China opens up financial sector
China will now allow foreign firms to own up to 51 per cent in securities, insurance and asset management and futures companies.
For banks, there is no specific mention of the maximum stake that foreign firms could own up to, but the 20 per cent ownership cap by one single foreign investor and 25 per cent collective ownership cap will be removed, according to the State Council Information Office.
However, UBS analyst May Yan reckons the new policy would benefit listed insurance companies and securities companies more than banks.
“Foreign banks have been exiting the China banking sector since 2008 through recent years, partly due to their capital stresses post the global financial crisis and partly because they are unable to be controlling shareholders and influence invested banks' operations," she said in a client note.
"With the ownership cap removed, they may reconsider the values of owning nationally licensed joint-stock banks or regional banks with superior quality and niche markets."
In her view, small banks focusing on niche markets or regions might attract interest.
"Smaller banks with geographical and niche market advantages may draw interest from foreign investors.
"Given some of them have superior returns, better asset quality and smaller balance sheets than most joint-stock banks, we think they could be marginal beneficiaries."
The analyst pointed out that among the mid-size banks, Bank of Communications may attract interest from HSBC, which currently owns 19 per cent of BOCOM’s shares.
"HSBC had expressed interest in the past to potentially upsizing its ownership if regulations allowed. However, foreign owners' capital strength could be an obstacle."
Message to foreigners
To Yan, the opening up represents a remarkable milestone.
In addition, she thinks this regulatory breakthrough could signal government's determination to execute the guiding principle of “letting market play a decisive role in the economy” as laid out in President Xi’s 19th Party Congress speech.
However, while such opening up in the long-run is likely good for the sector's development, Yan believes in the short-term it could bring uncertainties to domestic players, especially those weak non-bank financial institutions.
"The fact that the government is willing to take such challenges signals the Xi government’s strong political power and determination to embark on market reforms."
A key theme from the 19th Party Congress is continued tightening of regulations for the financial sector and prevention of systemic risk, with a particular focus on shadow banking activities.
Yan's research shows that China banks are shrinking their shadow banking exposure.
This view is supported by the fact that balance of interbank wealth management products decreased by RMB2 trillion in the 2017 first half.
"We expect tighter supervision to be a recurring theme in the longer term, and to be carried out in a gradual and orderly manner. The impacts are more negative for mid-and small -size banks than for large banks."
China banks are now trading at 0.76 times one-year forward price-to-book value following their ex dividend dates, in line with the average of the past three to four years.
The below-the-book valuation despite banks’ decent reported Return-on-Assets may suggest that the market is still concerned about a potential debt crisis, given China’s rising debt leverage and likely under-recognition of non-performing loans with state-owned businesses, according to Yan.
"Factors such as decelerating economic growth and disintermediation could also weigh on banks’ long-term Return-on-Equity, in our view."