band
• Peg to other currencies than just US

• Small bites in 12 to 18 months (Its Banks
  systems are not sophisticated to compete on the
  world stage)
• China will not be bullied
• Would introduce more flexibility
• A basket of currencies
• or
• A managed float

• China revaluation. In the US it is more a
  political issue, than real
• China decides by Government fiat rather than by
  the market

27
(No Transcript)