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2007 Asian Banks Competitiveness Ranking - iHome - The Chinese

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					     “2007 Asian Banks Competitiveness Ranking” Report

                         At the Request of “21st Century Business Herald”

                                     Jointly conducted by
           Faculty of Business Administration of the Chinese University of Hong Kong
                         Graduate School of the People’s Bank of China



Part One: Background for Asian Banks’ Competitiveness
Study
I. New Trends in Asian Banking

We entered 2007, with the central themes of the Asian banking industry dramatically changing as
the last echoes of the “survival reforms”i addressing the Asian Financial Crisis faded away

i. The “survival reform” of banks, such as capital injections from governments, the
separation of good from bad banks, the consolidation, restructuring, and acquisitions of
financial institutions, and the improvement in capital adequacy ratios, has been successfully
completed.

Banks in Asia in general maintain capital adequacy in excess of the requirements of the Basel
Accords of 8 percent for total capital and 4 percent for core capital. In 2006, the average capital
adequacy ratios of Indonesian, Thai, and Korean banks had reached 20 percent, 13.85 percent, and
12.31 percent respectively. The average core capital adequacy ratio of the Malaysian banks was
10.3 percent; while for Japan, the average total capital adequacy ratio was 13 percent for nine
major banks and 10 percent for 224 regional banks. And for the listed commercial banks in China,
most of their total capital adequacy ratios were also above 10 percent.

There has been good progress in improving asset quality as well. In 2006, the ratio of non-
performing loans (NPL) to total loans for Korean commercial banks decreased to less than 1
percent. In Japan, on average, the same ratio was below 1.5 percent for its nine major banks and
4.4 percent for 224 regional banks. It was 5 percent in Thailand and 5 percent-10 percent for both
Malaysian and Indonesian banks. And the NPL ratios for commercial banks in China were
dropping quickly, from more than 25 percent to less than 6.17 percent.

As for profitability, the return on assets (ROA) and return on equity (ROE) of Asian banks are
increasing, despite the fact that overall interest spreads are decreasing. For the Indonesian banking
industry, its average ROA had already reached 1.92 percent in 2002 with a ROE of about 14.8
percent, and these two ratios retained a high level of more than 2 percent and 20 percent
respectively afterwards. In 2005 and 2006, the ROAs of the Korean banks were all above 1
percent, and that of the Malaysian banks were above 1.3 percent. In the first half of 2007, for most
of the listed banks in China, the ROAs were also above or near 1 percent, and the ROEs were
between 11 percent and 31 percent. ii

As said by Mr. Rodrigo de Rato, the former president of IMF, “Either as the president of IMF or
as the former Financial Minister of a country, I admire the achievements that every country has
made. Each country has survived the crisis, and strong growth has been made there since.” iii

Although one cannot say that major restructurings, including bank capital injections by the
government, the separation of troubled bank portfolios into good and bad banks, the consolidation,
restructuring, and acquisitions of financial institutions, and the forced improvement in capital
adequacy ratios etc, are forever things of the past, at least they are no longer the main issues. In
various seminars and workshops, the themes that Asian bankers now discuss are sustainable
development, new business models, new business potentials, capital market development, the sub-
prime loan crisis and the effect of a slowdown in the US and Europe.

ii. The banks have been impacted by the rapid development of Asian capital markets.
Disintermediation by reducing large corporate credit bank demand has led banks to look to
increase their lending to small and medium sized enterprises (SMEs)

The growth of the Asian capital market in 2007 was a great shock for the banks. From the
beginning of 2007 until November, the stock market indexes of many Asian countries/regions kept
breaking their historical records. In developed economies, we know that the direct financing
through stock or bond markets drive large companies with good credit ratings away from the
banks leaving non-investment-grade clients – SMEs and retail clients – as the banks best major
asset source. iv

A senior manager from a Eur-American bank told us in his China office, “[Disintermediation] will
definitely happen in five to ten years. If you have not foreseen that, you will have a problem to
find the way out when it happens. SMEs and retail banking may still be ‘kids’ right now, but you
have to find the right business model to make these ‘kids’ grow up. It’s just a question of which
bank sees and understands it earlier.”

Worldwide, most large banks have very successful retail businesses. In developed countries, retail
business usually accounts for more than 50 percent of the business of commercial banks and
constitutes a prime growth sector for profits. Retail banking business involves all aspects people’s
lives -- housing, consumption, investment etc -- and has strong synergies and complementarities
with non-traditional financial services such as securities, insurance, mutual funds etc, so, relative
to the corporate banking business, the retail banking business has a tremendous potential to
generate fee income. Sixty-three Asia bankers, who have responded to our questionnaires,
predicted on average that, in the next five years, the income from fee-earning items of the retail
banking business will account for 34.59 percent of the total income while that from the corporate
banking business will constitute only 29.49 percent.

Thus, developing retail banking is not only a solution for banks to deal with disintermediation and
to maintain a sustainable growth of the banking business, but also an important foundation for
banks to increase their fee income and to reduce operational risk.

Another business line to supplement the reduced bank credit needs of the large enterprises is SME
banking, once considered as a high risk and low profit business. However, with the development
of bank information technology and the strengthening of risk management, the problem of
accurately assessing credit risk in SME financing is being solved gradually. What was previously
a dilemma for banks is now becoming a new opportunity and target market.

In order to obtain a precise knowledge of the investment and financing ecology of SMEs, as well
as the existing financial services available to them, the Asian banks competitiveness research team
this year conducted specific research on the subject. A special questionnaire was designed and 544
SMEs from 17 large and medium citiesv in China were studied. Compared with other researches,
this survey exhibits the ecology of the Chinese SMEs from a more micro point of view. The
financing alternatives of SMEs are rather restricted. While bank loans are the principal source of
capital, SME creditworthiness is a long way from ideal. Trade credit is also not yet well
developed. These factors have led to the development of the private capital market. In the west,
there is a so-called “small bank advantage” hypothesis concerning the credit relationship between
banks and SMEs: small and medium sized banks enjoy an advantage in SME financing over the
large ones. We came to a similar conclusion from our survey: Chinese SMEs tend to be more
likely to borrow from small and medium sized banks. But the information asymmetry caused by
the poor creditworthiness of SMEs together with the lack of information transparency, as well as
moral hazard and adverse selection problems have contributed mainly to the financing difficulty
of SMEs.

In our study, a senior financial analyst mentioned a few characteristic problems concerning the
development of SME financing. “The SME financing business also involves the development of
credit guarantee institutions. When expanding their SME financing business, large financial
holding groups often like to acquire first local credit guarantee companies, in order to obtain a
local SME credit database” In October this year, GE Commercial Finance announced a new
injection of USD50 million into the Credit Orienwise Group Ltd in China. At the same time,
Asian Development Bank, Citigroup Asia Business Investment Corporation, and Carlyle
Investment Group recapitalized the Credit Orienwise Group Ltd and the amount of investment
was increased to USD12,420,000, USD30,900,000 and USD 30,460,000 respectively. Besides,
American International Group (AIG), International Finance Corporation (IFC) and a financial
institution in Switzerland have already carried out a due diligence investigation on Chengdu Small
Enterprise Credit Guarantee Co. Ltd.

iii. The percentage of total income made up of fee earning business has improved steadily,
and banks’ ability to withstand market risk has been strengthened.

Another major change caused by the reduced credit needs of large enterprises is the development
of fee-earning business. A major source of bank fee business is customer risk management. In
contrast to the reduction in transaction costs, participation costs of the financial industry have
increased dramatically, as a result of the rapid development of the financial industry and the
increasing complexity of financial products in recent years. The participation cost we mean here is
the extra cost incurred by businesses to learn about the financial industry and its products. As the
participation cost increases, bank fee-earning business can gain through their provision of risk
management services. From the viewpoint of the banks, as competition for credit services has
intensified in recent years, the average interest spread of the Asian banking sector has continued to
shrink, and the importance of fee-earning business has become more and more obvious.

In this competitiveness study, we take “the sum of net interest revenue plus non-interest revenue
divided by the number of employees” as one of the objective indicators to measure a bank’s
competitiveness. In 2006, the Asian banking sector has obtained a relatively rapid growth in the
fee-earning business. In 2005, the total amount of non-interest revenue for the 123 Asian banks in
the sample was USD75 billion, with an average of USD610 million for each bank. In 2006, the
total amount of non-interest revenue for the 125 Asian banks in the sample increased to USD91.3
billion, with an average of USD740 million for each bank. The growth rate is about 22 percent.

In general, for commercial banks, the percentage of income derived from non-interest revenue
would be higher for a more developed economy. For example, for the 23 Japanese banks in our
sample, their net interest revenue in 2006 was 1.25 times of their non-interest income. This ratio
was 1.61 for the 12 Hong Kong banks, and 7.17 and 2.67 for banks in Mainland China and
Thailand respectively. For the other countries/regions in Asia, most of these ratios were around 2.

Among all Asian banks in this competitiveness study, the fee-earning business of the Indian
banking industry is worth noting. For the 14 Indian banks participated in this ranking practice, the
ratio of interest revenue to non-interest revenue for 2006 was reduced to 1.67, which make Indian
banks leaders in fee-earnings business. The banking sector in India is a pioneer in its national
economic reform. Back in 1985, the “reform working group” submitted a research report on the
money market to the Indian government. Based on the report, the Indian government launched a
series of reforms including enhancing financial regulations, speeding up the development and
promotion of the financial instruments for the credit market, removing the interest ceiling in the
demand deposit, and introducing new financial instruments such as commercial papers and saving
certificates etc to the short-term money market. The business of Indian banks has been well
integrated to the international market except that the exchange rate is strictly controlled by its
central bank. The Indian citizens have paid their water and electricity bills in cheques for many
years, not unlike Euramerican citizens. Much of the fee-earning business then arose vi

iv. “China opportunity” becomes a new growth potential highly recognized by the Asian
banking industry.

Although we benchmark to banks in other Asian countries, our focus in this study is on China.
Before the Financial Crisis in 1997, the Asian economy was led by Japan, who was followed by
the “Asian Four Dragons”, and then Mainland China, like a flight of geese. Now ten years later,
China has become the most powerful “locomotive” of Asia, and Asia has become the
“locomotive” of the world. Within Asia, Japan, and within the world, the US, are looking more
like cabooses going into 2008. “When the investors from every place of the world talk about
China, their voices increase suddenly.” vii The bankers are no exception.

Banks reflect their economies’ health. An economy, which is both large and rapidly growing,
provides inevitably a substantial growth space for the banking industry. The extent to which a
bank does business in such a region will have a direct effect on its competitiveness. One banker
commented, “This is much more important than some fashionable business theory.”

In conducting interviews with bankers, we discovered the China factor’s importance. For example,
when one banker gave his comments on Bank of East Asia, he asked carefully if we were talking
about the bank’s development in Hong Kong, or also including its business in Mainland China.
When he was told that the bank’s business in the Mainland was also included, he believed that the
competitiveness of Bank of East Asia should be ranked higher. “In Hong Kong, it cannot be
placed at the same layer as that of HSBC or Standard Chartered, but it can be in Mainland China.
That is very important.” Another banker believed that the competitiveness ranking of DBS (Hong
Kong) should be quite low, as DBS’s business in Mainland China directly belongs to its
headquarters in Singapore.

The Asian banks competitiveness ranking study this year specifically organized its researchers to
interview top executives of China offices for several foreign-funded banks, and completed a sub-
report on the subjectviii. The report specifically highlights the current status of the foreign-funded
banks in China. We found that foreign-funded banks are quite confident about their futures and
that nearly all of the interviewees are highly optimistic about the market potential. This
confidence may come partly from the fact that, in a certain sense, foreign-funded banks are
protected in Mainland China by its interest rate control, though this kind of protection is implicit.
Foreign bankers in China are also clearly confident that their own banking technologies and
systems can be effectively applied in the Mainland market. One concern expressed by foreign
banks in China concerned the funding of their assets. According to Chinese regulations, those
formerly branching foreign banks which converted into local subsidiaries with Chinese legal
person status in 2007 are subject to the regulation that their loan-to-deposit ratio should be well
below 75 percent in five years. As many of these banks loan to deposit ratios exceed 75 percent
now, this restriction is binding, which means that asset and liability management will become a
major concern in the next five years. The report also finds that bankers in the foreign-funded
banks regard this issue highly related to their own liquidity management, rather than simply being
a regulatory requirement. Such liquidity constraints as well as the large amount of capital frozen
by the new shares issued also make it urgent for foreign-funded banks to absorb more deposits. At
the same time and related to the problem, the foreign-funded banks all believe that China should
enhance its development of the money market in order to diversify the sources of funds of the
banking industry. For the matter of business development, it is found that foreign-funded banks
judge their different business prospects, mainly by reference to their parent banks’ prospects and
the economic conditions of the regions in which their parent banks are located.

v. US Subprime Mortgage Crisis “questions” the new direction of the Asian banking
industry.
In April 2007, the US Subprime Mortgage Crisis began with the financial distress of New Century
Financial Corporation, the second largest subprime mortgage company in US. The default rates on
the US subprime mortgage loans rose constantly afterwards, and subprime mortgage backed
securities prices plummeted Large institutions especially those involved in originating,
securitizing and investing in US subprime mortgage loans became mired in financial difficulties.
One after another, top financial institutions in the world such as HSBC, Merrill Lynch, Morgan
Stanley, J.P. Morgan Chase, Bear Stearns, Citigroup and Barclays Bank declared large losses. The
CEOs in Merrill Lynch and Citigroup resigned. The US Federal Reserves, Bank of England, Bank
of Japan, European Central Bank and many other central banks rushed to inject large amounts of
liquidity into the market to reduce the ill-effects of the credit crunch.

Though it happened in US and Europe, the problems that the Subprime Mortgage Crisis exhibit
are related to the development of the entire global banking industry. The financial developments
that they call into question are the very developments that constitutued what, over the last decade,
were widely believed to be the future of banking.

The first development that the Subprime Mortgage Crisis calls in question is the importance of
retail banking. Retail mortgage loans are the largest asset class in retail banking. Sub-prime
lending increased the pool of retail mortgage borrowers while securitization provided an incrased
pool of investors more able to bear the risk than the banks. When the crisis broke out people
found that financial institutions were just shifting credit risks. Because the risks were not properly
assessed and monitored, they exploded, causing economic harm even though they were no longer
on the balance sheets of banks.

A credit crunch following a period of over-enthusiastic expansion of lending is not a new
phenomenon. Smaller, more localized, unsecuritized versions of, the Subprime Mortgage Crisis
happened in Asia recently. Taiwan went through a crisis caused by excess lending in credit cards
and unsecured retail loans from the end of 2005. If disintermediation, brought about by the
expansion of capital and money markets, has made retail retail banking one of the best major asset
sources, then the main question for banks in future is to correctly measure and manage retail credit
risk.

The US Suprime Mortgage Crisis also calls into question the accuracy of financial engineering.
During the last decade in the US, the amount of loans that were securitized rose to approximately
the same amount as the amount of loans that were lent by banks from their own balance sheets.
The securitization process generated increased credit for society (expecially for retail borrowers)
and inceased fees for banks. At the same time, risks were spread away from banks to purchasers of
asset backed securities. The structures of these asset backed securities were designed using
complex statistical models. But in the sub-prime sector, those models failed. Some securities that
were rated as extremely safe were revealed to be very risky. Sub-prime lending represents about
one fifth of total securitized mortgage debt. The failure of securitization models in this substantial
sector may lead investors to doubt the quality of all such models
The Subprime Mortgage Crisis also calls into question the integrity of banks as they change their
culture from traditional borrowing and lending into a more market, fee-based orientation. Banks
hope to get fee income with almost no risk. If both the profit and the loss incurred from
investment both belong to the investors, the bank bears no market risk. This was seen as a model
for disintermediated banking business. In the buildup to the sub-prime crisis, bankers’ horizons
shortened. Loans were sold in securitizations; banks gained fees and originated new loans for
securitization, which were sold for more fee income and so on. Turnover of the bank assets
increased dramatically and formerly long-term assets were converted into available-for-sale assets.
Without strict standards, bankers became less cautious in assessing the risks in the loans they were
packaging for sale , as their focus turned from the quality of loans held to the quantity of loans
originated and securitized. Chuck Prince, former CEO of Citigroup summarized the culture just as
the crisis was breaking, “…as long as the music is playing, you’ve got to get up and
dance…We’re still dancing.” Shortly thereafter, the music stopped and Mr. Prince was fired.

 The subprime crisis has not brought down any major bank because securitization did effectively
shift the risk away from banks to investors in the mortgage backed securities. But the financial
engineers, bankers, investment bankers, monoline guarantors, and analysts in the credit rating
agencies made very large errors. To regain the financial markets’ trust will require time and
concerted efforts of all parties to refine their models, to improve credit risk management in loan
origination, and to apply due diligence in credit risk assessment. Only when the integrity of asset
backed security creation is demonstrably established will the disintermediation trend through
securitization be restored.



vi. A brief summary of the region’s new development direction.

With the end of the “survival reform” divergence has characterized the development of Asian
banks. Banking industries in new developing markets such as China, India, and Malaysia have
achieved quite remarkable results, reflecting the good economic performances of those countries.
In the contrast, some developed regions/countries in Asia, such as Taiwan and Japan, have slowed
down their speed of development.

From a banking report that Standard & Poor’s recently released we can see that, overall, the
banking industry in Asia has benefited from the good enterprise profitability, relatively steady
monetary conditions, healthy economic development and industry restructuring.              Bank
performances and asset qualities are now much better while the creditworthiness of the banks has
been improved fundamentally. As a result, the banks are now more capable of facing future
challenges. Moreover, the banking reform in Asia also has taken advantage of the economic
growth worldwide in the past few years. However, as Standard & Poor’s reminds us that economic
and industry risk, unexpected external shocks and unavoidable periodic economic slow downs
may also occur. x

The Japanese banks have traditionally played the leading role in the Asian banking industry.
However, that leadership is being challenged by the Chinese banks. Though the Japanese banking
industry has successfully solved its problems in non-performing loans, the banks have not enjoyed
a strong recovery: problems such as the downturn in loan businesses and decline in consumption
have reduced their ability to develop aggressively. The Japanese economy has turned better in
recent years, but the market is still not fully open and the level of protection against foreign
competition is still high. This makes many banking services expensive reflecting that the
structural problem of the Japanese economy has not yet been fully solved. This bottleneck also
restricts the future of Japanese banking industry development.

The growth in internal demand and the rapid economic development in India are backed by the
development of its banking industry. With annual GDP growth over 9 percent and money supply
growth being over 20 percent per year, inflation (currently at just over 6 percent) is the Reserve
Bank of India’s major concern.

Huge losses have been incurred for the banking industry in Taiwan as a whole, which is closely
related to the unstable political situation in recent years. Because of the limited internal demand,
continued slow economic growth, small bank size, and inability to exploit the vast market in
Mainland China, the banking industry in Taiwan is missing a valuable opportunity for
development.

The banking industry in Singapore is developing steadily. But constrained by its limited
development space in the domestic market,Singapore has chosen a multinational structure for its
banking industry. DBS is watching closely at the Asian banking industry and searching
continuously for merger and acquisition opportunities in recent years.

As an international financial center, Hong Kong is also the city in Asia with the most concentrated
presence of international banks. Benefiting from the close interaction in economic and financial
development between Hong Kong and the Mainland after the Handover, Hong Kong’s banking
industry has a large percentage of its transaction amounts with the Mainland. Within Hong Kong,
there continues to be fierce competition for banking services. With a steady domestic demand,
most of the increased demand for loans comes from offshore, especially from the Mainland
market.

Online banking in Korea is developing rapidly with a huge increase in the participation rate. One
of the problems in the Korean banking industry is about the credit cards. The average number of
credit cards that a Korean citizen holds is already the second highest in the world – only less than
that in US. However, the default rate on credit cards is increasing at a tremendous rate,
endangering it's the banking industry’s growth in profitability.

II. An Overview of the Banking Reform in China

In 2006, all important indicators of the Chinese banking industry exhibited improvement. By the
end of 2006, total bank assets of banking and financial institutionsxi reached RMB43,950 billion
(USD5,630 billionxii), a 17.3 percent growth from 2005. The sum of bank deposits and loan
amounts increased steadily. By the end of 2006, the total deposit balance accumulated to
RMB34,800 billion (USD4,460 billion), a 16.0 percent increase over 2005. Capital adequacy
ratios largely increased as well. By the end of 2006, 100 commercial banks fulfilled the capital
adequacy requirement of 8 percent, an increase of 47 since 2005. Asset quality improved
consistently. By the end of 2006, according to the five-category assets classification for bank loans,
total non-performing loans in commercial banks was about RMB1,250 billion (USD160 billion), a
reduction of RMB71.3 billion (USD9.14 billion) from that of 2005. The average impaired loans to
gross loans ratio was 7.1 percent, a reduction of 1.5 percent. The shortfall in loan loss reserves has
decreased greatly, from RMB627.4 billion (USD80.436 billion) in 2005 to RMB454.7 billion
(USD58.295 billion) in 2006 for major commercial banks. Banks’ profitability generating ability
has been improved as well. In 2006, the banking and financial institutions have realized a total
earning before tax of RMB337.9 billion (USD43.321 billion), among which the earnings before
tax for major commercial banks have been increased by 30.2 percent comparing with that of 2005.

In 2006, the main banking reforms in China were the shareholding reform of state-owned
commercial banks and the reform of the rural credit cooperatives. Meanwhile, the reform of other
banking and financial institutions continued apace.

In the stock reform of state-owned commercial banks, in April 2006, “Guidance to Corporate
Governance of State-owned Commercial Banks and the Relevant Supervision Thereof” was
published by the China Banking Regulatory Commission (CBRC), which provided guidance on
assessing the stock reform of state-owned commercial banks according to three categories and
seven indicators. Under the Guidance, CBRC shall make supervision and give guidance to the
work of stock reform of state-owned commercial banks in a timely fashion on the basis of
evaluation and monitoring. After the Bank of Communications and China Construction Bank were
successfully listed overseas in 2005, in 2006, Bank of China, Industrial and Commercial Bank of
China (ICBC) successively went public in the A-share market, where the mode of “A-share + H-
share” made history for the Chinese banking industry. The total amount of capital that these four
banks raised up during their IPOs was about USD47 billion. If calculated by the closing price in
the end of 2006, the total market capitalization that the state held had reached RMB3,606.2 billion
(USD462.333 billion). ICBC, Bank of China and China Constructions Bank have edged
themselves to the top ten banks worldwide. Meanwhile, the reform of the Agricultural Bank of
China continued.

In the reform of the rural credit cooperatives adopted by 30 provinces (regions and cities) by the
end of 2006, huge changes have taken place in management systems, modes of ownership, and
forms of organization and progress has been made. The reform in rural credit cooperative
management systems is almost complete. While investigating new modes of ownership and and
forms of organizations, rural credit cooperatives have been reducing their historical baggage and
increasing their profitability.

Regarding postal savings reform, in July 2005, the State Council passed a postal savings reform
proposal which finally revealed the plan to establish a postal savings bank. In June 2006,
construction of the Postal Savings Bank of China was approved by CBRC. On December 31,
China Post was officially authorized to set up the postal saving bank with shareholding ownership,
a historic step forward in standardizing the operation and management of the postal savings in
China.

In the reform of shareholding commercial banks, through the successful introduction of domestic
and foreign institutional strategic investors, the restructuring and reform of Guangdong
Development Bank has made a significant breakthrough. The operational situation of Shenzhen
Development Bank is facing a new challenge, while the financial restructuring of China
Everbright Bank and the reform of China CITIC Bank have made a substantive progress.

For the city commercial banks, domestic and foreign institutional investors have been introduced;
the disclosure of information has been further standardized, and a great amount of mergers and
acquisitions have taken place. Six city commercial banks and seven city credit cooperatives in
Anhui Province were merged into one Huishang Bank in 2005. In 2006, ten city commercial
banks restructured to Jiangsu Bank, and more than ten city commercial banks in Shandong
Province experimented to set up a cooperation association – a platform for cooperation. Bank of
Shanghai became the first city commercial bank to break regional constraints, and set up a branch
in Ningbo, while Bank of Beijing was also approved to open its Tianjin branch.

In the Chinese banking industry, “functional banking” was one of the key emphases for the
reforms in 2007. Increasing shareholders’ and customers’ satisfaction rates through improving
banks’ risk management ability and efficiency became the main focus for the post IPO Chinese
banks. Many banks have broken their previous separation of businesses between different
departments and have established new management modes centered in business flow rather than
departments. Functional banking reform that is customer-oriented, vertical, assessment-based, and
promotes centralized processing of background business is gradually being enforced.

The understanding and implementation of “process reengineering for functional banking” is
different for different banks. Differences arise from the differences between western and eastern
culture, as well as the precise conditions of different banks. Some of the Chinese bankers believe
that, following process reengineering, the success of functional banking will rest on management
control of the reformed banks. As the topic is so important for the year, we will make an in-dept
discussion about it in Part Three – Interviews with 103 Banking Experts, in the discussion of one
of the objective factors for competitiveness – “Efficiency”.



Part Two: Methodology for Asian Banks Competitiveness
Study
The second Asian Banks Competitiveness study strikes a balance between preserving the
methodology of last year and making improvements that increase the informativeness of the
rankings. We hold constant our definition of a competitive bank as “a bank that produces
sustainable future high returns for shareholders”. Each factor, objective or subjective, that will
increase the shareholders’ value, currently or potentially, will enhance a bank’s competitiveness.
According to this definition, we divide our measurement of competitiveness into three component
scores: a Profitability Score, an Objective Scorexiii and a Subjective Score. The profitability is
measured by the return on shareholders’ equity of the last two years. Objective factors are bank
specific factors including bank size, market share, asset quality, liquidity, capital adequacy,
efficiency and deposit base and branch network, while subjective factors are subjective ratings
obtained from interviews with banking experts. For consistency and continuity, the methodology
for computing the first two of those three component scores remains identical to that of last year.
However, we use a new method to derive the bankers’ ratings for 2007, which are weighted along
with that of 2006 to derive the final Subjective Score for 2007. We will return to the detailed
methodology in latter sections. In this manner, we are able to conduct the bank ranking of 125
banks in 10 Asian countries/regions.

We focus on Asia because Asian banks share geographic, historical and structural similarities.
Our definition of competitiveness as maximizing shareholder wealth accords with modern
financial theory and we design the methodology and calculate the overall competitiveness score to
fit this definition.

We use face-to-face interviews together with questionnaires to poll banking experts. Our
interviewees are senior bankers and analysts from investment banks, international bond rating
agencies and consulting companies who reside in Hong Kong or Mainland China.

As we did last year, we assign each of the three scores a weighting of one third, and take the
weighted average of standardized scores as the overall Competitiveness Score. The weightings of
the seven dimensions for Objective Score are the same as that of last year. The detailed calculation
of the Subjective Score will be discussed in detail in latter sections.


I. Definition of Banking

As one of our expert interviewees, the general manager of the China office for a leading global
bank in Shanghai commented, “Banking today is a nebulous concept. You may say we are a
traditional commercial bank or an investment bank – it all becomes blurred.” In this study, we
draw a clear distinction in a blurred industry: a bank is an institution that provides deposit, lending
and payments services to individuals and companies. We exclude investment banks, finance
companies, asset management companies and insurance companies at the same time knowing that
some of the banking groups we rank blur the distinctions, cross-sell non-traditional banking
products and in fact owe their competitiveness to their increased scope.


II. How We Derive 125 Sample Banks

We include banks from ten Asian countries/regions: Mainland China, Hong Kong, India, Japan,
Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand. The banks in the economies of
Indonesia, Vietnam, Cambodia, Laos, Myanmar and Bangladesh are omitted because their
activities are largely domestic and there is not sufficient knowledge of those banks in Hong Kong
and China (where we conducted our interviews) to enable us to assess those banks’
competitiveness.
Our sample includes banks that are listed on stock markets, banks that are privately held,
subsidiaries of banks or other financial institutions and banks owned by governments. When
dealing with subsidiaries of banks or other financial institutions, we analyzed their largest parent
entity in each of the countries/regions. For example Citibank Korea is treated as an independent
bank, without giving consideration to its parent bank holding company, Citibank NA or its
ultimate financial holding company, Citigroup Ltd., which are both registered in the US. We use
the subsidiary’s data for all calculations of our Profitability Score and Objective Score. This easy
separation of the subsidiary from the parent in the Profitability Score and Objective Score,
however, becomes much more difficult in the Subjective Scoring. The subjective competitiveness
of a parent company has deep impact on its subsidiaries. Our classification of subsidiaries as
independent banks (while treating branches as integrated) has led to entities in the same group
being ranked several times. In the extreme case the Standard Chartered group appears five times,
as Standard Chartered Korea, Taiwan, Thailand, Malaysia and Hong Kong, but not once as a
global bank.

In a departure from last year, where an Asian incorporated financial group is dominated by its
banking subsidiary or subsidiaries, we used the information from the group level. This affects
particularly the mega-banks of Japan, such as Chuo Mitsui Trust & Banking, Mitsubishi UFJ,
Mizuho Financial Group, SMBC and Sumitomo Trust. We did so largely to preserve a single
standard between these groups because while group data is available for all, subsidiary data is only
available for some.

Our definition of banking would have included cooperative banks had any single cooperative been
sufficiently large, but none were. But our definition excluded the centrals of those cooperatives
because a central’s business involves taking deposits from and making payments for their member
cooperative banks, not the public. The most serious exclusion by this was the Shinkin banks and
the Shinkin Central Bank of Japan.

We set lower limits to the total assets of banks in our analysis, to control number of banks and
increase comparability. Setting a uniform lower limit would have led to over-representation of
Japanese (mainly regional) banks while setting a high limit would have led to the total exclusion
of whole countries. If, say, a single threshold of USD20 billion was set, all Philippine banks would
be excluded. So we followed the practice of last year, including Thailand and Philippines banks
with assets over USD4 billion; Mainland China, Hong Kong, India, Korea, Malaysia, Singapore
and Taiwan banks with assets over USD10 billion, and Japanese banks with assets over USD40
billion. Even with these differential cut-offs, the numbers of banks per country ranged from 23 in
Japan to 3 in Singapore. Minor changes in each country’s list of banks occurred from last year
because we dropped banks with insufficient data (e.g., Bank of Boroda and Allahabad in India);
we increased banks where growth brought them over the threshold (e.g., Wing Lung Bank in
Hong Kong); and some banks exited because of reduced bank assets to below our limit (e.g.,
Nangyang Commercial Bank in Hong Kong).


III. Scoring Methodology
We would have liked to measure competitiveness as a bank’s ability to generate future returns for
shareholders. Unfortunately, there is no single measure available of such ability. So in our study,
we divide competitiveness into three component scores, which we weight equally: Profitability
Score, Objective Score, and Subjective Score. Two of those components, the Profitability Score
and Objective Score, used historical, published data, largely from the audited financial statements
of the banks, while the Subjective Score is a forecast by banking experts, a projection about the
future.

Since competitiveness concerns the future, one can legitimately argue that the measure of
competitiveness should be entirely forward looking – i.e., that it should be based entirely on
projections – yet two out of three of our scores use the past. If unbiased, informed forecasts had
been available, we would have used them. But they are not. In financial theory, the best forward
looking measure of financial value is the price of the bank’s equity shares in the public market. If
the market is efficient, in theory, this price impounds all future dividends and capital gains of the
stock in its current price. Why don’t we use some relative market value depending on share prices
(for example the market to book ratio) as a measure of competitiveness? We do not for two
reasons, firstly because the majority of the banks in our study are not traded. And secondly,
reliance on the current market measure requires a faith in market efficiency, while we do not
believe the stock markets of Asia (or indeed of the world) are fully efficient. Inefficiency means
the current prices are not fair. So we would have to predict the future price path of shares prices to
adjust for this lack of efficiency. Were we to adopt this approach, our ranking exercise would have
to predict the future prices of stocks. This activity performed better by stock analysts than by us.

In computing the overall score, we standardized each bank’s score by subtracting from it the
average score of all banks in the sample and dividing the difference by the standard deviation of
the scores. We then computed the simple average of the three standardized scores. Standardization
is to change the distribution of the variables into a new one where mean equals 0 and standard
                                                          x
deviation equals 1. If z is the standardized value, z          , where    is the mean and  is the
                                                          
standard deviation of the distribution.

i. Profitability Score

The Profitability Score is the two year average of the annual returns on average equity (ROE) as
reported by Bureau Van Dijk’s Bankscope Database. Two year average ROE ranged from
Citibank Berhad’s 33 percent to Bankthai Public’s -31 percent. No bank in our sample had end-
period negative equity, so cases where a bank has negative ROE all resulted from negative income;
hence, we made no adjustment to negative ROEs in computing the average or calculating the
standardized score.

Use of past profitability can be criticized, because past performance is no guarantee of future
performance. Among Asian banks in the most recent two years (2005 and 2006 end year data), the
correlation of annual ROE is about 39 percent, much lower than the 65 percent correlation we
observed for years 2004 and 2005. The lower correlation, if projected into the future, reduces the
usefulness of current profitability as a predictor of future profitability and, hence, competitiveness.
Nevertheless, we used for continuity and lack of alternative methods.

ii. Objective Score

We define the seven objective factors that were objectively and readily determined by accessing
Bankscope, “International Financial Statistics” or (in the case of number of branch and number of
employees) bank websites as follows:

    Size: the total assets of the bank.
    Market Share: The proportion of bank assets that the bank occupies in its national market.
    Asset Quality: The degree to which the bank controls and prices the expected loss of its
     loan portfolio measured by two ratios, the loan loss reserves to impaired loans and the
     impaired loans to gross loans ratio.
    Liquidity: The degree to which the bank can meet unexpected cash payment needs without
     substantial loss to equity capital measured by the liquid assets to customer and short term
     funding ratio and the inter-bank ratio being the ratio of funds lent to banks divided by funds
     borrowed from banks.
    Capital Adequacy: The cushion available to meet unexpected losses measured by the
     percent of total capital to total risk assets measured under Basel I and the percent of total
     equity to total assets.
    Efficiency: The degree to which the bank utilizes effectively its resources to maximize
     service output as measured by the cost to income ratio, the net interest revenue over earning
     assets ratio and the ratio of net interest revenue plus non-interest revenue divided by the
     number of employees.
    Deposit Base and Branch Network: The size of the bank’s core deposits relative to its
     total deposits and the number of branches.

Each of these indicators is standardized and signs are reversed as appropriate (for example, the
sign of the standardized measure of the impaired loans ratio is reversed since higher values are
associated with poorer asset quality). In the event that more than one indicator is used for an
objective factor, the value of that objective factor is the simple average of the indicators. If for an
indicator, a bank’s data is missing, the bank is given a zero value for the standardized score (i.e.,
the bank is given the value of the mean bank for that indicator). In the event such values are
missing, other banks’ average and standard division are averaged with the omission of that bank.

This problem of missing data occurred seriously in the asset quality dimension. Twenty-two of the
125 banks in the study did not have loan loss ratios or impaired loans ratios. Hence we had to
input values of zero on the standardized scores. In the liquidity and capital adequacy dimensions,
because we used two measures in each, the problem was less serious. In the former 31 banks were
missing an inter-bank ratio and in the latter 12 banks were missing a Basel total capital ratio. And
similarly, because we had three measures of efficiency, the loss of total revenue per employee
because we were missing number of employees in 33 cases was not disruptive to the final
objective rankings.

We determined the final Objective Score by constructing a weighted average of the individual
objective factors, with the weights taken from the average responses interviews with 77 bank top
executives and equity and debt bank analysis in the 2006 study. These weights ranged from 13.4
percent for deposit base and branch network to 15.8 percent for asset quality. We believe that the
relative importance of individual objective factors has not changed greatly from last year. But as
we noted last year, true bank competitiveness is not a linear combination of any of the objective
factors, where more is better. Their importance is non-linear, with optimal levels (for example) of
liquidity and capital adequacy above which more is no longer better. And the weights and optima
depend on changing competitive situations. Hence, the Objective Score is, at best, a rough
estimate of competitiveness; this is also why we need to combine it with Profitability Score and
Subjective Score to derive the overall competitiveness.

iii. Subjective Score

Competitiveness – expected future returns to shareholders – is forward looking and therefore
cannot be known with certainty. Like all predictions, it is subjective. To capture this subjective
element, we used an expert questionnaire and interview approach. We contacted by Email with
follow-up telephone calls and faxes, all leading Asian banks in the study with a branch or a
subsidiary in Hong Kong or Mainland China and asked to conduct face to face interviews between
our professors and their top management. We also contacted the international major bond rating
agencies, consulting companies and investment banks and asked to interview their chief analysts
who dealt with Asian banks. Altogether, we were able to interview 103 Asian banking experts.
This high response rate is due to the generosity of the members of the banking and bank analyst
community. The good will of these men and women allowed us to obtain valuable data and
insights. We extend to them our heartfelt, deep gratitude, and apologize not incorporating many of
their insights and for committing mistakes or over-simplifications that may misrepresent the banks
they lead, assess and advise.

Our Subjective Score differs radically from the Subjective Factors that we measured last year.
Whereas last year, we identified, for each bank, nine subjective factors, this year we measure only
one – competitiveness in terms of ROE over the next five years. And last year, whereas we asked
interviewees to rank banks’ subjective factor performance only within each country/region, this
year we asked interviewees to combine two country/regions and rate the banks within both. We
collapsed nine subjective factors into one for the simple reason that last year our expert
interviewees tended to rank banks similarly, regardless of which subjective factor was being
assessed. Whether this high correlation stemmed from the inability of the expert interviewees to
distinguish between factors or whether the factors themselves are highly correlated does not really
matter from an empirical point of view. We concluded that trying to rate different subjective
factors is largely a waste of time.

We asked each interviewee to choose two regions with which he or she was familiar, to combine
the lists of banks from those two regions and to rank each of the banks in the combined list in the
order of their competitiveness from the most competitive to the least. We asked them to rank at
least 12 banks or, if the top 12 contained banks from only one region, rank banks until at least one
bank from the second region entered the list. If there were less than 12 banks in total, the
interviewee was asked to rank all banks. By doing this, we constructed paired lists of ranked banks
that we used to calculate the Subjective Scores of the banks. The mathematical method is as
follows.

We first constructed the average ranking for each paired list composed of the banks from two
regions (“paired lists” designated Pi , i = 1… n). For example, P1 is the paired list for Chinese and
Hong Kong banks; P2 is the paired list for Chinese and Japanese banks, and so on. Since there are
10 regions in the study, n could obtain a maximum of (102 – 10)/2 = 45. In fact, because we are
based in China and Hong Kong we obtained 20 paired lists of which 15 contained two
countries/regions, two contained one country/region, and two contained three countries/regions
and one contained four countries/regions. Because slightly less than half the potential paired lists
are missing, our ability to verify ranking consistency and validity was reduced.

Pi is an ordered vector composed of the members j, j = 1… m where m can range from 10
members (for the Philippines – Singapore paired list) to 44 (for the China – Japan paired list). In
ordering the members of Pi we compute for each bank an average rank r being the simple average
of all ranks assigned to the banks by the interviewees who selected the ith paired list. We made
however, two adjustments first: omitting own bank bias and imputing ranks for unranked banks.

We requested each interviewee not to rank his or her own bank or a bank controlled by the same
company as controls his or her bank, but some did anyway. Before taking the average, we must go
through the lists of banks, and remove the own banks from the lists. So, for example, if there were
five interviewees who chose Pi , and if two of the interviewees’ banks or associated banks were on
the list, then in calculating the average ranks for those banks, five observations would be used for
all of the banks in the list except those where there were own-banks. For those two banks, only
four observations would be used in computing the ranks. Note that we should not imply rankings
for own banks. We follow this procedure regardless of whether the interviewees had actually
ranked their own banks.

We asked each interviewee to rank not less than 12 or m (if m is less than 12) banks.
Notwithstanding our request, some ranked fewer, so in theory r could range from 2 to m banks. If
the number of banks ranked by the interviewee is less than m, we assign to banks in excess of the
number ranked a default rank, which is the rank number of the last ranked bank plus one. Note
that omitted own-banks, (whether the interviewee has voluntarily omitted his or her own bank or
whether we remove the own bank as described above) are NOT assigned the default rank. They
are simply omitted from the observations, thereby reducing the number of items for averaging to
obtain the elements of Pi as described above.

We then combined the 20 paired lists of ordered members where each member (Pi,j) is associated
with an average ranking ri,j. Note that there was not 100 percent agreement among interviewees, so
the ri,j. are not whole numbers. For example, in the China-Hong Kong paired list, the first six
members are Hong Kong and Shanghai Banking Corporation Limited, China Merchants Bank,
ICBC, Standard Chartered, China Construction and Hang Seng with average rankings of 3.67,
4.89, 5.35, 5.81, 5.9 and 6.25 respectively.

The following describes the procedure by which paired lists were combined. First, we describe the
approach assuming that each of the paired lists has equal validity. Then we discuss weighting
procedure.

In each iteration t, we identify the bank that is least dominated by other banks, select that bank as
the top ranked bank, assign to it the average ranking r j .t from the paired lists of which it is a
member.


                    r  i
                             i , j ,t

(1)      r j .t 
                            ni

These r j .t only refer to the least dominated bank averaging across paired lists where that least

dominated bank is ranked. Here, ni is the number of paired lists in which the least dominated bank
appears. The least dominated bank is then removed from those paired lists in which it is a member
and the 1 is added to the average rankings of the banks in the paired lists in which the selected
banks is not a member. We repeat the procedure for t iterations, with t= 1, 2, … T with T being
determined by the point where there are no banks left to rank. Because the ranking of banks
changes in each iteration of this process, we had to introduce another subscript t.

We define a “least dominated” bank to deal with the failure of consistency among the paired lists.
If all paired lists were consistent, one would simply identify at each t, the un-dominated bank,
where “un-dominated” means that there are no banks left above it in the ranking. If we had
complete consistency and all cross-pairs were included (if n=45), there would be a unique ranking
with no ties introduced because of failure of validation. (Of course, ties could still exist because
they were correctly ranked as being equal).


So, we need to define a variable to summarize the degree of dominance, which we name it as d j .t ,

where d j .t = average number of banks above the bank in the paired lists where the bank appears

in the tth iteration.


                   (count (r
                    i
                                        i , k  j ,t   ri , j ,t ))
(2 )   d j .t 
                                        ni

It may well be that, at any iteration, two or more banks will have the same d j .t . In that case, all

banks with the same d j .t are withdrawn simultaneously. If more than one bank is so withdrawn at

the tth iteration, the rankings ri,j,t of each bank in a list not including each of the withdrawn banks
is incremented by one before ri,j,t+1 in the t+1th iteration. This means that, rankings of banks in
those paired lists not including either (or any) of the two (or more) banks withdrawn are
incremented by 2 (or more as appropriate).

This simple procedure would work if there were equal numbers of assessors for each paired lists.
In fact, the number of assessors for each bank in each paired list ranged from 28 for the maximum
number of assessors in the Hong Kong – China list to one for the Korea – Malaysia paired list.
Hence, equations (1) and (2) were altered to address this different validity by using a weighting
variable w, which is applied to the summations in (1) and (2).


        vi
wi 
        vi
         i



Where vi=number of interviewees contributing to the ith paired list, while the summation takes
place over the paired listed containing the estimated bank.

Equations (1) and (2) should now be changed to the following equations respectively:


                        r  i
                                            v
                                    i , j ,t i

(1’)   r j .t                                   ;
                                v
                                i
                                        i




                         (count (r
                        i
                                                 i , k  j ,t   ri , j ,t )vi )
(2’) d              
                                                 v
             j .t
                                                         i
                                                 i



And, the actual ranking used in calculating the Subjective Score is the rank of the bank upon

withdrawal, r j .t , not the degree of dominance, d j .t . The smaller r j .t is, the higher a bank’s

ranking would be, and correspondingly, a larger Subjective Score. So, the sign of r j .t is actually

opposite to that of the Subjective Score. Therefore, we have to make some adjustments to obtain

the final Subjective Score we actually want. That is why we standardize r j .t , and reverse it, to

derive the standardized Subjective Score for the 2007 study. The larger this score it, the higher a
bank’s ranking would be.

When we asked our expert interviewees to define their Subjective Score rankings in terms of
expected ROE, several of them challenged our definition. One Japanese banker commented, “The
city mega banks do not compete with the regional banks and one region’s banks do not compete
with another region’s. Of course, we know about the mega banks, but we do not know how the
banks of other regions are performing. This is different from Hong Kong where the market is
small and everyone competes across the market. Also in Japan, banks do not compete by ROE.
They compete by market share.”

We specified a five-year horizon, because we anticipated that projecting beyond five years was
too difficult. But the time-frame proved problematic for some of our respondents. A top manager
of one of the leading Chinese banks, who rated Chinese banks highly, stated, “Projections of 5
year ROE are highly dependent on the business cycle. A truly competitive bank manages well in
good and bad times. But the five year time frame may not place China into a recession.” Other
bankers concurred that the five year time limit might not be a “through the economic cycle”
forecast and therefore may be biased.

Both the Profitability Score and the Subjective Score differ much from that of last year, where the
country/regional changes are apparent. For the Subjective Score only, the average ranking of
Chinese banks go up by 21, which reflect the changes in ideas that banking experts have in the
country/regional level.

But much of the difference actually comes from the methodology changes in calculating
Subjective Scores. Last year, we did not ask interviewees to compare banks between countries, but
rather, asked them to rank each bank according to its specific factors (regulatory environment,
market conditions, management and internal control, innovation and professionalism, customer
service delivery, staff quality, information systems and technology, and overall bank reputation),
and make country/region comparisons. In this way, we were able to derive the subjective ranking
of each bank in its own country/region, and the comparison in subjective factors between different
countries/regions, so that we could build the Subjective Score for each Asian bank accordingly.
This is much different from what we did this year.

As we used two different methods to derive the final Subjective Score, and interviewed different
banking experts, we combine the subjective scores of the two years to get the final Subjective
Score for each Asian bank in 2007, to fully utilize our information as well as for continuity. The
methodology is described as below:

Final Subjective Score for Bank A in 2007 = Standardized Subjective Score in 2007 As Reported
in the Survey * 0.6 + Standardized Subjective Score in 2006 As Reported in the Survey * 0.4. We
assign a value of zero (the industry average, because values are standardized) to those banks that
were not in the sample of 2006. This is consistent with how we deal with those banks with some
objective factors missing.

The final subjective score obtained is the Subjective Score for each Asian bank in 2007, to which
we rank banks accordingly. We assign it a weighting of one third, to calculate the final
Competitiveness Score along with the Profitability Score and Objective Score.
Part Three: Interviews with Banking Experts

As we did in 2006, we conducted interviews with banking experts through questionnaires and
face-to-face interviews. The interviewees we selected are bankers residing in Hong Kong or
mainland China, and analysts from investment banks, international bond rating agencies and
consulting companies.

The total number of bankers and financial experts that we interviewed reached 103 this year.
Compared with last year, the number of interviews we conducted and included in our sample has
been greatly enhanced, especially for the banks in Mainland China. Altogether we interviewed 25
bankers and nine financial experts in Mainland China, including four board chairmen, eight Bank
presidents and nine vice presidents. For those bankers in countries/regions other than Mainland
China, we made appointments with them in Hong Kong. As an international financial center,
Hong Kong has a wealth of financial institutions and financial professionals. Their professional
view of banks’ rankings across Asia, may be more objective, and would be able to uncover more
problems associated with Chinese banks, than those domestic studies conducted previously. For
the 2007 study, we interviewed 28 Hong Kong bankers, six Indian bankers, seven Japanese
bankers, four Taiwan bankers, two Malaysian bankers, two Singapore bankers, two Thai bankers,
one Philippine banker, seven Hong Kong financial experts and ten bankers/analysts in other
regions. Choosing Hong Kong as the base region for conducting interviews is also a main reason
why we are able to complete this research within a reasonably short period of time. In the future, if
possible, we will try to conduct interviews simultaneously in other countries/regions of Asia, to
increase our sample size and reduce regional bias.

The interviews with banking experts have provided us with very valuable information and views
for our study. In the following sections, we will briefly discuss the ideas and comments that these
banking experts have contributed according to the dimensions of competitiveness.


I. Profitability: The Key is Sustainability

We assign, as we did in our previous study, one third of the overall score’s weight to profitability.
Although we did not separately poll interviewee opinions concerning this weighting, many
interviewees offered their comments about its validity.

One Indian banker noted, “ROE is not the appropriate measure of a bank’s profitability or
competitiveness. If you get one US dollar return from one US dollar that you invested, that is only
one dollar. The scale of business is more important. Of course, you cannot sacrifice profits for
scale. However, scale is a very important indicator in measuring competitiveness in the banking
industry.”

A Chinese banker said, “I cannot agree more with you that one should define competitiveness
from the perspective of return to shareholders, and I would like to emphasize on the word
“sustainability” of the return to shareholders. Only sustainable return to shareholders can reflect
truly a bank’s core competitiveness. Sustainability means that you must understand the risk behind
the profit. For example, if there are two different banks with different profitabilities, high
profitability does not necessarily indicate high profit generating ability, as there is implicit risk
hidden behind. How to adjust the risk? I think Basel II provides a very good adjustment
mechanism. The aim of Basel II is to make it possible to assess banks using the same risk criteria.
Some banks are backed by high risk; they have high profitability and look fine. However, if we
adjust for risk, these banks will go down.”

An interviewee from Hong Kong believed that some banks’ profitability is highly vulnerable to
outside forces; thus, it is not stable and we cannot take it as a measure of competitiveness. “Retail
banking’s ROE in Hong Kong is highly dependent on the interest spread of HIBOR. The constant
decrease of the interest spread in the past few months leads to the decreases in banks’ profits. But
recently, the Hong Kong Monetary Authority (HKMA) began to buy US dollars (and sell Hong
Kong dollars) to maintain the linked-exchange rate. The increase in liquidity has lowered the
inter-bank interest rates; therefore, interest spread goes up and the profitability of banks is
improved. In China, if the corporate tax rate can reduce to 25 percent, it would also largely
increase the profitability of the banks. This means, no matter how the long-term competitiveness
would be, banks’ profitability is changing all the time.”

This banker also talked about the issue of risk adjustment, “Nowadays, the profitability of banks
in East Europe is very high, but with high risk associated. The International Retail Banking
Council has just held an annual meeting in South Africa. One conclusion that they have made is
that some banks now have very high profit margins and very high profitability, however, this does
not mean that these banks are competitive.”

One of the methods to stabilize profitability is to take the weighted average of ROEs of a longer
time span as the measure of the profitability indicator. One banker proposed, “This year, you use
the average ROEs of 2005 and 2006, but I suggest you use a three-year’s average. This would
reveal a longer-term which is more stable.”

However, a vice president of a Chinese central bank disagreed with putting more weight on
historical profitability, “It is fine to take average of more years. But even for sustainable returns to
shareholders, we are talking about the future. Then, isn’t that the more recent year it is, the more
closer the link would be?”

II. Discovering the New Perspectives of Objective Factors

Especially in our interviews with Mainland Chinese bankers, we reviewed, using an open-ended
format, the seven constituent factors of the Objective Score: size market share, asset quality,
liquidity, capital adequacy, efficiency and deposit base and branch network.

i. Size

Interviewing banking experts provided us with new perspectives to understand how size affects
competitiveness.
One of our interviewees believed that banks need to choose between differentiation and size, but it
is not always at a bank’s discretion to be distinctive, so size becomes more important to
competitiveness. “From the perspective of market competition, a bank -- every bank -- needs to
differentiate itself. However, in environments where regulations are rigid, innovations are hard to
implement. This hurts a bank’s efforts to differentiate itself. In this regard, there is only one
choice for a commercial bank – to depend on size. Why does everyone emphasize size so much? I
think this is reasonable, because it is so hard to be distinctive. If we do not have size either, how
can we win?”

Another banker from a Euro-American bank thinks in another way. He believes how size affects
competitiveness is a matter of management. “Managing a bank is like managing a factory.
Textbooks tell us that everybody should do business with high margins, and avoid business with
low margins. How a bank develops is from taking deposits. A man deposits his money into the
bank. The bank considers another man’s credit is good, and the bank itself wants the interest
spread, so lends him the money. Then bank branches develop one by one. But nowadays, taking
deposits and lending loans is no longer a business with high margins. So why are Citibank, HSBC,
Standard Chartered, ICBC still doing this traditional business and opening new branches?
Textbooks also tell us that they are looking for economies of scale. When internal management is
very efficient, economies of scale will arise. Management cost [per transaction] will be reduced.
Even though the contribution [to fixed costs] remains constant, profits will increase. There are so
many branch networks out there, with the same brand and the same management team. If we
divide them into different regions and integrate the supporting management, the economies of
scale will show up. How size affects competitiveness, is rather a matter of management.”

ii. Market Share

Most of the bankers that we interviewed take very seriously market share. “This is common
knowledge: banks should compete on size. And market share, surely, should be included as an
indicator for assessing a bank’s competitiveness,” one of our bankers said.

Especially in the interviews with senior managers of large banks, market share is a term that we
heard frequently.

A board chairman from a very famous bank said, “Because of the restrictions regulatory
authorities set on our bank, our bank loans grow by less than 13 percent, while the [Chinese]
national average grows by more than 17 percent. We lag by four to five percent. This four to five
percent reduces our market share, but we cannot ignore the national macro-economic controls.”

However, the banker believed that sometimes reducing some of the market share may reduce
much of the risk. He said some banks let their loans increase beyond regulatory guidelines,
understanding that they may be fined by the regulatory authorities. “We will not do that, because
[firstly], we are a large bank, and a state-owned bank; secondly, we think it is necessary to guard
against risk. For example, mortgages. Now housing prices are increasing too quickly. We cannot
say that there are bubbles everywhere, but in some places, there are problems. With such high            Comment [BF]: I have changed the
growth rates, some small banks may be willing to expand [their mortgage portfolios quickly] and          stated meaning that was placed in
take risks, but we have a different risk preference.”                                                    brackets, be4cuase in Chinea’s interest
                                                                                                         rate environment, it did not make sense.
                                                                                                         Credit risk can strike overnight, but not
Some other bankers, think market share is sometimes important, sometimes not, depending on the           interest rate risk.
stages of market development. The importance of market share is more important in a fast-
growing market rather than in a developed one. “In the Mainland, I even do not need to consider
what my rivals are doing!” a banker that had experienced very fierce competition in the Hong
Kong banking industry said. “In the Mainland, the whole market is expanding. Though there are
many banks competing, there is so much room for expansion that one need not consider what
competitors are doing. Even cooperation with the competition is fine. The whole market is
expanding: this year it is 10 billion, and next year it may expand to 100 billion. One can
concentrate on one area and succeed…. This is very much different in Hong Kong, where this
year it is 10 billion, but next year it is merely 10.5 billion. Everyone there fights over market
share.”

iii. Asset Quality

Some bankers regard asset quality as a substantial indicator of competitiveness.

One of our bankers said, “Our bank cares about two things, the appearance and the essence. . The
first thing concerns the level of customer service. Does the bank serve its customers
appropriately or not? Is the bank is really customer-orientated? And are customers really
satisfied? The second thing is about risk control and asset quality. These need to be implemented
properly. If a bank has good service, but bad asset quality, it may still not be sustainable. So I
think the most important aspects are these two. Of course these two things must be backed by
appropriate mechanisms, systems, regulations, and resource-allocation.”

As we mentioned in “Profitability” above, some bankers whom we interviewed think that asset
quality is highly related to whether the profitability indictor is valid or not; hence, they feel that
asset quality should have been weighted more heavily. We define competitiveness from the return
to shareholders’ perspective, take the average ROE for the most recent two years alone as the
profitability indictor, and assign it a weighting of one third together with the Objective Score and
Subjective Score. However, there are many sub-indicators for the Objective Score. Asset quality is
only one of seven. This method, therefore, means that we may greatly underestimate the
importance of asset quality.

Some bankers proposed that we should take a more thorough perspective to treat assets and risk,
rather than measuring the bank’s asset quality alone. A bank president for the China region in a
multi-national bank commented, “Assets are risky, right? What are the bank’s assets? Loans.
Credit risk is the most important [risk a bank faces]. It can collapse in a flash….If 70 percent of a
bank’s profitability comes from the interest spread, then [if defaults increase], in one night, you
will face big troubles. The most important thing for a banker is to be aware of risk. Interest is the
price for asset, and the problem for interest spread is a typical market risk. The movements in
price determine the movements in profitability. If you rely too heavily on bank loans, one day you     Comment [BF]: I have shifted the
will realize that taking deposits and lending loans are no longer your core business, because they     quotation marks, because the speaker
are now the ones that lose the largest amount of money! … If we measure asset quality in this way,     appears still to be talking about his bank.
we would be better off reducing our assets, and earning the same amount of income from fewer
                                                                                                       Comment [BF]: I have altered the
assets. “
                                                                                                       meaning slightly here

iv. Liquidity

Liquidity of a bank sometimes is an imminent problem. If it is not properly handled, a bank will
be frozen. The bankers that we interviewed gave some extreme examples regarding to this issue in
China.

One senior manager in the capital department of a bank commented that liquidity management can
be really strange. When he was interviewed last October, he said, “Our bank has just borrowed
some money from the inter-bank market, with interest of about 4 percent. We then lent this
money to a small bank at an interest rate of 2 percent.” The background to this surprising case
was that, the small bank had encountered some liquidity problems at that time, and owed money to
the bank to which our interviewee belongs. Had it not helped the small bank, and had the small
bank’s problems increased, the interviewee’s bank would have incurred a much greater loss.

A banker from a European bank that entered the Chinese market recently complained that keeping
a bank liquid really gives him a headache. He said, “Now, yield-curve-invterting volatility of short
term interest rates in the inter-bank market where short-term rates rise suddenly like a roller-
coaster, temporarily surpassing medium-and long-term interest rates is really serious. When the
event that dries up liquidity passes, short-term interest rate drop suddenly. Interrest rates for
medium- to long-term maturities over one year are quite smooth, while there is much volatility in
short-term interest rates. Whenever there is a big IPO, the yield curve inverts and there is much
volatility in the market. It happens sometimes during holidays like the Golden Week [in the first
week of October]. However, nowadays as the stock market capitalization gets larger and larger,
more and more funds reserved for purchasing new shares are being frozen, which cause very
negative effects in the money market. As our bank is a net interbank borrower, this gives my
colleagues in our treasury department a dreadful headache.”

Though under some circumstances, maintaining high liquidity is the only solution to the problem,
under other circumstances, especially in banks that have large core deposit bases and are well-run,
the importance of maintaining high liquidity is reduced or even reversed. One interviewee bank
had just experienced a large transferal of deposits from from time deposits to current accounts. In
answer to our query as to whether this shift resulted in problems for capital allocation, its senior
manager commented “In theory, it would. If we borrow short and lend long, the worst outcome is
lack of liquidity. However, the problem at hand is that we have too much liquidity. Especially for
a large bank like us, in September this year, 70 percent of our new deposits were not lent out.”

v. Capital Adequacy
The success of the survival reforms subsequent to the Asian Financial Crisis reduced the urgency
of increasing equity capital in Asian banks. But capital adequacy of banks remains a precondition
to successful bank reform. Some banks that already met capital requirements in past years can
now take preemptive opportunities in developing other aspects of competitiveness.

A banker of a Chinese bank that has already gone through the process of restructuring, going
public and increasing its capital adequacy ratio said, “This year, everyone else was very concerned
about going public, pricing, introducing strategic investors and negotiations, but we were able to
put much of our efforts into internal reforms, with little effort needed on capital. In all of our work
arrangements, 80 percent of our efforts were on internal restructuring and reform. The outcome
has been remarkable.”

A bank’s capital adequacy is very closely related to its financial safety. Commercial banks are a
privileged industry, so to some extent, regulatory authorities place more emphasis on capital
adequacy than the banks themselves. The amount of a bank’s capital directly affects its scope for
expansion and development. One of our bankers said, “It works this way for regulatory authorities.
The amount of capital determines how much business you can do. Only if you have the capital
can you do the business. If you are running out of capital, you cannot expand your business,
because once you do, you will have too much risky assets that require more capital. If you do not
have enough capital to cover those risky assets and if something serious happens, it will be
disastrous.”

vi. Efficiency and Functional Banking

In conducting our open-ended interviews, rather than broadly discussing efficiency, an abstract
concept, or narrowly focusing on our scoring definition of efficiency (the weighted average of
standardized values of three measures for efficiency – the cost to income ratio, the net interest
revenue over earning assets ratio and the ratio of net interest revenue plus non-interest revenue
divided by the number of employees) we directed our interviewees’ attention to functional
banking. The Functional Banking Reform was the major new theme of Chinese banking in 2007.
Correct implementation of functional banking can lead directly to improving efficiency.

One very famous Chinese banker commented in the interview that, “Some leading regulators have
issued instructions emphasizing that a banking reform should concentrate on functional
restructuring and customer services. The allocation of internal systems and processes should be
customer-oriented. The biggest concern at hand is compartmentalization. We have to break down
the many levels of hierarchies and departments, and convert the ‘hierarchy bank’ into a ‘functional
bank’. And the key is to provide the best services to customers at the lowest cost by using the most
convenient methods.”

Another banker added, “What is functional banking? There is no precise definition at hand.
Functional banking is a sort of efficiency. It is best when your [service] quality and cost have
achieved a perfect balance. Though there is no clear definition for it, more and more, I understand
that the next step for banks’ development is not only to mitigate risk and fulfill the requirements
of regulatory authorities, but also to satisfy shareholders’ requirements for returns. Every step that
a bank takes should be coordinated through functional banking.”

The previous banker’s view of functional banking is to optimize efficiency. Another banker
describes a “third aspect” of functional banking. “Nowadays while most banks are implementing
functional banking, they are concentrating on two aspects: one is about internal information flow,
to convert the original ‘bureaucracy driven’ flow into functional flow. The other aspect concerns
organization restructuring, to integrate the front-office and the back office into one department to
achieve a flatter organization. They have not yet done the third thing, which is also the most
difficult one. That is, you should look at the setup of bank departments. There must not be too
many, but also there must not be too few. Without some very necessary departments, risk control
[for example] cannot be properly implemented. But if there are too many departments, costs will
go up and efficiency will be reduced.”

If we regard profitability, capital adequacy and credit quality as responsibilities of a bank’s senior
management, then the scope of functional banking is wider still. The decisions and preparations a
bank must make for such functional banking restructurings are considerable..

A highly-experienced pioneer in Chinese functional banking sector commented, “I made up my
mind to implement functional banking when I was a president. In the second half of 2005, we
decided to remove corporate banking from our branches, and concentrate on retail banking. It is
easier to say than to do. To implement this functional separation, I spent a month or more in high
pressure observation of the situation in Guangtzhou. We needed to transfer many of our
employees into the retail business, but many of the banking professionals in China have little idea
on how to conduct retail business. Our bank at last completed this successful separation and, more
importantly, our business was not adversely affected.”

Another banker – a senior financial manager -- emphasized that each bank needs to implement
functional banking reforms in accordance with its own characteristics. He said, “The concept of
functional banking is still vague right now. It is necessary for a bank to rebuild its organizational
structure and business flow, but it should do so according to its own needs. There are two kinds of
organizational structures world-wide. One is mainly vertical, supplemented by horizontal lines.
The setup of project departments is just like this. The other one is just the opposite. It is hard to
say which one is better. Most Euro-American banks are mainly set up horizontally, but this is not
without cost. The only thing that their presidents do in their China branches is to coordinate. In
daily business connections with them, [their] employees from every department are coming to us
for the same thing. I am so confused, but can do nothing about it. For their business in China, they
have to report individually to their bosses in Hong Kong.”

“Functional banking is a cultural thing. HSBC and the Citibank are set up both vertically and
horizontally. However, HSBC is more oriental, so it is more vertical and less horizontal than
Citibank,. It emphasizes verticality and integration. All Asians like integration. But there is no
integration in departments. If you assign both 50 percent power to verticality and horizontality
nobody would take the role of coordination, they will fight.” Other interviewees also agreed that
cultural was important in determining the course of functional banking reform.

vii. Deposit Base and Branch Network

“Taking deposits and lending are the core businesses of a bank. This cannot be truer for Asian
banks.” This comment made by a Hong Kong banker determines the importance of deposit base
and branch network for Asian banks. One banker from Mainland China mentioned, for traditional
deposit business, the loss of large amounts of saving deposits would put pressure on the banks’
liquidity.

One example illustrates the importance of branch network, agreed to by most of our bankers. “In
China, the vast branch network of domestic banks forms a competitive advantage in retail deposits
over foreign banks,” which help the banks to expand their loan business. A senior manager of a
French bank commented in Shanghai, “It is not at our discretion to absorb deposits. It is the
outcome of the whole bank’s services. Especially for our bank, because we do not have branches
across China, we need to maintain our business through inter-bank borrowing.”

In the long run, as one Euro-American banker mentioned in his China office, the importance of the
deposit base and branch network is negatively related to the degree of development in the money
market. Reduction in the dependence on deposit bases, and even branch networks may be an
important strategy to save resources. “[Today in China] there is no variety of funding sources.
You have to open new branches. Only this can help you obtain deposits. The choice faced by
everybody is the same. Yet this might cause tremendous waste, as opening new branches is very
costly. If there were a developed inter-bank market, some banks could rely on inter-bank loans,
and some banks could rely on taking retail deposits. In this way, banks could diversify funding
and could become more specialized. However, at present, every bank is competing in taking
deposits. The reason is simple: there is not yet a well-developed money market.”

Deposit structure has a significant influence on cost as well. One senior manager of a giant bank
was quite satisfied by the fact that his bank now takes much of its deposits in the form of current
deposits. “Many people converted their time deposits into current deposits, which largely reduced
our cost. Citizens use their deposits to invest, but on the other hand, a large amount of money is
deposited into our bank from intermediary institutions, securities companies, and insurance
companies, to the current account.”

Reduction in deposits may be a driving force for business innovation. A banker commented on
deposit separation, “When one door is closed, another one is opened. Many banks find that there is
much opportunity to earn non-interest income through financial products. The resurgence of the
capital market brings the awareness of financial management, which in turn will affect the future
operating philosophy of a bank.”

Some of the Objective Factors will have a huge influence on Subjective Factors, and branch
network is one of them. A branch network impacts customer service. A Hong Kong banker
commented, “If you score [branching] on a scale from one to ten, Chinese banks can get a score of
ten.” The vast distribution of branch networks makes it easy for domestic Chinese banks to fulfill
their customers’ needs, because face-to-face interaction is very important for a commercial bank.
An effective payment system can get a customer closer. But which one will make a bank better off?
A senior manager for a major commercial Chinese bank commented in Hong Kong, “If the foreign
bank is not located conveniently to the customer, no internal efficiency of payments procedures
will help its payments service.”


III. Subjective Factors’ Determinants of Domestic versus Foreign Bank
Competitiveness in China

In 2006, we introduced a set of subjective factors which determine bank competitiveness. This
year, although we substituted a single subjective assessment in our ranking exercise, we still
believe in the importance of the subjective factors as an analytical construct. In this section we
use that construct in our survey of competition comparing domestic and foreign-funded banks
within the Mainland China area.

Unlike objective factors, subjective factors such as corporate governance, internal control, credit
risk management, innovation, customer service, corporate culture, information systems, reputation
and brand awareness and the legal and regulatory environment are difficult to quantify. The
difficulty is compounded if we compare banks in different countries and across different lines of
business. As a result, we believe that, when discussing the subjective competitiveness of
commercial banks, we de well to concentrate on a specific geographic area -- Mainland China --
and a specific service – providing traditional banking services to corporations.

Geographically, we make our focus on Greater China, especially the Mainland to analyze the
future competitive conditions of banks. For different bank “classes”, we choose the source of
capital as a criterion, to compare between domestic banks and foreign-funded banks in Mainland
China. As corporate banking accounts for more than 80 percent of total revenue for domestic
Chinese banks, and many of the foreign-funded banks which open up their business in China are
still highly dependent on corporate banking, we limit our comparison to the corporate banking
sector.

To measure the difference in subjective competitiveness between Chinese and foreign-funded
banks, we asked interviewees to assess 72 statements divided into nine factors of competitiveness:
corporate governance, internal control, credit risk management, innovation, customer service,
corporate culture, information systems, reputation and brand awareness and the legal and
regulatory environment. Altogether, we were able to obtain 63 questionnaires conducted by face-
to-face interviews. Several senior bankers who did not complete our questionnaires, nevertheless
devoted substantial time to our open-ended interviews. A table of the questions and responses is
found in the Appendix.

i. Corporate Governance

The pros and cons of government ownership of Chinese banks were seen by our interviewees as
largely offsetting.

One Mainland Chinese banker that we interviewed believed that the importance of corporate
governance depends on different stages, “Corporate governance structure is sometimes important,
sometimes not [but its importance is now been largely reduced] Why it is not important nowadays?
Long ago, we did not have shareholders, or corporate governance structure, but only internal
control. Risk awareness was low at that time, so that corporate governance was important.
However, everybody is so aware of risk now, and every aspect is taken good care of, the chance
that we make stupid mistakes is very low.”

“Ultimately, ownership and control determines how effective corporate governance is.” Added
another Mainland banker.“A real corporate governance structure will be very effective. But why
it is not for the present? Because it is not composed of real stakeholders. A structure is just a
structure. In China, it is hard to make it take further effect. Whether a bank is competitive should
depend on its internal management, and internal control system, including the efficiency of
internal structure. Risk control is not enough; one must improve efficiency. This is the key.”

One Malaysian banker summed up the pros of government ownership as follows “The government
is able to deliver business. For example the IPOs were essentially delivered to investment banks
and investors by the government.” Clearly thinking along the same lines, a global bond ratings
analyst group manager said, “Ownership by the government lowers corporate governance
standards but raises competitiveness.”

A team leader of an investment financial institution bank equity analyst group said, of government
support for banks, “In China, like in Japan, Korea and Taiwan, most people do not really believe
that market forces can achieve an appropriate balance. The mutual help system allows an
asymmetrical allocation of pain in times of economic difficulty. The difficulty for an external
competitor in this environment is the opacity. For a non-local bank, the information asymmetries
are much greater reducing the confidence that one can place on negotiation. In the US, who is
secured and unsecured is highly transparent, allowing level playing field negotiation. The banks
know the risks ex-ante, and if they lose, it is their own fault. But in China, for a non-local bank,
the information asymmetries are much greater reducing the confidence that one can place on
negotiation.”

Respondents were nearly unanimous that the transferal of directors and top management between
the government and state-owned banks puts Chinese banks at a competitive disadvantage. An
Indian banker’s response typified this view. “There are advantages and disadvantages but the
disadvantages outweigh the advantages. Connections to the government are useful. But it leads to
less professionalism and more ad-hoc-ism in banking. It is not the way a banking system should
work.”

The incentive pay structures for senior management forms a competitive disadvantage for
domestic Chinese banks, most interviewees agreed. But one Chinese banker cautioned that money
is not everything: “It is not only about high pay. I need to go through the position first…The best
compensation package is not the one with the highest pay, even for Citibank…I attract my
employees with a platform…”

One of the major innovations of the last several years in corporate governance in Chinese banking
has been the selling of strategic equity stakes of Chinese banks to foreigners. Does it improve
Chinese banks’ competitiveness? Certainly the foreign bankers believe it does, but Chinese
bankers and analysts are significantly less sanguine about the benefits of stakes than are the
foreigners. But one manager of a major global bank in China stated: “This is one sided. If the
foreign banks had not bought the stakes, would your stock prices have gone up so much? If you
don’t believe it, just try forcing them to sell. After they sell, would the stock prices go down?
There is value-added in foreign strategic investments.”

ii. Internal Control

In general, bankers and analysts view Chinese banks’ control structures as relatively weak and
forming a comparative disadvantage. One Japanese banker noted that such weak control systems
might actually be an advantage in the short run. He said, “The Chinese banks have weak control
systems. This is a cost advantage, because control systems are very expensive. When things are
going well, a lighter cost load will help the bank. The idea that weak control is a comparative
advantage assumes that the economy will continue to do well, which it most probably will for the
next five years.”

Most interviewees thought that Chinese banks have laxer rules than foreign banks, but several
noted that the reverse was true to some extent. Said one Malaysian banker based in Hong Kong,
“Stricter rules are applied to party members in charge of Chinese banks. But for other staff, this is
not true.”

A Mainland Chinese bank top executive based in Hong Kong noted, “On paper, Chinese banks
have far more rules concerning conduct of employees than foreign banks. For example, employees
are expected to behave in a way befitting of bankers outside office hours. No foreign bank
requires that. They are not allowed to invest in stocks not only during office hours but also after
office hours. No foreign bank requires that. [Chinese bankers]… are not allowed to invest in
stocks not only during office hours but also after office hours.”

Concerning corruption and its punishment, most interviewees felt that corruption was a more
serious problem for Chinese than for foreign banks. But there was considerable disagreement
about whether corruption when discovered was actually punished more severely for Chinese banks.
One Thai banker noted, “There is corruption in all banks, everywhere. But only among the state-
owned banks in China is corruption very severely punished.” Several cited the potential of a death
sentence in China, something that does not exist elsewhere in the world for corruption offences,
but as one banker noted, “The severity of the punishment depends on the person being prosecuted.
This is less the case in foreign banks.”

All respondents agreed that the current process reengineering to achieve functional banking (see
above) within leading Chinese banks including incentive pay structure reform will improve their
efficiency and competitiveness, but a Thai banker cautioned, “Any reengineering will help, but we
have to see the new structures that they come up with.”

iii. Credit Risk Management

Our interviewees predict that credit services will continue to be the most important contributor of
profits in future and credit risk is the most critical risk in commercial banking. But the integrity of
a credit risk management system is never proven in a market boom. Only in an economic
downturn does one find out if a bank’s credit risk management system works. So it is both
interesting and unsettling that, while our respondents believe that credit risk is judiciously
managed by foreign banks, no consensus exists between as to whether Chinese banks are currently
managing credit risk well. Particularly foreign analysts are the quite pessimistic about the Chinese
credit risk management systems while Chinese bankers are cautiously optimistic.

One head of financial institution equity analysis at a leading global investment bank in Hong
Kong highlighted some reasons for the differences of opinion: “Credit risk for Chinese banks
differs from elsewhere because they do not face inherent business cycle risk. A lot of normal
lending is mandatory. It is very hard for a bank to say “no” to any project that has been designated
as a priority. Whether it is the Three Gorges project or the expansion of a steel mill, bankers feel
compelled to support top priority projects, even if the banker feels the project is a big mistake.
They know the principles. They get the cross guarantees between companies. The government
implements the policy lending system. If they have to enforce the collateral, they can achieve
successful enforcement, whereas a foreign bank may be unable to. This is similar to the Korean,
Japanese, and Taiwan model. The listed state-controlled companies, the banks and the government
form a mutual help circle, unlike in the US, European model where a dynamic balance is achieved
through market forces.”

The degree to which policy loans are still being made, the degree to which implicit guarantees will
aid banks if those loans go bad in the future, and the functioning of the new market mechanism are
yet to be tested in adverse conditions.

iv. Innovation

The market for commercial banking services in China rapidly changes from year to year, a fact
that brings opportunities and risks to innovation. But in the long run, in commercial banking, a
bank must be innovative to succeed. Moreover, leading foreign banks’ innovations in commercial
banking present a strong comparative advantage relative to leading Chinese banks in the Chinese
market. These beliefs are widely held among the expert respondents to our study. But innovation
in China is more constrained than in other markets because, as one Hong Kong head of a
Malaysian bank commented, “Regulations are less clear in China and … services are prohibited if
not specifically allowed, [so] risks of introducing new services are high.”

Do foreign banks actually offer different services from their Chinese competitors? Opinions differ.
One head of financial institution equity analysis in a global investment bank in Hong Kong stated,
“… Banking is largely traditional. The innovative part of banking is only a small segment – say
10-15 percent, but the foreign banks have targeted that segment, which provides higher value
added.” Another stated, “Banking services are constant. The needs have always been there. But
the needs before the banking reforms, were not traditionally well met.” Notwithstanding this, the
same banker believes that the services are not the same for foreign and Chinese banks because
foreign banks are not lending to domestic Chinese customers. They do not have the deposit base
so they are restricted in their funding ability.


The chief manager based in China of a leading Singapore bank stated, “Because foreign banks in
China have no way to offer full services to all Chinese clients in the way Chinese banks can, so
the foreign banks use their areas of greatest strength to target specific services to different
customers. Their products of comparative strength are financial products to achieve risk control.
… The scope is not necessarily large but with such a large total market, the results that can be
achieved in specific segments will not be too bad.”

Most innovations in commercial banking can be copied quickly. One Indian banker noted, “The
lead time of foreign bank innovations are not very long, because banks can easily see what each
other are doing and can copy very quickly. So this is not a great competitive advantage. For
example, domestic Chinese bank branches in Shanghai have been remodeled to offer the same
comforts as foreign banks. This innovation just had a six months lead time. The innovation race is
implemented at the local branch manager level. He sees what the competition is doing, is
threatened and reacts by copying. Bringing in the foreign banks spurs the local banks.”

Derivatives are the innovative area in commercial banking most cited as products in which foreign
banks have a strong sustainable comparative advantage over domestic banks. A leading Japanese
banker commented, “Recent regulations have allowed more transactions in derivatives. Here the
foreign exchange and interest rate derivatives of foreign banks allow them to meet customers’
hedging needs. However, it takes time to build derivatives capabilities among Chinese banks.”

We will return to the interaction between innovation and the regulatory environment in the last
section of this topic.

v. Customer Service

Banking is a service business. In the long run the bank that offers the best service at the most
competitive price will achieve the highest market share. But the banker-customer relationship is a
sticky one. The costs for a commercial banking customer to change his bank are relatively high, so
the customer prefers to remain with his existing banker. So, from the banker’s point of view, the
customer portfolio changes slowly. As one head of financial institutions equity analysis based in
Hong Kong in a global bank stated, “In Chinese banks, employees are part of the long
relationship banking model. There is a tremendous stickiness in commercial banking customers.
The foreign banks are only starting out.”
For foreign banks, the lack of branch network has a negative effect on their customer service and
profit generating, including financial services to large corporations, township and village
enterprise lending, and SME financing. Lending opportunities to SMEs are not completely closed
to foreign banks, but they are highly restricted. As the head of a Thai bank in Hong Kong
stated,“Very soon, whatever technology difference you have will be outweighed by the location
advantage. The Chinese advantage in renminbi payments is only a branch network advantage. ”

Regarding township and village enterprise lending, a top manager of a major Chinese bank in
Hong Kong noted, “In terms of village and township lending, the more local the bank is, the
better the service and the more potential profit can be generated. So city commercial banks,
because they are local, have an advantage in SME lending. ”

Overall, interviewees believed that lending to SMEs needs to be more localized and tailor-made
by branches. The exercise of judgment in credit risk management is more important concerning
non-financial than financial-factors. In comparing different types of banking institutions, urban
commercial banks and rural commercial banks have a better comparative advantage.


One vice president for a shareholding bank in China noted, “We mainly target enterprises,
especially SMEs, among which medium sized enterprises account for a larger percentage.
However, for shareholding banks like us, the personnel structure and branch network do not
perfectly match the target. There should a wider branch network. However, state-owned banks are
not a perfect fit either. Urban commercial banks and rural commercial banks are better. Their
judgment ability in non-financial factors is stronger than that in financial ones, including their
good grasp of character and familiarity with local people.”

Answering our questionnaire respondents agreed with the assertion that “China shareholding
banks and city commercial banks are more competitive than other banks in SME lending in
China” while respondents disagreed with the statement that “Foreign banks are more competitive
than other banks in SME lending in China” . Though banks like DBS and Standard Chartered are
moving into SME lending, their limited branch networks place them at a strong comparative
disadvantage.

Regarding the risks inherent in SME lending, one Mainland Chinese banker commented,
“Historically problematic loans mainly occur in SMEs, especially in township and village
enterprises. There are two major reasons: the first is closely related to local governments. The
leaders in county, township and city governments intervene in the banks. The second relates to the
management and control ability of the banks themselves. The first problem has been corrected to
some extent, while the risk management of the bank remains. For large corporations you can
supervise their businesses, but for small enterprises or private enterprises, you cannot. I think that
the best way to solve this is to hand over the responsibility for each loan to a specific person. [In
our bank] we emphasize this over and over again, because in China, the personal reputation of
individuals is actually very important, whenever there is enough collateral. If, in each case, a
specific person takes responsibility, it will solve the problem. As long as this person always
conducts his business according to the law, this condition will work well. When every one says
this guy is industrious and thrifty without doing anything bad, it would be quite safe to issue the
loan.”

One banker attributed the slow development in SME financing to the fact of interest rate control,
which corresponds to the previous statements to some extent, “Nowadays, banks are not willing to
lend to SMEs, not because its interest spread is too narrow, but because the interest spread for
large clients is too wide. If it is so profitable to lend money to large clients, then why would a
bank lend to SMEs? At present, there is an interest floor for loan rates so that large clients cannot
enjoy a reduced interest rate. I would rather conduct business with large corporations. Only when
interest rates are set in a free market can the diversification of bank lending occur. Because the
interest rate is the most important price for financial markets, and this price is planned, many of
the changes cannot take place.”

vi. Corporate Culture

Corporate culture in general favors the competitiveness of foreign banks. Chinese banks suffer
because on average the quality of employees is lower. One foreign banker bluntly stated, “Foreign
banks can afford to pay more, so they get better people.” A top executive of a leading Chinese
bank stated: “Most foreign banks operate in major cities. In major cities, the quality of
employees tends to be better than the quality of employees in minor cities. This fact, plus the fact
that leading Chinese banks are in every city, means that the quality of Chinese banks’ employees
tends to be below foreign banks’ employees.”

But Chinese bankers have a deep knowledge of local economic conditions that gives them a
comparative advantage over foreign bankers. This knowledge advantage is only partially offset by
foreign banks knowledge of global conditions.

It is a common belief among the interviewees that the culture of value creation is more instilled in
foreign banks than in Chinese banks. Our interviewees also considered that employees of leading
foreign banks in China strive to increase profits for their banks more than the employees of
leading Chinese banks. Some of the interviewees believed this relates to the incentive mechanism.

Chinese banks gain a slight comparative advantage from greater loyalty of their staff. This loyalty,
however, is being eroded by the extremely high demand for banking expertise. As one leading
Hong Kong banker resident in Beijing commented, “Today, there is a complete insufficiency of
experienced people. So it is a good market in which to be a banker. Talking about risk in banking,
this is management risk. If we open a branch, we have to have experienced people, because the
effects [of inexperience] could be devastating. So even if [the regulators] opened up the whole
market, we could not develop that fast.”

On average, interviewees agree that banks cannot change their cultures easily simply by hiring
away staff from other banks.

vii. Information systems
Information systems also constitute a comparative advantage for foreign banks. Foreign banks are
faster in executing transactions, and they have a comparative advantage in commercial banking
over Chinese banks with regard to the hardware and software of their information systems, their
access to IT systems and their analytical skills.

One Hong Kong banker residing in China believed that the “late-comer’s advantage” of Chinese
banks gives them an advantage in IT equipment and technologies. She said, “Because they did
not have them before, so they [Chinese banks] go to US and Europe and bring the best into China.
So don’t think that Chinese banks don’t have good equipment. They have a lot of money after the
IPOs, and this does not take much. Foreign banks, however, have the historic burden of legacy
systems. For example Hong Kong banks have their equipment already, but they are not the most
advanced and it would be too costly to replace them all.”

A foreign banker in China, who believes Chinese banks are now better equipped in information
system, emphasized that when he referred to “software and hardware” he meant the those systems
that had been bought, “Especially the software, I do not mean applications. Regarding applying
the systems, foreign banks’ systems are better.”

According to one head of Asian bank equity analysis in Hong Kong, the main reason here is the
lack of experience, “Previously, banks in China have not gone into IT. Some people look at the
very large amount of money that Chinese banks have recently spent on IT and think they must
now be adequate, but they are still underdeveloped.”

Chinese bank IT systems suffer because, although the IT systems may be in place, the information
they contain may not have the degree of accuracy found in foreign banks. Said one analyst:“The
information flow between the branches and headquarters is not as real time as you would think by
looking at the newly implemented information systems. There is still poor integrity of branch
information. Only once per year is there an audit, so the information between audits is not
sufficiently high quality. ”

Some banks are far more advanced than others. Commented one equity analyst, “ABC is one
sixth of the market. If you take out ABC, then the quality rises dramatically. But ABC is a legacy
bank with a huge branch network.”

Information is shared better within foreign banks than within Chinese banks giving rise to a
greater “silo” culture problem among Chinese banks. One Thai bank executive thinks, “It is the
fault of the Cultural Revolution. Employees in China just want to do their own job well. If you
ask them for help, but it is not directly part of their job, they will not do it. They do that to protect
themselves, so that later, nobody will blame them for exceeding their authority. This is different
in Thailand where there is more open sharing. ”

Our interviewees concluded that inadequacies of information systems lead to poorer allocation of
costs and risk capital in Chinese banks than foreign banks. Does this matter? One Chief executive
of a Hong Kong bank believes it does “[We] enjoy an advantage because [our system] optimizes
profitability per client account rather than optimizing profit per branch. This allows better service
and higher profitability.” A Hong Kong-based top manager of a Chinese bank stated, “Risk capital
is not allocated in Chinese bank, so one cannot talk about the inappropriate allocation of risk
capital.” But one head of a Malaysian bank in Hong Kong commented, “It is true that costs and
capital are inappropriately allocated, but it does not matter.”

And there was a general agreement that, when it comes it comes to the actual data in the
information systems, neither foreign banks nor domestic banks have a comparative advantage in
the Chinese commercial banking market.

viii. Reputation and Brand Awareness

The bank, not the banker is more important for both securing and retaining customers in Chinese
commercial banking. In responding to our questionnaire, most interviewees agreed that
advertising counts for less than word of mouth creating brand reputation and awareness for
Chinese banks but not for foreign banks. Most also think that the well established brands of
Chinese banks form an important competitive advantage over foreign banks in commercial
banking in China. But one chief executive of Hong Kong operations stated, “The issue is NOT
the brand. It is the historical relationship. Customers are already there and it is hard to take them
away. In the major cities, there is more migration of customers between banks in search of better
service. But in smaller cities, customers are more likely to stay with their existing banks.”

Does the fact that a bank is Chinese and not foreign in and of itself give that bank a comparative
advantage in the commercial market in China? Opinions are divided. Foreign bankers on average
and especially foreign analysts say yes, to a certain extent. But Chinese bankers and even more so,
Chinese analysts, say it makes no difference.

An Indian Banker heading the Chinese operations from Hong Kong believed that, “There is some
nationalism here. A Chinese customer would rather bank with a Chinese bank than a foreign bank.
But in India, the reverse is true. The bank you use is a fashion statement. Young people in India do
not want to be seen banking with a ‘stodgy’ bank. They would prefer a Citibank.”

ix. Legal and Regulatory Environment

The vast majority of our respondents strongly agreed that the changing legal and regulatory
environment of China provides good opportunities for service innovation in China, but most
foreign bankers feel that the playing field is still not level: laws and regulations of China favor the
domestic banks. As one Indian banker lamented, “[Our branch] is restricted to deal only in
foreign currency in China and will be so for two years. The playing field is not level. The
foreigners pump money into China but then cannot remit profits out. Without foreign remittance
you cannot talk about a level field. The regulations are so tedious that we cannot do our job.”

This view, however, is not shared by domestic bankers and analysts. As one top executive in a
Chinese bank in Hong Kong stated, “Under WTO, both domestic and foreign invested banks are
treated identically. There should be no favor. The perception that the playing field is not level has
a long history and will not be changed suddenly. The foreign banks are now hard pressed to
compete. The deposit and loan rates are the same for both, but it will take a long time for foreign
banks to builds domestic deposit bases. The banks face the same rules, but domestic banks,
because they are established, benefit from those rules more.”

And some foreign bankers concur with this view. A foreign banker emphasized, “With the new
bank regulations, wholly owned subsidiary banks are treated the same as domestic Chinese banks.
So the distinction under law between domestic and foreign banks does not matter any more.”


As a Japanese senior banker commented in Hong Kong, “The current position is quite neutral.
With WTO, there have been many changes. The wholly owned subsidiaries of foreign banks now
operate more freely. But the speed at which we can open branches is not yet known. In one year,
we will know the extent of the liberalization. We hope that it will be faster.

And an Indian bank manager in Hong Kong noted, “Regarding the regulatory environment in
China, various aspects are left up to local jurisdictions. So something might be given the green
light in Shanghai, but not elsewhere. The interpretation may be different in Shanghai and Beijing.
This may present challenges to foreign banks.”

Most interviewees agreed with the statement that “Domestic banks’ better knowledge of the laws
and regulations of China place them at a comparative advantage in providing banking services to
companies in China”. The proponents also regarded “government ownership” as an advantage.

There was relatively strong agreement that domestic banks’ greater knowledge of the laws and
regulations of China, and of the extent to which these laws and regulations are subject to
alternative interpretations, place them at a comparative advantage in providing banking services to
companies in China. But one chief banking analyst in Hong Kong begged to differ, “Just because
that the domestic banks have the knowledge of laws, regulations and practice does not mean that
someone else does not also have the knowledge. Some banks think that the playing field is not
level but I have an alternative interpretation. The Chinese are moving rapidly towards a much
more level playing field than has been the case in the past.“

Competition in deposit taking and lending is certainly restricted because interest rate regulations
continue to restrict competition in China and this restriction works in favor of domestic banks, but
as one banker noted, “Little scope does exist for competition in deposit and lending through
cutting the interest rates on loans or increasing deposit rates. But actually the rules permit
considerable freedom. All pay the deposit ceilings, but then compete on services to corporations,
involving cross selling and building the full banking relationship ….The floor on lending rates
does not restrict actual pricing of credit risk with rates above the floor. The problem is that, with
current competitive pressures, borrowers are not being charged sufficiently high interest rates.”
There was near unanimity, however, that in the Chinese commercial banking market, Chinese
Banks have a competitive advantage because political connections will win them valuable clients.

In summary, Chinese and foreign bankers are currently competing in somewhat different markets
within the commercial banking space in China. Foreign banks’ comparative advantages in
governance, control, innovation, information systems and corporate culture are neither absolute
nor, in the long term, unassailable. Chinese banks’ distribution capabilities and access to funding,
information, customers and government will continue to give them decisive advantage in most of
the market for many years to come.



Part Four: Ranking Results

I. Overall Changes in Asian Banks Competitiveness Status

Before we comment on the actual results of the competitiveness rankings, we first analyze the
changes from last year in Asian banks’ profitability and Objective Scores. To allow meaningful
comparisons, we reduce our sample to those 109 banks that appear in both years’ rankings.

i. Profitability

As the measure for profitability, for those banks that appear in both years’ rankings, the average
ROE of 2005-2006 is 11.0 percent, essentially the same as 10.9 percent, of 2004-2005. Among all
countries/regions, banks in Taiwan and Thailand had the biggest fluctuations. Average ROEs
have decreased from merge by positive profits of 6.2 and 5.0 percent in 2004-5 to -2.9 and 8.4
percent respectively for 2005-6. Taiwan is an overbanked market with little domestic and
restricted foreign opportunities. Credit card losses, starting from 2005 led to severe deterioration
in overall ROE and eroding of bank capital. The decline of the Profitability Scores of Thai banks
are mostly influenced by two banks, Bank Thai and TMB, who experienced huge losses (ROE
negative 69 percent and negative 24 percent respectively) due to commercial credit portfolio
write-offs. Both have since been recapitalized with strategic shareholders but their results pulled
down average Thai profitability. The two year average ROE of Indian banks was approximately
constant at a high 17 percent, substantially over the Asian average The average of both ROEs of
Indian and Singapore banks improved in 2006, after a moderate decrease in 2005. For Singapore
banks, 2006 ROE at 14.5 percent surpassed the level of 2004. The average ROE of Hong Kong
banks (17 percent) is nearly the same as that of last year. For banks in the other five
countries/regions, average ROEs have increased in 2006. Chinese banks’ profitability has
remained stable to risking at just over 12 percent while Philippine banks’ ROE has increased from
9.2 percent to 10.2 percent. And for banks in Korea, the average two year ROE has remained
unchanged at 17.8 percent as profitability in 2006 fell to 2004 levels after the large increase (to
19.8 percent) in 2005. Japan’s banks continue to underperform in ROE with the current 8.7
percent two year average marginally exceeding last year’s two-year average on the strength of
2006 ROE exceeding 2004. .
ii. Size

We take total banks assets as a measure of bank size. For those banks that appear in both years’
rankings, their average bank size reached $117.9 billion in 2006, increased by 22.8 percent
compared with last year. Driven by continued economic growth throughout the region, average
bank size has increased for banks in all countries/regions, though by different degrees. The
increases are the biggest for banks in Korea and Singapore, by 35.9 percent and 32.2 percent
(reaching $96 billion and $111 billion) respectively; while growth is the smallest for banks in
Hong Kong and Taiwan, by 16.2 percent and 10.5 percent respectively (reaching average sizes of
$67 billion and $36 billion). For banks in the other countries/regions, their bank assets all have
increased by more than 20 percent. Among them, the average assets for banks in Mainland China
reached $250 billion in 2006 a 21.8 percent increase compared with last year, making China
Asia’s largest banking market.

iii. Market Share

We take the proportion of bank assets that the bank occupies in its national market as a measure of
market share. For those banks that appear in both years’ rankings, the average market share that a
bank occupies in its national market is 7.2 percent, an increase of 6.8 percent compared with last
year. Our criterion that banks exceed a minimum asset size for inclusion in out study biases our
sample towards big banks. Hence, this increase in market shares means that the market share that
big banks take in their national markets has increased to some extent. Among all countries/regions,
this increase is the biggest for banks in Taiwan, from 4.2 percent to 7.0 percent. This 66.6 percent
increase reflects that, after a series of mergers and acquisitions, the market shares of leading banks
in Taiwan is still increasing; however, given the small average size of Taiwan’s banks,
considerable scope for more consolidation remains. Meanwhile, the average market share of
Japanese banks has decreased by 14.8 percent from 2.63 percent in 2005 to 2.2 percent in 2006. In
Singapore the market structure is identical to last year: three major banks – DBS Bank, Oversea-
Chinese Banking Corporation Limited OCBC, and United Overseas Bank Limited UOB still
dominate.

iv. Asset Quality

We divide asset quality into two sub-indicators: the loan loss reserves to impaired loans ratio and
the impaired loans to gross loans ratio.

Regarding the loan loss reserves to impaired loans ratio, for those banks that appear in both years’
rankings, the average ratio for 2006 is 76.1 percent, a decrease of 13.2 percent compared to that of
2005 – 87.8 percent. The loan loss reserves ratios has decreased the most for Taiwan and Thai
banks, by 37.6 percent and 31.5 percent respectively. Correspondingly, the ratios have improved
for banks in Korea, Singapore, Philippines, Malaysia and Mainland China. The increase is the
greatest for Korean banks, whose loan loss reserves ratio reached a high 135.8 percent, an increase
of 20.3 percent compared with 2005. This coverage rate is much higher than the average in any
other Asian country/region. Meanwhile, the ratios are low in India, Japan and Thailand, only a
little bit higher than 60 percent. For Mainland China, the average loan loss reserves ratio reached
87.2 percent, a 5.8 percent increase compared to last year, and this is the third largest loan loss
reserves ratio in Asia, after Korea and Philippines.

Regarding the impaired loans to gross loans ratio, for those banks that appear in both years’
rankings, the ratios have decreased in all countries/regions, except Taiwan. The Asian average was
3.6 percent in 2006, decreased by 11.9 percent compared with the level of 2005 – 4.1 percent.
Among all countries/regions, Singapore, India and Philippines have reduced the most, by 40
percent, 27 percent and 21 percent respectively. Even though, the ratio of impaired loans to gross
loans for Philippines in 2006 was still 10 percent, much higher than the other Asian
countries/regions; the ratio was also a high 9.4 percent for Thailand. For banks in Mainland China,
the ratio was about 4 percent in 2006, a slight decrease from 2005, but still higher than the Asian
average of 3.64 percent.

We standardize the above two ratios, reverse the sign of the latter, and take their simple average as
the measure of asset quality. If the measure has a positive (negative) value, it indicates that the
country/region’s asset quality is better (worse) than the Asian average.. The larger the magnitude
of the positive (negative) value, the better (worse) is the country/region’s asset quality. For both
2006 and 2005, the banks with the best asset quality are in Hong Kong and Taiwan, whose
standardized asset quality value are much higher than the Asian average. For Hong Kong, though
its ratio of loan loss reserves to impaired loans is only 83.1 percent this year – a 17.4 percent
decrease compared to that of last year – it is still higher than the Asian average; its ratio of
impaired loans to gross loans has reached to a level of 0.88 percent in 2006, which is the lowest
among all Asian countries/regions. Thus, according to this measure banks in Hong Kong have the
best asset quality among all Asian countries/regions. For banks in Taiwan, the ratios deteriorated
to a certain extent in 2006, but are still better than the Asian average, especially the ratio of
impaired loans to gross loans, which is only a half of the Asian average. Besides, the standardized
value for Korean banks is also above average in the last two years, while they are below average
for banks in India, Japan, Malaysia, Philippines and Thailand. And for banks in Mainland China
and Singapore, their average asset quality has turned positive in 2006, indicating that the asset
quality for those two countries has been certainly improved, surpassing the Asian average.

v. Liquidity

We use two ratios – the liquid assets to customer and short term funding ratio and the inter-bank
ratio (the ratio of funds lent to banks divided by funds borrowed from banks) – to measure
liquidity.

For the ratio of liquid assets to customer and short term funding, for those banks that appear in
both years’ rankings, the average ratio for 2006 is about 18.5 percent, an increase of 4.3 percent
compared to that of 2005, when it was 17.7 percent. This ratio has increased the most for
Philippine banks – by more than 100 percent – to a level of 11.5 percent, but is still smaller than
the Asian average. Banks in Thailand and Japan also improve by good percentages: 35.7 percent
and 31.0 percent respectively. Ratios have decreased for banks in Hong Kong, Singapore and
India, by 26.1 percent, 9.7 percent and 6.3 percent respectively. And for banks in Mainland China,
the average ratio of liquid assets to customer and short term funding has increased by 3.9 percent –
compared to that of 2005 – to a level of 16.1 percent, but is still below the Asian average.

We now turn to the inter-bank ratio. The average banks in our study are liquidity providers. The
average value for those banks that appear in both years’ rankings is 221.6 percent. Compared to
the value of 2005, which is 240.5 percent, the ratio has decreased by 7.9 percent. The country with
the biggest fluctuations is India – decreased by more than a half – from 335.5 percent to 139.9
percent. For all countries/regions in Asia, this ratio takes the value of around 200 percent, except
for Korea. It is the highest in Hong Kong, 378.6 percent; while for Singapore, Indian and
Malaysian banks, it takes a value of around 100 percent to 200 percent.

If we take the average standardized value of the two ratios to measure liquidity, we can see that
the value does not fluctuate much for 2006 and 2005 for all Asian countries/regions. It is high in
Hong Kong and India – above the Asian average; while it is low in Mainland China, Japan, Korea,
Philippines, Singapore and Taiwan – below the Asian average. And for banks in Malaysia and
Thailand, whose liquidity measures were below the Asian average in 2005, the values improved to
a level higher than the Asian average in 2006.

vi. Capital Adequacy

We use two ratios – the Basel capital adequacy ratio and the percent of equity to assets – to
measure capital adequacy.

The average Basel capital adequacy ratio was 12.4 percent in 2006 for those banks that appear in
both years’ rankings, a modest increase from the value of 2005, which was 12.2 percent. Among
all countries/regions, the ratio for Mainland China increased by the largest percentage – 10.7
percent – to a level of 9.9 percent, but Mainland Chinese banks’ capital adequacy is still below the
Asian average. India, whose banks average Basel capital adequacy ratio increased by 5.2 percent
showed the second largest percent increase. Its ratio was 12.2 percent in 2006, very close to the
Asian average. Meanwhile, the ratio decreased somewhat for Malaysia, Korea, Singapore and
Hong Kong . Among all Asian countries/regions, Philippine banks had the highest Basel capital
adequacy ratio, 17.3 percent.

For the ratio of equity to assets, if we consider banks that appear in both years’ rankings only, the
Asian average is about 6.5 percent in 2006, essentially the same as in 2005. Similar to the Basel
capital adequacy ratio, the ratio of equity to assets has increased the most for banks in Mainland
China – by 16.26 percent – to a level of 4.15 percent, but is still lower than the Asian average. At
the same time, the ratio of equity to assets has decreased in India, Singapore, Malaysia, Hong
Kong and Taiwan, by percentages ranging from 0.68 percent to 9.15 percent. The ratios are high
for banks in Singapore and Philippines (10.28 percent and 9.89 percent respectively) making
Singapore and Philippines the two countries with the highest bank capitalization in Asia.
If we combine the two ratios and take their average standardized value, we can see that, the capital
adequacy value does not fluctuate much around years 2006 and 2005. The ratios in Hong Kong,
Malaysia, Philippines, Singapore and Thailand are above the Asian average, while the ratios in
Mainland China, India, Korea and Taiwan are below the Asian average. Although Mainland
Chinese banks’ overall capital adequacy improved significantly – not only for Basel capital
adequacy ratio, but also for the equity to assets ratio -- its standardized capital adequacy value is
still the lowest among all Asian countries/regions. And the standardized value in Japan, which was
negative in 2005, has been turned positive in 2006, indicating that the overall capital adequacy in
Japan is now better than the Asian average.

vii. Efficiency

We use three ratios – the cost to income ratio, the net interest revenue over earning assets ratio and
the ratio of net interest revenue plus non-interest revenue divided by the number of employees – to
measure efficiency.

If we consider only banks that appear in both years’ rankings, the Asian average cost to income
ratio in 2006 is 50.2 percent, a decrease from 52.0 percent from in 2005 Except for Thailand,
Singapore and Korea, the ratios have decreased widely across all Asian countries/regions,
indicating that the level of cost control has improved. Among all countries/regions, Japan and
Mainland China have improved the most: their cost to income ratios have been decreased by 9.3
percent and 9.2 percent respectively. Mainland China particularly has a cost to income ratio of 43
percent, making it the third lowest in Asia, following Hong Kong and Singapore. The ratio in
Thailand is the highest in Asia, 67.3 percent, an increase of 13.0 percent compared with last year.

For the net interest revenue over earning assets ratio, for those banks that appear in both years’
rankings only, the Asian average is 2.2 percent, essentially the same as 2005. However, the ratios
for Singapore and Thailand have increased greatly, by 18.5 percent and 16.4 percent respectively.
Hong Kong and Mainland Chinese Banks also improved their net interest revenue to earnings
assets by 7.9 percent and 6.37 percent respectively. For the other countries/regions, their net
interest revenue over earning assets ratios are lower in 2006 than that in 2005, with the percentage
of decrease ranging from 10.76 percent (Taiwan) to 0.57 percent (Malaysia).

The ratio of net interest revenue plus non-interest revenue divided by the number of employees is
a rough measure of the productivity of employees. If we consider banks that appear in both years’
rankings only, the Asian average for 2006 is $240 thousand, compared to that of 2005, which is
$228.2 thousand. Similar to the ratio of net interest revenue over earning assets, Thailand and
Singapore have increased by the largest percentages. The ratio has improved for all other
countries/regions except Mainland China, whose ratio has decreased somewhat to $124.7
thousand, about half the productivity of employees in the average Asian bank in 2006.

If we combine the three ratios to measure efficiency, we can see that, for both 2006 and 2005, the
standardized efficiency for Asian banks does not fluctuate much. Using this measure of efficiency,
Mainland China, Hong Kong, India, Korea and Malaysia exceeded the Asian bank average while
Japan, Philippines, Taiwan and Thailand were below it. For those countries/regions whose values
are above the Asian average, among all three indicators of efficiency, there are nevertheless one or
two ratios below the Asian average. Note that the low efficiency scores of Taiwan cause other
country/regions efficiency scores to rise because of our standardization procedure. Also the
overall efficiency score obscures divergence between the scores in its constituent parts. For
example, Mainland China’s average efficiency score is close to the Asian average, but this
obscures substantial underperformance in employee productivity (partly attributable to
underdeveloped fee income generation) and overperformance on net interest income to earning
assets and the cost to income ratio.

viii. Deposit Base and Branch Network

We use the size of a bank’s core deposits relative to its total deposits and the number of branches
to measure deposit base and branch network.

For the ratio of a bank’s core deposits relative to its total deposits, for those banks that appear in
both years’ rankings, the value does not fluctuate much in the last two years. The average ratio for
all Asian countries/regions is 93.2 percent. It is the highest in Philippines, 98.0 percent; and lowest
in Malaysia, 80.3 percent. But this measure is impaired because data is not available for Korea and
Thailand. And the ratios for the other countries/regions are all larger than 90 percent, except for
Singapore’s 85.3 percent.

If we consider banks that appear in both years’ rankings only, their average number of branches in
2006 was 1170, a decrease of 2.3 percent compared to 2005 (1197 branches). This high value is
mostly contributed by banks in Mainland China and India, whose average numbers of branches
are 4555 and 2456 respectively. For other countries/regions, this figure ranges from 141 in Hong
Kong to 622 in Philippines, far below the value in Mainland China and India.

If we combine the above two figures to measure deposit base and branch network, we can see that,
for both 2006 and 2005, the average standardized values are positive for both Mainland China and
India, indicating that their deposit base and branch network are better than the Asian average;
while the values are negative for Hong Kong, Korea, Malaysia, Singapore, Taiwan and Thailand,
indicating that their deposit base and branch network are worse than the Asian average. The
positive signs in Mainland China and India are largely due to their large nation-wide branch
networks. And for the other two countries, Japan and Philippines, thanks to the high ratio of core
deposits to total deposits and the large number of branches in Philippines, their standardized
measure of deposit base and branch network turned from a negative sign in 2005 to a positive sign
in 2006. (Please refer to the Appendix.)


II. The Top Fifteen Banks in 2007 Asian Banks Competitiveness Ranking

The competitiveness rankings of 125 banks in 10 Asian countries/regions are shown in the
appendix. In presenting the rankings, besides the competitiveness scores, we also provide three
sub-scores for competitiveness dimensions: Profitability Score, Objective Score and Subjective
Score.

Within the overall ranking, the distribution is quite even: in the top fifteen banks, there are three
Hong Kong banks, three Chinese banks, two Thai banks, two Korean banks, two Japanese banks,
one Indian bank, one Singapore bank and one Malaysian bank. Within the top fifteen banks in
Profitability, there are four Malaysian banks, three Indian Banks, three Hong Kong banks, two
Chinese banks, two Korean banks and one Japanese bank. Within the top fifteen banks in
Objective Rankings, Chinese banks are the most numerous with four. There are three each from
Hong Kong, Singapore and Japan and one each from India and Korea. The Subjective Ranking’s
top 15 include three each from Hong Kong and Thailand, two each from China, India and Korea
and one each from Japan, Malaysia and Singapore.

Only two banks, Hong Kong and Shanghai Banking Corporation Limited (Hong Kong Bank) and
Standard Chartered Bank (Hong Kong) Limited (Standard Chartered) place in the top 15 of all
three rankings so, not surprisingly, they are ranked first and second in the overall competitiveness
ranking. Hang Seng bank, the third-placed bank, ranks in the top 15 by subjective and Profitability
Rankings but is 17th in the Objective Ranking.

We list the introduction of the top fifteen banks in overall competitiveness as below.

1st Hong Kong and Shanghai Banking Corporation Limited (HSBC)’s first place flows from
its first place Subjective and Objective Scores and its Profitability Score – ranked 13th. Its
Subjective Score is a very large 0.3479 points above second ranked Mizuho, the greatest
difference between Subjective Scores in our rankings. The high rank in Objective Score comes
more from market share (where it accounts for 44 percent of its local Hong Kong market) than
from any other factor. In size, HSBC is the 8th largest bank in the region with $405 billion in
assets. HSBC’s asset quality ranks 22nd; liquidity is 24th, and capital adequacy ranks 40th .
Efficiency and deposit base and branch network are below the mean.

2nd Standard Chartered Bank (Hong Kong) Limited, a wholly owned subsidiary of Standard
Chartered PLC (UK), owes its ranking to a 22.2 percent return on equity (11th), high Objective
Score (5th), and high Subjective Score (5th). The Objective ranking flows largely from high asset
quality, liquidity, capital adequacy and efficiency. Standard Chartered’s UK parent has strong
presence in Africa, the Middle East and Asia. Its Indian branch network is the largest for a non-
local bank. It has substantial subsidiaries in Korea, Malaysia, Taiwan and Thailand. Tamasek, the
investment arm of the Singapore government (which also controls DBS Bank (6th in
Competitiveness)), holds a 17 percent stake in Standard Chartered.xiv

3rd Hang Seng Bank. Although it is an independently registered bank, 62.1 percent of its equity is
owned by Hongkong Bank. We analyzed Hang Seng as if it were an independent bank. Hang Seng
shows high profitability (4th) and high Subjective Score (7th), and its Objective Score ranks 17th.
Since May 2007, Hang Seng has operated in China largely through its wholly owned subsidiary
Hang Seng Bank (China) Limited, with 18 outlets in Beijing, Shanghai, Guangzhou, Dongguan,
Shenzhen, Fuzhou and Nanjing and is pursuing an aggressive expansion. In a departure from past
practice, this year for the first time, Hang Seng’s chairman is not the same person as Hongkong
Bank’s, indicating that Hang Seng may pursue more independent policies in the future.xv

4th Industrial and Commercial Bank of China (ICBC) is the 4th most competitive bank, based
on its Objective Score in which it ranks second in Asia and its Subjective Score, where it ranks
16th. Its Profitability Score ranks 52nd. This second place Objective Ranking comes from its large
size (the largest bank in China and the third largest in Asia after Mitsubishi UFJ (13th in
Competitiveness) and Mizuho (11th in Competitiveness)), high market share of 22 percent, strong
deposits and branch network (second only to the Agricultural Bank of China (41st in
Competitiveness)). A mid-ranked bank in terms of profitability, its Subjective Score has jumped
from 37th in 2006 to 16th in 2007, which has propelled it increase in overall competitiveness
ranking from 8th place last year. This revised perception of the competitiveness of ICBC is
reflected in its successful global initial public offering in October 2006. Its market capitalization is
the largest in the world at present.

5th China Construction Bank (CCB) shares many of the strengths of ICBC, ranking 6th in its
Objective Score. It has declined from last year’s fourth place as its increase in Subjective Score
(rising from 44th to 23rd) did not sufficiently offset its decline in profitability (with two year
average profitability falling from 22.6 percent to 18.3 percent or from 11th to 26th place in terms of
ranking). The change in Profitability Score in CCB mainly comes from the changes in government
taxation. During its process of restructuring in 2005, CCB was given preferential tax treatment on
income tax (Bank of China and ICBC were also given the same preferential tax treatment), as one
component of the restructuring. However, this preferential tax policy was abandoned in 2006,
which made CCB’s ROE decrease dramatically to 15.0 percent in 2006 from 21.6 percent in 2005..
CCB’s high Objective Score is driven by its large branch network (3rd place in Asia after two
other Chinese banks, Agricultural Bank of China (41st in Competitiveness) and ICBC), its large
size (5th), and its large market share. CCB’s global IPO in October 2005 was the first of the Big
Four Chinese banks to privatize in international markets. Its main stakeholder, holding nine
percent of its shares, is Bank of America. That investment gives Bank of America a book gain of
in excess of $30 billion and forms a part of the $81 billion capital gains western banks have
enjoyed.xvi

6th DBS Bank, is the largest bank in Singapore owned 29 percent and effectively controlled by
the Singapore government. It owes its high ranking to its high Objective Score (3rd ) and
Subjective Score (8th ), and would have scored higher had it not been for its disappointing
profitability (8.6 percent). Its Hong Kong subsidiary, DBS Hong Kong, ranks 31st in
Competitiveness. Its China presence is through a wholly owned subsidiary DBS Bank (China)
Limited and branches of its parent.

7th Kookmin Bank enters the top 15 for the first time this year. It does so on the strength of a high
Objective Score (15th ), good profitability of 19.3 percent leading to a rank of 20th and a
Subjective Score of 13th leading to substantial increasing of standing. With assets of $213.9 billion,
the bank is 11th in Asia. Its Objective score is also boosted by high efficiency (3rd) and a large
market share in the Korean market.
8th Bank of China rises 10 places to enter the top 15 this year on the strength of a continued good
Objective Score (7th) and a dramatic improvement of its Subjective Score (rising from 34th to
20th). With $682.3 billion in assets, it ranks 7th in terms of size and 5th in terms of deposits and
branch network in Asia. As the Chinese bank with the largest international presence, it is more
diversified than the other Big Four and is well positioned to profit from the increased pace of
globalization. Its majority-owned subsidiary, Bank of China (Hong Kong) (22nd in
Competitiveness) outperforms the parent in profitability 23rd versus 55th and has recently acquired
a five percent stake in Bank of East Asia (36th in Competitiveness).

9th Shinhan Bank owes its rise this year from 15th to 9th position to a continued high Subjective
Ranking (6th) and improved profitability (22.2 percent ROE ranking 10th versus 30th last year).
New Shinhan, the product of the merger of old Shinhan and Chohung bank in 2006, has assets of
$169.7 billion and has recently expanded aggressively into Asian private banking. Since the
merger, the principal of equal sharing of top management positions between the former two
banks’ teams has been maintained.xvii Shinhan’s largest stakeholder, since 2006 is BNP Paribas of
France with 9.4 percent of the shares.

10th Public Bank Berhad of Malaysia is the 10th placed bank. Relative to all other banks in the
top ten, Public Bank is small with $41.8 billion in assets, ranking it 60th in Asia. It owes its
position to its high Subjective Score (10th ) as well as high profitability (16th ). Its Objective
ranking of 26th stems from a relatively high market share (15 percent of Malaysia) and good asset
quality. Public bank is the largest independent (i.e., non-government linked) corporation by
market capitalization in Malaysia. Public Bank entered the Greater China region in 2006 with the
purchase of the Hong Kong-based Asia Commercial Bank.xviii One of our interviewees
commented, “Public Bank Berhad is a top Malaysian bank because it focuses on consumers and
SMEs, has strong management and a good Malaysian brand.”

11th Mizuho Bank is the first Japanese bank to enter our rankings, moving up three places from
last year, largely based on its high Subjective Ranking of 2nd. Its mega-bank-creating merger
between Dai-Ichi Kangyo Bank, Fuji Bank and Industrial Bank of Japan seven years ago, is
widely considered to have been successful. The banking group’s $1.2 trillion in assets put it in
second place Asia-wide in terms of size, which propels it into 19th in terms of Objective Score
notwithstanding its middling asset quality and efficiency and relatively low capital adequacy and
liquidity. Its profits are modest (ranked 68th). Mizuho’s strategic emphasis on global investment
banking and asset management to complement commercial banking activities is evident in its
merger of Mizuho and Shinko, creating a securities house to rival Nomura, Daiwa, Nikko and in
its recent corporate cultural changes.xix Mizuho is the first Japanese bank to convert its branches to
a subsidiary in China and looks to increase the rate at which branches can be rolled out.

12th Siam Commercial Bank Public Company Limited owes its 12th place to a high Subjective
Score (ranked 3rd) and reasonably good profitability (ranked 22nd). A relatively small bank with
assets of $28.6 billion, it is smaller in size than its Thai competitors Bangkok Bank (15th in
Competitiveness) and Krung Thai Bank (33rd in Competitiveness). Siam Commercial’s Objective
ranking is 43rd, with relatively high capital adequacy (19th) and efficiency (30th) but with lagging
asset quality. Its largest shareholder is the Crown Property Bureau (i.e., the Thai Royal Family). A
bank with a social mission, Siam Commercial, which is celebrating its 100th anniversary this year,
leads the Thai retail banking market in several key product areas, such as mortgages, credit cards
and insurance.

13th Mitsubishi UFJ Financial Group, with $1.5 trillion in assets, is the largest bank in our study.
Its 12.2 percent ROE represents an improvement over last year but, because it slipped slightly in
both Subjective Score and Objective Score, its ranking has dropped by 3 places. Although the
merger that created MUFG is now two years old, its degree of success is still not clear. In Japan,
the bank is making its retail franchise its key engine of growth and has also taken strategic stakes
banks in the region such as Malaysia’s Bumiputra Commerce Bank (46th in Competitiveness).
Already the top bank by assets, MUFG has set as a target to increase its market capitalization to
the top five.xx MUFG’s commercial bank BTMU has changed its China presence from branching
to a subsidiary this year and hopes to roll out additional branches quickly to complement its
existing ones. It has set up a strategic relationship with China Merchants Bank (21st in
Competitiveness) which it hopes to develop further in future.

14th HDFC Bank of India, owes both to its performance and its slipped ranking to its Subjective
Score (9th, but last year it was 6th). Notwithstanding is relatively small size (with $20.9 billion in
assets) and its relatively small share in the Indian market, it has an Objective Score of 33rd, largely
because of its high efficiency and liquidity. Together with ICICI (28th in Competitiveness and
slightly larger than HDFC), it was an early pioneer the mid 1990s in the liberalization of the
Indian banking industry. It remains a leader among the private sector banks and is now 80 percent
owned by non-Indians – Citicorp is the largest shareholder with 13 percent. It has a reputation for
being customer-focused, outward-looking and modern and has successfully diversified itself away
from its original base. HDFC has also invested in international business process outsourcing to
India, being a 50-50 owner with Barclays of Intelenet Global Services.xxi

15th Bangkok Bank Public Company Limited is widely recognized as the top business bank of
Thailand, with a substantial international presence, including a large operation in Hong Kong and
several branches in China. Its overall Competitiveness ranking has advanced from 23rd last year to
15th. Its relatively high Objective ranking (20th) is attributable largely to relatively high capital
adequacy, liquidity, efficiency and market share in Thailand, but it is lagging in asset quality. Its
profitability (14.5 percent) places it 50th in Asia. While it is the largest bank in Thailand, with
$41.4 billion in assets, the bank is medium sized in our sample. After Asian Financial Crisis,
Bangkok Bank stepped into western capital markets to meet the continuous demand in capital,
which led to a substantial decrease in family shareholdings. For example, Mr. Chatri
Sophonpanich and his family’s shareholding in Bangkok Bank was greatly reduced from 35
percent to 10-12 percent, and foreign shareholdings was increased to 49 percent. Since then, the
bank’s operational performance has greatly improved and its reputation has been restored.


III. Changes in Rankings Compared with Last Year
Comparing the ranking results of this year with that of last year, we can see that, for all the 109
banks that appear in both years’ rankings, four have changed by 31 to 40 places in overall
competitiveness ranking; five have changed by 41 to 50 places in overall competitiveness ranking,
and two have changed by over 50 places in overall competitiveness ranking. In the following
section, we will briefly discuss some of the banks whose overall rankings have changed most
dramatically.

Taishin International Bank and E. Sun Commercial Banks

Among all the 109 banks that appear in both years’ rankings, the overall competitiveness ranking
of Taishin International Bank has changed the most, from a ranking of 32nd in 2006 to a ranking of
123rd in 2007, a fall of 91 places. Its Profitability Ranking dropped by 34, from 90th in 2006 to
124th in 2007; its Objective Ranking has dropped by 90, from 9th in 2006 to 99th in 2007; and its
Subjective Ranking has dropped by 45, from 49th in 2006 to 94th in 2007. Taishin owes its
dramatic fall to the credit card / cash card debacle in Taiwan which led it to lose a third of its
equity in one year. The bank’s own annual report cites “ .. negligence in risk management “ and
“…excessive card consumption among consumers…” Poor performance in asset quality and
efficiency pulled down the Objective Score. And the drop in Subjective Rankings is likely the
result of peer bankers’ reaction to its poor performance.

The Taiwan credit care and cash card debt crisis also adversely affected E. Sun Commercial
Bank’s. Its overall competitiveness ranking dropped from 41st in 2006 to 103rd in 2007, a fall of
62 places. The drop was attributable to its Profitability Ranking dropping by 75, from 21st in 2006
to 96th in 2007. The bank’s ROE has deteriorated from 27.0 percent in 2004, to 11.9 percent in
2005, and finally to 1.1 percent in 2006 Although Objective Ranking rose slightly from 97th in
2006 to 95th in 2007, its Subjective Ranking, dropped by 60, from 23rd in 2006 to 83rd in 2007.

Oriental Bank of Commerce Limited and Axis Bank

The overall competitiveness rankings of two Indian banks, Oriental Bank of Commerce Limited
and Axis Bank Limited (formerly know as UTI Bank Limited) have both changed by 45. Oriental
Bank of Commerce was ranked 31st in 2006, but only ranked 76th in 2007. Its Profitability
Ranking has dropped by 47, from 25th in 2006 to 72nd in 2007; its Objective Ranking has dropped
by 14, from 24th in 2006 to 38th in 2007; while its Subjective Ranking has dropped by 54, from
61st in 2006 to 115th in 2007. Like the Taiwan banks discussed above, Oriental Bank of Commerce
owes much of its fall to ROE, which decreased, from 24.19 percent in 2004, to 13.11 percent in
2005, and then to 11.03 percent in 2006. Though the change in magnitude is not as big as the two
Taiwan banks, this decreasing trend nevertheless pulls down the Profitability Score of Oriental
Bank of Commerce greatly, as ROEs of most Asian banks have been increasing in recent years.
The change in the bank’s Objective Ranking is not less with the drop in ranking by 14 is mostly
related to the reduction of liquidity. Note here that Oriental Bank of Commerce still has liquidity
well in excess of the Asian bank average, and probably in excess of liquidity needs.

Axis Bank dropped by 45 from 39th in 2006 to 84th in 2007. Its Profitability Ranking has risen by
7, from 26th in 2006 to 19th in 2007; while its Objective Ranking has dropped by 39, from 65th in
2006 to 104th in 2007. The drop in the bank’s Objective Score is the result falling loan loss
reserves to impaired loans and deterioration in capital adequacy. The decline in efficiency is a
statistical artifact of our scoring system. Last year, we had no count of employees, and assigned
the average score in employee productivity to the bank. This year, upon obtaining the employee
count, the relatively high employees per total revenue dragged down Axis’ efficiency scores.
Finally, both Oriental Bank of Commerce and Axis Bank’s declined substantially because of the
changed methodology in Subjective Ranking. Whereas our old methodology assumed that banks
within each country were evenly distributed in terms of competitiveness, our new methodology
allows our experts to express their opinions about individual bank across countries. Both last year
and this year, Axis bank was ranked third within Indian banks (just after HDFC and ICICI) but
this year even though its ranking among Indian banks did not change, it was not highly ranked
against banks in other countries.

Bumiputra-Commerce Holdings Berhad

In contrast to the above two Indian banks, the overall competitiveness ranking of Bumiputra-
Commerce Holdings Berhad has risen by 45, from 91st in 2006 to 46th in 2007. Its Profitability
Ranking has risen by 24, from 97th in 2006 to 73rd in 2007; its Objective Ranking has risen by 19,
from 69th in 2006 to 50th in 2007; while its Subjective Ranking has risen by 23, from 63rd in 2006
to 40th in 2007. The bank’s improvements in assets, market, profitability, and Subjective Ranking
all constitute the main force that pulls up Bumiputra-Commerce Holdings Berhad’s overall
competitiveness ranking.

Agricultural Bank of China and Bank of Beijing

The overall competitiveness rankings of two Chinese banks, Agricultural Bank of China and Bank
of Beijing have both risen by 41. The overall competitiveness ranking of Agricultural Bank of
China for the year 2006 was 82nd; but increased to 41st in 2007. The bank’s Profitability Ranking
has risen by 13, from 121st in 2006 to 108th in 2007; its Objective Ranking has dropped by two,
from 6th in 2006 to 8th in 2007; while its Subjective Ranking has risen by 40, from 122nd in 2006
to 82nd in 2007. The improvement is largely due to the bank’s ROE and Subjective Rankings. And
the improvement in Subjective Ranking is attributable to interviewees’ more favorable view of the
banking industry in China and their expectation that the future reform of Agricultural Bank of
China will be successful. At present, Agricultural Bank of China is the only bank among the Big
Four Chinese State-owned banks that has not yet completed its reform. The successes of the
reforms and listings of China Construction Bank, Bank of China, and Industrial and Commercial
Bank of China probably build up interviewees’ confidence in Agricultural Bank of China’s future
reform.

The overall competitiveness ranking of Bank of Beijing has also risen by 41, from 103rd in 2006 to
62nd in 2007. Its Profitability Ranking has risen by 55, from 100th in 2006 to 45th in 2007; its
Objective Ranking has improved by 19, from 81st in 2006 to 62nd in 2007; while its Subjective
Ranking has risen by two, from 82nd in 2006 to 80th in 2007. The main reason for the improvement
in rankings of the bank is its improvement in ROE. From 2004 to 2005, ROE of Bank of Beijing
rose from 5.1 percent to 6.9 percent, and jumped sharply to 22.9 percent in 2006. Meanwhile, the
bank’s liquidity and efficiency have also improved.

Chinatrust Commercial Bank

The overall ranking of Chinatrust Commercial Bank dropped by 40, from 34th in 2006 to 74th in
2007. Its profitability ranking dropped by 68, from 46th in 2006 to 114th in 2007; its Objective
Ranking rose by 33, from 55th in 2006 to 22nd in 2007; while its Subjective Ranking dropped by
57, from 20th in 2006 to 77th in 2007. Though Chinatrust Commercial Bank has improved to some
extent in bank assets, market share, asset quality and liquidity in the past year, which has pushed
up the Objective Ranking of the bank by 33, the bank’s ROE deteriorated. The ROE ratios were
16.0 percent and 15.4 percent for 2004 and 2005 respectively; but dropped substantially to -14.7
percent in 2006.

Punjab National Bank

From 2006 to 2007, the overall competitiveness ranking of Punjab National Bank dropped by 39,
from 16th in to 55th. Its Profitability Ranking dropped by 30, from 13th in 2006 to 43rd in 2007;
while its Objective Ranking dropped by two, from 21st in 2006 to 23rd in 2007. For the
Profitability Rankings, the bank’s ROE was 23.7 percent in 2004, but it dropped to a level of 15
percent and fluctuated in 2005 and 2006. As we take the average ROEs for 2004 and 2005 as the
measure of 2006’s profitability, and use the average ROEs for 2005 and 2006 as the measure for
2007’s profitability, this leads to a sudden drop in the Profitability Score of the bank within the
time range.

Standard Chartered Bank (Taiwan) / Hsinchu Bank

Our measure of the overall competitiveness ranking of Hsinchu Bank, acquired by Standard
Chartered Bank in October 2006 fell by 38, from 80th in 2006 to 118th in 2007. The bank’s
Profitability Ranking, based on year-end 2004 - 2005 and 2005 -2006 dropped by 75, from 43rd in
2006 to 118th in 2007 respectively as the effects of the credit and debt card crisis eroded the
bank’s competitiveness. Its ROE was 16.0 percent in 2004 and 15.7 percent in 2005, but losses in
2006 eroded a quarter of its equity and left the bank vulnerable to takeover. Its Objective Ranking
dropped by 32, from 86th in 2006 to 118th in 2007; while its Subjective Ranking dropped by 29,
from 79th in 2006 to 108th in 2007. The drop of Standard Chartered Bank (Taiwan)’s Objective
Score is a result of deterioration of the bank’s liquidity and capital adequacy. Our measures of
competitveness have yet to reflect any improved post-takeover performance

Canara Bank

The large drop of Canada bank in ranking from 2006 to 2007 of 34 (from 20th to 54th) is largely
attributable to the fall in its Subjective Ranking 68, from 39th in 2006 to 107th in 2007. This again,
reflects the change in Subjective Ranking methodology discussed above under Oriental Bank of
Commerce and Axis bank, and may reflect a bias of our sample of banking experts, drawn from
those resident in Hong Kong and China. The bank’s drop is also partly caused by its Profitability
Ranking drop of 11, from 17th in 2006 to 28th in 2007. The bank’s Objective Ranking remains
constant at 29th.



Part Five: Mainland Chinese Commercial Banks

I. An Overview of 21 Commercial Banks in Mainland China

Our study includes 21 commercial banks from Mainland China, most of whose rankings have
improved, due to improvements in Profitability and Subjective Scores. China’s fast economic
growth and effective banking reform have improved dramatically bank profitability. And the
increased confidence of our expert pool of bankers in Hong Kong and Mainland China in China’s
future economic growth has boosted the Subjective Scores. As one of our interviewees said, “The
competitiveness of a bank is equivalent to the competitiveness of its country.”

i. Bank Assets

Aggregate bank assets of the 21 Chinese banks in the sample exceed $4 trillion, and account for
92.3 percent of total bank assets in Mainland China. The total assets of the “Big Five” commercial
banks – Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB),
Bank of China (BOC), Agricultural Bank of China (ABC), and Bank of Communications – make
up more than 70 percent of the total bank assets in Mainland China. This reflects substantial
concentration in the Chinese banking industry, which may retard future improvements in services
as it reduces competition. Asset quality, measured by measured by the average of two
standardized ratios (loan loss reserves to impaired loans and impaired loans to gross loans), has
turned positive, suggesting that the overall asset quality of Chinese banks has surpassed the Asian
average. However, Chinese banks’ average ratio of impaired loans to gross loans was 3.8 percent
in 2006, still higher than the Asian average, which was 3.6 percent. This ratio was high for many
of the small and medium sized banks and some of the state-owned banks.

ii. Profitability

The average ROE for the Chinese banks in the sample was 13.7 percent, much higher than the
Asian average of 11.0 percent. This profitability reflects a strong macro economic environment
that has improved the debt-repaying abilities of industrial and commercial enterprises. But
profitability is not exceptional by Asian standards. The profitability of only one bank, Industrial
Bank of China, ranks within the Top 10 in Asia, and only one other one Chinese bank, China
Merchants Bank, ranks within the top 20. Among the rest, eight are placed between 50th and 100th,
and four rank below 100. Another structural problem of the Chinese banking industry is that the
profitability for most median to small banks as well as some city commercial banks is not high
enough. This also reflects that the improvement in the overall profitability of the Chinese banking
industry is mainly through the profitability improvement in the Big Four banks (except the
Agricultural Bank of China) after their ownership reforms and public listings.

iii. Capital Adequacy

The average Basel total capital adequacy ratio for all the 21 Chinese banks is about 10 percent,
lower than the Asia average of 12.4 percent. The average equity to assets is 4.5 percent, while this
ratio is 6.5 percent for Asian banks. Among the 21 banks, five still have Basel capital adequacy
ratios averages below the minimum requirement of eight percent. These facts demonstrate that the
capital adequacy status of Chinese banks still needs to be improved. As of the time of writing,
neither Agricultural Bank of China nor China Everbright Bank had been recapitalized. And
because most Chinese banks are growing more quickly than they can accumulate profits, even
those whose Basel capital adequacy ratios exceed eight percent will need to access capital markets
to increase their equity.


II. Individual Bank Discussion

Our study demonstrates substantial variance in the competitiveness of these 21 Chinese banks.
Three of them – Industrial and Commercial Bank of China, China Construction Bank and Bank of
China – entered the Top 10 (4th, 5th, and 8th respectively). Two ranked from 21st to 30th; two
ranked from 31st to 40th; three ranked from 41st to 50th; two ranked from 61st to 70th; one ranked
from 71st to 80th; two ranked from 91st to 100th; four ranked from 101st to 110th, and two ranked
from 111th to 120th.

We commented on Industrial and Commercial Bank of China, China Construction Bank and Bank
of China in the “Top Fifteen Banks” in Section II, Part Three above. In this section, we briefly
introduce the 18 other Chinese banks.

1. China Merchants Bank

China Merchants Bank ranks 21st in overall competitiveness, and its profitability, Objective Score,
and Subjective Scores rank 34th, 60th, and 4th respectively. China Merchants Bank is famous for
retail banking, especially credit cards, where it takes a leading position. By the end of 2006, China
Merchants Bank had assets of $119.6 billion, 2.7 percent of total bank assets in China. The bank’s
asset quality is improving continuously; its ratio of impaired loans to gross loans was 2.1 percent
in 2006. However, its bank loans are too concentrated, with the sum of its bank loans issued to its
ten largest clients’ accounts accounting for 36.5 percent of the bank’s net capital. Furthermore,
most of these ten clients are concentrated in the transportation industry. For 2006 and 2005, China
Merchants Bank’s average return on equity was 16.8 percent making China Merchants Bank one
of the best performers in China. China Merchants Bank has a good capital adequacy: its Basel
capital adequacy ratio and the ratio of equity to assets are 11.4 percent and 5.9 percent
respectively. But even with these comfortable capital ratios, if China Merchants maintains its
rapid 30 percent per year asset growth, it too will have to tap capital markets soon.

2. Shanghai Pudong Development Bank
Shanghai Pudong Development Bank ranks 24th in overall competitiveness, and its profitability,
Objective Score, and Subjective Score rank 33rd, 28th, and 27th respectively. By the end of 2006,
Shanghai Pudong Development Bank had assets of $88.3 billion, or 2.0 percent of the total bank
assets in China. Its asset quality was quite good compared to other listed banks in 2006. Its ratio of
loan loss reserves to impaired loans was a high 152.7 percent, and its ratio of impaired loans to
gross loans was a low 1.8 percent. Shanghai Pudong Development Bank’s profit generating ability
is good. Its net interest revenue over earning assets ratio was 2.8 percent, while its cost to income
ratio was 41.5 percent. The bank’s average return on equity for 2006 and 2005 was 16.9 percent.
Though Shanghai Pudong Development Bank issued 5.9 billion new shares in the second half of
2006 and so improved its capital, its Basel capital adequacy ratio and the ratio of equity to assets
were still relatively low: 9.3 percent and 3.6 percent respectively. We believe the bank needs to
expand its equity capital base in order to support its future growth.

3. Bank of Communications

Bank of Communications ranks 32nd in overall competitiveness, and its profitability, Objective
Score, and Subjective Score rank 53rd, 46th, and 15th respectively. Bank of Communications listed
on the Hong Kong Stock Exchange in June, 2005, becoming the first domestic commercial bank
that listed abroad. At the end of 2006, Bank of Communications had assets of $220.2 billion, 5.0
percent of the total bank assets in China. At the end of 2006, the Ministry of Finance, which held
21.8 percent of the bank’s total shares, was the bank’s largest shareholder; while its strategic
shareholder, HSBC, had a shareholding of 19.9 percent. Bank of Communications’ asset quality
improves continuously. Its impaired loans to gross loans ratio and loan loss reserves to impaired
loans ratio in 2006 were 2.0 percent and 93.1 percent respectively. The bank has high efficiency.
Its net interest revenue over earning assets ratio was 2.5 percent, and its cost to income ratio was
41.6 percent. The average return on equity was 13.9 percent for 2006 and 2005. And the Basel
capital adequacy ratio and equity to assets ratio are 10.8 percent and 5.3 percent respectively.
Compared to the bank’s fast expansion in bank assets, its capital reserves need to be enlarged. In
2007, Bank of Communication’s capital strength was enhanced through an equity financing of
$24.8 billion in the A-share market.

4. China Minsheng Banking Corporation

China Minsheng Banking Corporation ranks 37th in overall competitiveness, and its profitability,
Objective Score, and Subjective Score rank 15th, 92nd, and 26th respectively. China Minsheng
Banking Corporation was the first shareholding commercial bank nationwide whose shareholders
are mainly enterprises without state ownership. Compared to other commercial banks, the funding
status of Minsheng Bank is quite good. In 2006, the bank’s loans increased dramatically; its
capital adequacy improved to a certain extent, and its capital adequacy was not bad. By the end of
2006, Minsheng Bank had assets of $92.9 billion, about 2.1 percent of the total bank assets in
China. The asset quality of Minsheng Bank improved in recent years. Its impaired loans to gross
loans ratio and loan loss reserves to impaired loans ratio were 1.3 percent and 103.6 percent
respectively. However, one thing worth noting is that the bank loans of Minsheng Bank are too
concentrated: the bank loans issued to its ten largest clients accounted for 43.7 percent of all the
bank loans, very close to the ceiling set by China Banking Regulatory Commission (CBRC). At
the end of 2006, its Basel capital adequacy is was a low 8.1 percent, while its equity to assets ratio
was 2.7 percent. In June 2007, Minsheng Bank issued 2.4 billion shares for private placement in
the A-share market, improving the bank’s capital adequacy.

5. Agricultural Bank of China

Agricultural Bank of China ranks 41st in overall competitiveness, and its profitability, Objective
Score, and Subjective Score rank 108th, 8th, and 82nd respectively. By the end of 2006, Agricultural
Bank of China had the largest branch network in Asia – 24,937 domestic branches, offshore
branches in Singapore and Hong Kong, and representative offices in London, Tokyo and New
York. It is the only state-owned commercial bank that has branches and electronic networks in
every county and every city in China. However, among all the large commercial banks in China,
Agricultural Bank of China ranks last in financial and operational status. Its recapitalization and
ownership reform is still ongoing. The ranking of Agricultural Bank of China has improved to a
large extent because of nation-wide rather than bank-specific factors (see Section III in Part Three).

The profit generating ability of Agricultural Bank of China is quite weak. Its average return on
equity is 4.2 percent for 2006 and 2005. The bank’s cost to income ratio is 54.9 percent – high for
China -- and the net interest revenue to earning assets ratio is a low 2.0 percent. As the bank
customers are mainly from the under-development rural area and the overall asset quality of the
Agricultural Bank of China is poor. But there have been some improvements in recent years. At
the end of 2006, the impaired loans to gross loans ratio decreased from 26.2 percent (at the end of
2005) to 23.4 percent. The assets of the bank have increased constantly, with an annual growth
rate of 12 percent from 2005. Agricultural Bank of China’s new business mainly targets telecoms,
energy and transportation industries in the costal developed areas, but its existing portfolio still is
dominated by agricultural loans. There is insufficient bank capital: the equity to assets ratio in
2006 was only 1.57 percent.

6. China CITIC Bank

China CITIC Bank ranks 45th in overall competitiveness, and its profitability, Objective Score,
and Subjective Score rank 36th, 75th, and 33rd respectively. In 2006, its Basel capital adequacy
ratio and total capital to assets ratio were 9.4 percent and 4.5 percent respectively. In April 2007,
an IPO of $5.5 billion substantially increased its capital adequacy. In 2006, China CITIC Bank
had a good profitability; its two-year average return on equity was 16.1 percent, and ranks 36th in
profitability. Because of the good economic environment and the financial restructuring before the
IPO, the bank’s asset quality and risk management ability improved greatly. However, as the
bank’s major source of funding is time deposits of corporate clients, the cost of funding is higher
than those competitors with retail deposit bases; meanwhile, its personnel cost has nearly doubled
in the past two years, and the cost to income ratio is 45.87 percent. Overall, China CITIC Bank is
a medium-sized bank, highly dependent on corporate banking. Its cost of debt capital and credit
risks is high. In 2005, China CITIC Bank unveiled a new strategy aiming to develop its retail
banking (including mortgage loans, customer credit, credit cards and loans to SMEs), and set a
target that retail banking should account for 20 percent of its overall business in three years.
However, China CITIC Bank seems to be running out of time to fulfill this goal.

7. Industrial Bank

Industrial Bank ranks 47th in overall competitiveness, and its profitability, Objective Score, and
Subjective Score rank 9th, 107th, and 38th respectively. The overall ranking of Chinese banks’
profitability is low in Asia, but Industrial Bank is an exception. This raises the overall
competitiveness ranking of Industrial Bank even though its Objective Ranking is low. In 2006, the
asset quality of Industrial Bank was distinctively high compared to other banks; its impaired loans
to gross loans ratio was 1.5 percent. However, the amount of loans was increasing too fast, which
may hurt its asset quality in future. In 2006, the bank’s return on equity was a high 26.2 percent;
its average return on equity for two years reached 23.9 percent, and this makes Industrial Bank the
only Mainland China bank that enters the Asian Top 10 in Profitability Ranking. However, as
Industrial Bank’s branch network is limited, its source of funding mainly is through non-core
deposits and company bonds. Hence, the bank’s cost of capital is high relative other banks. Its net
interest revenue to earning assets ratio and the cost to income ratio are 2.4 percent and 38.9
percent respectively. Though Industrial Bank has raised RMB16.0 billion in the A-share market,
its overall capital reserves are not strong enough. The Basel capital adequacy ratio and equity to
total asset ratio in 2006 were 8.7 percent and 2.6 percent respectively. In the medium term, as its
bank loans are increasing quickly, Industrial Bank will need further infusions of equity capital.

8. Bank of Beijing

Bank of Beijing ranks 62nd in overall competitiveness, and its profitability, Objective Score, and
Subjective Score rank 45th, 62nd, and 80th respectively. The significant improvement in the overall
competitiveness ranking of Bank of Beijing is attributed mainly to its improvement in Profitability
Score, as well as asset liquidity and bank efficiency which improve its Objective Ranking as well
(refer to Section III in Part Three). In 2005, ABN-AMRO and International Finance Corporation
(World Bank Group financial institution) injected a large amount of capital into Bank of Beijing.
ABN-AMRO became its largest shareholder, and Bank of Beijing, from then on, became the only
city commercial bank whose largest shareholder is non-Chinese. Bank of Beijing has 118 branches.
By the end of 2006, its assets were $35 billion, about 0.79 percent of the total bank assets in China.
The bank’s return on equity increased quickly, from 6.9 percent at the end of 2005 to 22.9 percent
at the end of 2006, making the average return on equity 14.9 percent. The bank’s cost to income
ratio was 29.6 percent, and its net interest revenue to earning assets ratio was 2.2 percent. At the
end of 2006, Bank of Beijing’s Basel capital adequacy was 12.8 percent, and its equity to total
asset ratio was 3.6 percent. In September 2007, Bank of Beijing listed on the A-share market,
thereby increasing its capital reserves.

9. Bank of Shanghai

Bank of Shanghai ranks the 64th in overall competitiveness, and its profitability, Objective Score,
and Subjective Score rank 44th, 93rd, and 51st respectively. Bank of Shanghai equity investors
include the International Finance Corporation, HSBC, Shanghai Commercial Bank and other
foreign banks. In April 2006, with the official opening of its Ningbo Branch, Bank of Shanghai
became a multiregional bank. By the end of 2006, Bank of Shanghai had assets of $34.6 billion,
about 0.78 percent of the total bank assets in China. The bank has 4580 employees and 208
branches. The profitability of Bank of Shanghai is quite good. The average return on equity for the
2006 and 2005 was 15.2 percent. The bank has low impaired loans to gross loans ratio. At the end
of 2006, the ratio of impaired loans to gross loans was 3.1 percent, while the loan loss reserves to
impaired loans was 75.7 percent. Its cost to income ratio was 37.7 percent, and the net interest
revenue to earning assets ratio was 2.3 percent. The bank’s capital adequacy is quite high: its
Basel capital adequacy ratio for 2006 was 11.6 percent.

10. Bank of Tianjin

Bank of Tianjin ranks 79th in overall competitiveness, and its profitability, Objective Score, and
Subjective Score rank 76th, 85th, and 68th respectively. At the end of 2005, ANZ Bank invested as
a strategic investor over $100 million or 20 percent of the enlarged capital of Bank of Tianjin.
With that investment, ANZ Bank became the foreign investor with the largest stake among all
Chinese banks. The introduction of ANZ bank not only helped Bank of Tianjin improve its
capital reserves, but also helped it improve its operations and management. By the end of 2006,
Bank of Tianjin had assets of $10.4 billion, about 0.24 percent of the total bank assets in China. It
is also the fourth largest city commercial bank in China. In 2006, the profitability of Bank of
Tianjin improved to some extent, but was still not very high. The average return on equity for the
2006 and 2005 was 10.6 percent. The bank’s asset quality is quite good. At the end 2006, the ratio
of impaired loans to gross loans was 3.0 percent, while the ratio of loan loss reserves to impaired
loans was 103.36 percent. The bank’s cost to income ratio was 32.0 percent, while its net interest
revenue over earning assets ratio was 2.6 percent. The capital adequacy of Bank of Tianjin is high:
in 200 its Basel capital adequacy ratio was 11.7 percent, while its equity to assets ratio was 6.1
percent.

11. Hua Xia Bank

Hua Xia Bank ranks 96th in overall competitiveness, and its profitability, Objective Score, and
Subjective Score rank 62nd, 96th, and 91st respectively. In 2003, Hua Xia Bank listed on the
Shanghai Stock Exchange. In November 2005, Hua Xia Bank entered a series of agreements with
Deutsche Bank, on transfer of shares, long-term strategic co-operation, technical support and
assistance, and credit cards. By the end of 2006, Hua Xia Bank had assets of $57 billion, about
1.29 percent to the total bank assets in China. Shougang Group is its largest single shareholder,
holding 20 percent of its shares while Deutsche Bank is the fourth largest shareholder, with 7.0
percent.

Compared to other listed banks in Mainland China, the profitability generating ability of Hua Xia
Bank is quite poor. In 2006, its net interest revenue to earning assets ratio was only 1.8 percent,
and its cost to income ratio was 42.8 percent. The average return on equity for 2006 and 2005 was
12.9 percent, ranking Hua Xia Bank 62nd. The impaired loans to gross loans ratio, however,
decreased dramatically from 6.1 percent at the end of 2002 to 2.8 percent in December 2006,
though this improvement was mainly due to the fast growth of bank loans. The bank’s Basel
capital adequacy ratio at the end of 2006 was 8.3 percent, while its equity to assets ratio declined
from 2.9 percent at the end of 2005 to 2.6 at the end of 2006, not sufficient to sustain Hua Xia
Bank’s speedy expansion. Hua Xia Bank needs to look for new sources of capital.

12. Jiangsu Bank

Jiangsu Bank ranks 97th in overall competitiveness, and its profitability, Objective Score, and
Subjective Score rank 104th, 82nd, and 68th respectively. Jiangsu Bank is a shareholding
commercial bank,with registered capital of RMB7.85 billion, created from the merger of ten city
commercial banks in Wuxi, Suzhou, Nantong, Changzhou, Huai’an, Xuzhou, Yangzhou,
Zhenjiang, Yancheng, and Lian Yungang in Jiangsu Province. By the end of 2006, the bank had
established a network of 414 braches and had 7281 employees. Its total assets were $19.4 billion,
about 0.44 percent of the total bank assets in China.

As Jiangsu Bank is less than two years old, it is still in the process of integrating employees,
businesses and assets and developing its strategy. In 2006, the bank’s return on equity was 5.0
percent, ranking Jiangsu Bank 106th. Its impaired loans to gross loans ratio was 2.6 percent while
its loan loss reserves to impaired loans was 111.8 percent. The cost to income ratio was 44.5
percent, the net interest revenue to earning assets ratio was 1.9 percent, and the capital adequacy
ratio was 13.0 percent.

13. Shenzhen Development Bank

Shenzhen Development Bank ranks 102nd in overall competitiveness, and its profitability,
Objective Score, and Subjective Score rank 41st, 124th, and 60th respectively. At the end of 2004,
Newbridge Capital purchased 17.9 percent of Shenzhen Development Bank’s shares from its
shareholders, and became the largest shareholder of the bank. In September 2005, Shenzhen
Development Bank signed an agreement with GE Capital Financial on strategic cooperation. At
the end of 2006, the bank had assets of $33.4 billion, about 0.75 percent of the total bank assets in
China. The profitability of Shenzhen Development Bank improved greatly in 2006; its return on
equity increased from 6.1 percent in 2005 to 25.1 percent in 2006. The average return on equity
for the two years was 15.6 percent. The bank has successfully switched its loan portfolios to
secured loans with high returns. With its interest spread increased and costs reduced, its use of
capital is more efficient and its loan portfolio is much healthier. Moreover, the successful
restructuring of bad loans and improvements in asset quality have reduced the need for extra loan
loss provisions. The reduction in the actual tax paid further improved the bank’s profitability.

14. Shenzhen Ping An Bank

Shenzhen Ping An Bank ranks 104th in overall competitiveness, and its profitability, Objective
Score, and Subjective Score rank 87th, 112th, and 64th respectively. Shenzhen Ping An Bank
formerly was the first city collective bank in China – Shenzhen Commercial Bank. In 2006,
Ping’An Insurance acquired 89.4 percent of the shares originally held by other shareholders, and
became the controlling shareholder. In 2007, Shenzhen Commercial Bank merged with another
bank held by Ping’An Insurance in Shanghai and Fuzhou, and started inter-regional operations.

The profitability of Ping An Bank is low. The average return on equity for 2006 and 2005 was 8.2
percent, and ranking 87th in profitability. This low profitability mainly comes from the burden left
from writing-off historic bad loans. The bank’s asset quality improved a lot in 2006, but is still
quite weak. The impaired loans to gross loans ratio is 7.5 percent, and there are not sufficient loan
loss reserves, which only account for 65.4 percent of impaired loans. The bank’s 2006 cost to
income ratio was 43.1 percent, while its net interest revenue to earning assets ratio was 2.3 percent.



15. Beijing Rural Commercial Bank

Beijing Rural Commercial Bank ranks 106th in overall competitiveness, and its profitability,
Objective Score, and Subjective Score rank 86th, 119th, and 65th respectively. Beijing Rural
Commercial Bank was founded in October 2005 through the reformation of Beijing Rural Credit
Cooperative. The bank has a network of about 700 branches and 8000 employees. By the end of
2006, the bank had assets of $19.8 billion, 0.45 percent of the total bank assets in China. The
profitability of Beijing Rural Commercial Bank is quite weak. The average return on equity for
2006 and 2005 was only 8.4 percent. In 2006, the bank’s impaired loans to gross loans ratio was
10.6 percent, while the loan loss reserves to impaired loans ratio was 33.7 percent. Its cost to
income ratio was 54.3 percent, while its net interest revenue over earning assets ratio was 2.4
percent. The bank’s Basel capital adequacy ratio was 8.7 percent, slightly in excess of
CBRC/Basel capital requirements. However, as the impaired loans to gross loans ratio is high, and
there are not insufficient loan loss reserves, the bank will need to further enlarge its capital
reserves.

16. Shanghai Rural Commercial Bank

Shanghai Rural Commercial Bank ranks 107th in overall competitiveness, and its profitability,
Objective Score, and Subjective Score rank 93rd, 113th, and 66th respectively. Established in
August 2005, Shanghai Rural Commercial Bank is a shareholding commercial bank formed by the
merger of rural credit cooperatives, credit cooperative unions and urban cooperative unions of the
districts and counties of Shanghai. The bank has a registered capital of RMB3 billion, about 4000
employees and 330 branches with coverage in every rural county of Shanghai. In November 2006,
ANZ Bank purchased 19.9 percent of Shanghai Rural Commercial Bank’s shares. By the end of
2006, the bank had assets of $17.4 billion, which accounted for 0.39 percent of total bank assets
in China. The profitability of Shanghai Rural Commercial Bank is quite weak with ROE in 2006
and 2005 of 6.75 percent. But its asset quality is good with an impaired loans to gross loans ratio
is 1.7 percent and a loan loss reserves to impaired loans ratio of 98.5 percent. Its cost to income
ratio is a high 85.3 percent. Moreover, it is undercapitalized with its Basel capital adequacy ratio
for the year 2006 of only 7.3 percent.
17. China Everbright Bank

China Everbright Bank ranks 113th in overall competitiveness, and its profitability, Objective
Score, and Subjective Score rank 112th, 121st, and 86th respectively. China Everbright Bank was
founded in August 1992, with headquarters in Beijing. The bank completed its joint stock reform
in January 1997, thus becoming the first domestic state-owned, nationwide joint-stock commercial
bank with equity investment from international financial institutions. By the end of year 2006, the
bank’s assets were $76.1 billion, about 1.7 percent of the total bank assets in China. The major
shareholders of China Everbright Bank include: a state-owned enterprise – China Everbright
Group Ltd (a shareholding of 24.2 percent), and China Everbright Limited (a shareholding of 21.9
percent), while Asian Development Bank is its fifth largest shareholder, with 1.9 percent of its
total shares. Though the bank’s asset base is large, its asset quality is not good. Besides, the bank
loans are highly concentrated; its profit generating ability is poor, and its capital reserves are
insufficient. These all constitute the reasons why China Everbright Bank is ranked rather low in
the competitiveness ranking. (As China Everbright Bank’s full Annual Report of 2005 was not
published at the time of our research, except bank assets, the data we used in this ranking for this
bank, such as its objective data and ROE, are derived from its Annual Report of 2005.)

As of late 2007, the restructuring of China Everbright Bank, under the direction of Huijin
Company (which is to be the controlling shareholder), has reached its last stages. It is anticipated
that the restructuring will entail entry of strategic investors and public listing with a view to
improving the bank’s governance, control and overall operations.

18. Guangdong Development Bank

Guangdong Development Bank ranks 114th in overall competitiveness, and its profitability,
Objective Score, and Subjective Score rank 115th, 98th, and 105th respectively. In 2006, Citigroup
purchased 19.9 percent of Guangdong Development Bank and became a strategic shareholder,
leading its restructuring. By the end of 2006, the bank had assets of $47.9 billion, about 1.08
percent of the total bank assets in China. As its restructuring has just been completed, Guangdong
Development Bank’s profitability in 2006 was still poor with negative ROE for 2006 and 2005
(the only Mainland Chinese bank with negative two year average ROE in our sample). Many of
the bad debts were sold in the restructuring, so the bank’s asset quality has improved a lot.
However, as of 2006 there were still insufficient loan loss reserves. In 2006, the ratio of impaired
loans to gross loans was 3.8 percent, while the ratio of loan loss reserves to impaired loans is 89.0
percent. The bank’s 2006 cost to income ratio was 59.84 percent, and its net interest revenue over
earning assets ratio was 1.8 percent.



Part Six: Written After the End of “Survival Reform”
There is a high degree of continuity between last year’s rankings and this year’s. Omitting those
banks that do not appear in both years, the correlation between the overall scores for this year and
last year is 83 percent. The top three ranking banks last year are the top three again this year,
although Standard Chartered and Hang Seng Bank have changed places. Within this year’s top 15
banks, 11 remain unchanged while four banks are newcomers – Kookmin Bank, Bank of China,
Public Bank Berhad, and Bangkok Bank Public Company Limited. These four replace
Kasikornbank Public Company Limited, Hana Bank, State Bank of India and Malayan Banking
Berhad

On a countries/regional basis, Mainland Chinese and Singaporean bank competitiveness has
improved the most, with the average rank of banks in these two countries going up by 16 places;
while the average rank of Indian and Taiwan banks has dropped the most, by 23.

In the Subjective Rankings, Mainland Chinese banks also improved the most, with a rise in the
average rank of 11 places; while the average ranks of Taiwan and Thai banks dropped by 23 and
19 places respectively. The Profitability Scores of those banks in Taiwan and Thailand decreased
dramatically, lowering the average rank of the banks in those two regions.

In the Objective Rankings, Japanese banks rose the most with average ranks going up by 18. In
contrast, the average rank of Malaysian banks dropped by 12. Except for asset quality and
liquidity, the other objective factors for Malaysian banks were low compared with banks in other
countries/regions. For other countries/regions, there is not much change in the Profitability
Ranking and Objective Ranking between the two years, demonstrating consistency of our study.

Researchers hope, for convenience sake, that interviewees will give consistent answers with as
much consensus as possible on each subject, so that the results of a study become widely accepted
common knowledge. Consistency is highly valuable for drawing conclusions. However, in our
study the opposite has occurred. We face a diversity of opinions. Looking through the notes that
we made during the interviews with dozens of bankers, we find a heated debate.

Over the past year, sustained by the rapid economic growth, the profitability, asset quality, and
business performance have improved a lot for many Asian banks. Though the problems revealed
by the US Subprime Mortgage Crisis have enlarged the risks in the worldwide economy, the
positive reforms made in the last several years and the steady development in Asian banks make
them more capable of handling such risks. The “survival reform” consisting of capital injections
from governments, separation of bad banks from good banks, mergers and acquisitions of
financial institutions, and improving the capital adequacy of the banks has almost reached its end.

If it was the Asian Financial Crisis a decade ago that make Asian banks reform themselves for
survival, then Asian banks are looking in 2007 for their own niches. How to position their core
competitiveness, how to judge future prospects and make proper adjustments, and how to search
for new development potentials under conditions of fast capital market growth and profound
reform of financial systems -- the answers to these questions, naturally involve huge differences of
opinion among different bankers.

Our research results on business prospects reflect these differences of opinion. We asked expert
interviewees to rank in terms of potential for generating profits over the next five years the four
main business categories of banking, namely corporate banking, retail banking, investment
banking and private banking, and assign them a discrete value from 1 to 4 respectively. Though
the interval is between 1 and 4, the commercial banking business which is ranked at the top is only
1.2 points higher than the private banking business that ranked at the bottom. For Chinese bankers,
the lack of consensus is even more striking: retail banking is ranked first while private banking is
ranked last, but there are only 0.8 points between them. Obviously, there are considerable
differences of opinion.

One head of Chinese business for a leading Euro-American retail bank commented, “Nowadays,
everyone is talking about retail banking. Why is that? According to the common rule in
international markets, if it is 100 in the stock market, it may be 150 to 200 in the bond market.
When the stock market develops together with the corporate bond market, those companies with
good credit ratings will leave their banks for the capital markets. Those commercial bank clients
with good credit ratings would then escape. However, the banks have built vast branches and
developed strong systems. Where should the money of the banks go? Retail banking. Only those
clients with non-investment grade will remain.”

But a vice president in the China branch of an Asian bank was quite optimistic about the
commercial banking business. “Currently, commercial banking accounts for 80 percent to 90
percent of the total banking business for foreign-funded banks in Mainland China, and it also
would be the No. 1 in the future. Industries in the Mainland have huge potential. This is not
America, not Europe, not Hong Kong or Taiwan. Industries in the Mainland will continue to
develop rather fast, which means that there will be plenty of space for developing commercial
banking.”

A Hong Kong banker brought up another point. “It is hard to say which one is important.
Business is cyclical. Now the industrial and commercial enterprises are performing quite well;
many plans for industries and infrastructure are implemented quickly, so the profits that banks can
earn in commercial banking are larger [than from retail banking]. However, according to our
experience, it is hard to rank these two. There is a clear cycle: when commercial banking goes up,
retail banking will go down to some extent. In other periods when economy is not that good and
commercial banking declines, retail banking goes up to offset it somewhat.”

Bearing this in mind, it is dangerous to draw a quick conclusion regarding which business has the
best prospects. Different banks in Asia will seek different solutions.

The successful conclusion of the “survival reform” period calls for the improvement of bank
supervision to a higher level. In the last decade, the independence, transparency and consistency
in bank supervision as advocated by the Basel Concordat has been well implemented in many
countries. Enforcement of regulatory standards of capital adequacy and asset quality has had
substantial effect in improving the soundness of financial systems. And the importance and
urgency of supervisory reforms of the financial sector are increasingly appreciated.
In Mainland China, a major issue concerns the future direction of market reforms relating to
interest rates. Implementing market mechanisms in money and capital markets to determine
interest rates, the price of capital, will have deep and wide influences on the banking industry.
Without pricing the differences in credit risks among different types of clients through market
determined interest rates, there will be no supply and demand balance within each risk class. In
the absence of differential pripcing, bank lending will be skewed to clients with high credit ratings
such as large corporations, while the businesses of clients with lower credit rating such as retailers
and SMEs will be denied capital.

Interest rate control has an influence on the allocation of capital across different regions as well.
With interest rate controls, debt capital is rationed. As a result, some developed areas may enjoy
priority in debt capital allocation while under-developed areas where the risks for conducting
banking business are higher will lack capital. Today, in China, banks are prevented from reducing
lending rates below an administrative floor, although there are no regulatory barriers charging
higher interest rates for higher credit risk. In fact, however, banks lack the management
mechanism for the calculation and administration of risk premia, so higher rates are not normally
charged. In our interviews, some Chinese bankers attributed the misallocation of financial
resources between developed and under-developed areas and the lack of credit for retail business
and SMEs to the fact that interest rates are not yet determined by market mechanisms.

One banker that we interviewed noted that, as a shareholding bank, they care about profitability.
As interest rates are all the same, they only carry on SME business in the economically developed
province of Zhejiang, where the profitability is high for SMEs, and there is low risk of default.

Interest rate control also affects the measurement and development of fee-based business, another
strategic development opportunity for Chinese commercial banks. One of the bankers that we
interviewed commented, under current interest rate policies, “… because there is a protected
interest spread, if you want to hand me your business, I will not charge you other fees. However, it
is hard to develop fee-earning activities. I can provide you with free consulting business, but I also
want to retain your good loans. In this way, fee-earning business charges are subsumed into loan
rates.” Another banker added, “Only if the interest spread is narrowed will banks be willing to
charge. If not, we do will have enough reasons make those charges.”

Even though most bankers believe the interest rate market reforms will contine to be a long and
gradual process, European and American bankers in their China representative offices tended to
highlight the conditions needed for such reforms, “The reason why China maintains a large spread
between deposits and loans is to assist with the banking reform, and to take care of problem of
capital adequacy. However, the public listing of those banks and the profits earned over the last
few years has already solved the problem of undercapitalization. This necessary condition for
interest rate market reforms is already fulfilled.”

The final problem leftover from the “survival reform” is Asian banks’ search for new growth
opportunities. Two aspects matter: one is that banks in other countries/regions now regard China
as an important strategic market; the other is that Chinese banks themselves are accelerating their
speed of internationalization. Based on this consideration, we set the theme of “21st Century
Annual Finance Conference together with the releasing ceremony of ‘2007 Asian banks
competitiveness Ranking Report’” as the “Internationalization and Localization of Chinese and
Foreign-Funded Banks”.

One of our senior bankers noted, “Take a look at the big banks in the world and take the top 20.
They are all global banks. No big bank would say, I am big, but I am only domestic.”

However, mergers and acquisitions involve asymmetry information and risk. They also lead to
more responsibility, more pressure and longer working hours for the professions to get it done.

 “Work as the Wall Street bankers do. This is only the beginning of the training of our own
international bankers in China.” One of the bankers we interviewed noted with a smile.

				
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