Will CBA’s Maoist Chinese strategy pay off?

Commonwealth Bank’s guerrilla tactics of circling provinces before zeroing in on the cities is an unusual approach to take in its Chinese expansion. And it just might work.

Lankao is a relatively poor county in China. But it has a special place in Communist mythology: it is where the legendary and selfless cadre Jiao Yulu worked and died. His deeds have been eulogized in Chinese propaganda films and literature and by chairman Mao himself. 

While it may be a famous county in China, it's about to become a lot more well known among Australians, thanks to Commonwealth Bank of Australia. The bank recently received a license to operate a fully-owned bank in the county, highlighting its bid to expand aggressively in China’s vast hinterland.

CBA is focusing on two particular regions with its expansion: the Henan and Hebei provinces (Langkao is a county in Henan). The former is an agricultural province with 100 million inhabitants and the latter is the steel-producing capital of the world. The bank is tactically avoiding the crowded markets of Beijing, Shanghai and the eastern seaboard in favour of China’s under-banked and under-serviced regional areas.

To date CBA has 15 wholly-owned or controlled county banks.

When the CBA board visited China recently it didn’t even go to any megacities, instead it visited cities that few people had heard of before such as Zhengzhou, Shijiazhuang and Jiyuan. 

Simon Blair, the group executive in charge of international financial services, explains to China Spectator why the bank is pursuing this regional strategy.

“Foreign banks are tightly controlled in terms of ownership structure if they play in the traditional space like trade finance,” he says. “But you can still do a lot more by being a bit more flexible by looking at owning 80 or 100 per cent of county banks.”

Though foreign banks account for less than 2 per cent of total banking assets in China, Blair thinks there is more opportunity for foreign banks than many  commentators realise. One area that the bank has identified is the credit-starved small and medium-sized enterprise sector.

Chinese SMEs are struggling to access credit in China despite their explosive growth and contribution to the economy. Analysts estimate their funding costs to be about 15 per cent, significantly higher than the central bank’s official rate of 6 per cent (China’s SMEs struggle to jump the credit hurdle, August 28).

Blair explains CBA’s regional strategy, which focuses on the banking needs of SMEs and agribusiness, is aligned with Beijing’s national economic agenda, which is also becoming increasingly focused on SMEs as well as central provincial areas and agriculture.

“Historically, SMEs haven’t had a great opportunity to access lending” he says. “What we are trying to do in Asia is focus on SMEs and that is where we can add value.” Blair explains there are certain misconceptions about the banks strategy.

“A lot of people when they hear about our strategy in China, because county banks are in small locations, people often think about them as the Albury-Wodonga's of the world,” he says. But many regions where CBA operates in the country are cities with more than one million inhabitants.

CBA’s regional strategy can be compared to Mao’s guerrilla tactic of using the countryside to encircle and finally capture the cities. Chinese telecommunication giant Huawei has effectively adopted this strategy to conquer both domestic and overseas markets.

One of the biggest issues for analysts looking at Chinese banks at the moment is about their deteriorating credit quality. Almost no one believes Beijing’s official claim that Chinese banks are able to maintain a national average of non-performing loan at about 1 per cent of their banks.

Blair, who sits on the board of Hangzhou City Commercial Bank -- which is 20 per cent owned by CBA -- gives China Spectator his views on the official non-performing loan figure.

“Do I actually think the Chinese national average is still one? I would say it is a bit optimistic,” he says as diplomatically as he can. “There are other places where NPL figures may not be accurately reported.”

The banker explains that there is no doubt that the non-performing loan ratio has been under a lot of pressure lately. However, he says CBA is monitoring these figures “very, very closely” at its partially-owned banks -- Hangzhou City Commercial bank and Qilu Bank -- and he is confident Hangzhou Bank’s NPL of 1.4 per cent is accurate.

Apart from watching out for non-performing loans, another big challenge for CBA in China is to keep a close eye on the two Chinese banks. One of them was hit by a massive scandal in 2011 when its management was cleaned out after the discovery of a $227 million commercial paper fraud.

CBA is trying to strengthen credit and risk management infrastructure at these two banks, including sending executives to work there. Currently, the head of retail banking at Hangzhou Bank and the head of SME banking at Qilu Bank are CBA employees on secondment. Until recently, the bank had also appointed a chief risk officer to Qilu.

“As a result of that, we have a pretty good idea of what is going on. Not all foreign banks with this type of strategic partnership have executives working in there,” he says.

Of the big four banks, CBA alone has adopted an unusual China strategy by focusing on regional opportunity. It is interesting to see whether its Maoist strategy would work.

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