Cleaning Up Bank of China

Chairman Liu Mingkang is no stranger to hardships. His latest may be his toughest.

Liu Mingkang allows himself only a fleeting smile when he describes his unlikely banker’s résumé.

Long before he became chairman and president of Bank of China, Liu says, in English perfected during a three-year posting in London, he spent 11 years tilling the fields in back- ward Danyang County during the Cultural Revolution. Then, he endured three years as a technician in a steel plant in the same place, some 200 miles from Shanghai, before, at age 33, passing an exam that earned him a job in the Nanjing branch of state-owned Bank of China.

Two decades later, Liu still has plenty of obstacles to over- come. “We have a vision of becoming one of the world’s lead- ing international banks,” Liu says, in his office atop the bank’s glass-prismed headquarters in Beijing, which was designed by Chinese-American architect I. M. Pei. With assets of $409 billion—half of it in foreign currency—Bank of China already ranks among the top 25 financial institutions, on a par with Société Générale SA of France and Germany’s Commerzbank AG. Yet, if the Chinese government didn’t prop it up, Bank of China would be technically bankrupt. Moody’s Investors Service rates the bank a D– without taking government sup- port into account.

Liu, now 55, needs to make the bank solvent and prepare it for an onslaught of foreign competition as China gradually dismantles trade barriers over the next five years—a con- dition of its World Trade Organization (WTO) membership. To do that, he’s been cutting staff, introducing lending con- trols, expanding into new areas such as insurance and throw- ing open the bank’s books. One discovery: 26 percent of the bank’s loans outstanding are nonperforming—about five times the ratio of rivals like Citigroup Inc. and HSBC Hold- ings Plc. Last year, Liu was forced to write off almost $1 bil- lion of bad loans, resulting in an 8 percent fall in pretax profit to $1.3 billion. “It is very challenging but very exciting,” says Liu of his job. “I like it.”

A big part of the challenge will be rooting out corruption and restoring confidence in the bank after a series of fraud, money-laundering and embezzlement scandals were disclosed at its Hong Kong, New York and domestic branches in the past year. Liu had to delay his plan to make a $4 billion–$6 billion initial pub- lic offering of a stake in the bank’s Hong Kong branch—the first foreign listing by a Chinese bank. He plans to sell a small stake in Bank of China (Hong Kong) Ltd. to a foreign bank and then list a minority portion on the Hong Kong and New York stock exchanges. Liu declines to discuss potential part- ners or give a timetable for the IPO.

“Investor confidence has to be restored before the bank can list,” says Arthur Lau, Hong Kong–based director of financial institutions at Fitch Ratings.

‘If I invite guests, should I clean the house beforehand or after they come?’ Liu asks.

The first scandal erupted in September, when Hong Kong’s Independent Commission Against Corruption said it had uncovered a long-running $6.4 billion money-laundering operation at Po Sang Bank Ltd., one of the 11 banks that a month later were merged into BoC (HK). In January, China’s central bank announced it had censured Bank of China for “serious irregularities” at 51 mainland branches. On Jan. 11, the government announced that Liu’s predecessor, Wang Xuebing, had been placed under investigation for loan irregularities involving $326 million that occurred when he ran BoC from 1993 to 2000. Wang was unavailable for comment.

Then, on Jan. 18, the U.S. Office of the Comptroller of the Currency and China’s central bank announced they had fined BoC a total of $20 million for making preferential loans, issuing fraudulent letters of credit and other misdemeanors at its New York branch from 1991 to 1999. Wang had headed the New York branch from 1989 to 1993. On March 15, Liu said that $483 million had been stolen from a Bank of China branch in Kaiping, Guangdong—the freewheeling province adjacent to Hong Kong—during what he described as “a decade of lax management.” Liu said the money had been laundered through Macao and Las Vegas en route to Canada.

Liu, who is not accused of any wrongdoing, says the scandals are a positive sign because they show he’s mopping up corruption at the bank before offering shares to foreign investors. “If I invite guests, should I clean the house before- hand or after they come?” he asks.

Some analysts say the recent scandals could be just the tip of the iceberg for China’s four biggest banks, which account for 70 percent of the country’s market and which for years have lent at the government’s behest rather than based on clients’ creditworthiness. “It would not be surprising if similar acts of misconduct at mainland Chinese banks continue to occur over the next few years,” Standard & Poor’s cautioned in a statement in January, when it kept Bank of China’s debt rating unchanged at BB+—taking into account its government sup- port—but warned that it might have to downgrade if further scandals erupted. “The banking system is the weakest link in the Chinese economy,” says Dong Tao, chief economist at Credit Suisse First Boston in Hong Kong. “The government wants reform, and if people like Liu don’t carry it through, the country’s long-term prospects could be in jeopardy.”

At Bank of China, Liu has a lot to clean up. In addition to its commercial banking business, Bank of China owns an investment bank, Bank of China International (BOCI), and life and property/casualty insurance companies. The BoC group has 13,000 branches spanning both China and the world’s major financial centers, not to mention such banking outposts as Almaty, Kazakhstan, and Lusaka, Zambia.

Bank of China is the country’s oldest bank, tracing its roots back to the Great Qing Bank, the de facto central bank of China’s last emperors. Formally established by democratic President Sun Yat-sen when he overthrew the Qing dynasty in 1912, BoC has served China’s rulers ever since, even at times acting as the country’s central bank.

That’s often meant lending recklessly to unprofitable state-owned enterprises, many of which could not afford to repay the money. Such so-called policy loans couldn’t be called in for fear that the resulting unemployment would destabilize the country. It was only in 1998 that the government changed the practice, allowing banks to lend based on merit rather than on political considerations.

Policy loans also created fertile ground for corruption. “You could grant a loan for a project that did or did not exist,” says Terry Chan, a Hong Kong–based analyst at Standard & Poor’s. “You’d just have to say it was for the development of the economy.”

It’s that legacy that Liu is struggling with. “By cleaning house, Liu is showing a clear sense of direction and urgency,” says Tina So, assistant director of Schroder Investment Management, which has $5 billion under management in Hong Kong.

“We must open the door much wider,” Liu says. “We must carry on our reforms much more quickly.”

Liu personally wins high marks as a manager. “He is a man of the highest integrity and represents the best of the new leadership in China,” says Henry Paulson, chairman of Goldman Sachs Group Inc., which is underwriting the BoC (HK) listing along with UBS Warburg LLC and BOCI. “My view of Liu is very positive,” says economist and China banking specialist Nicholas Lardy, a research fellow at the Brookings Institution in Washington, D.C. “He’s one of the few world-class Chinese bankers. He has really pushed the bank forward on disclosure.”

The child of university professors, Liu grew up reading English Romantic poetry such as Keats, Shelley and Byron, which he still enjoys in his spare time. After joining Bank of China as an English interpreter, Liu was sent to London in 1984 as manager of trade settlement and business promotion. There, he studied at night for his MBA. At the time, China—through the London branch of Bank of China— was starting to be courted as a potential customer by such international investment banks as Goldman, Sachs & Co. and Lehman Brothers Holdings Inc. On his return to China, Liu rose to head the important branch in wealthy Fujian province, across the strait from Taiwan.

He also came to the attention of China’s reformist pre- mier, Zhu Rongji, for his determination to modernize the bank and cut red tape. With his fluent English, Liu could interact easily with foreign bankers and clients without getting intoxicated by the high life that went with making such con- tacts, says Guy Cui, a Beijing-based director of N. M. Rothschild & Sons Ltd. In 1998, after announcing a plan to clean up the bad loans at government-owned banks, Zhu appoint- ed Liu deputy governor of People’s Bank of China, the country’s central bank. Less than two years later, he was named chairman of then troubled China Everbright Group, a Hong Kong–listed company controlled by China’s State Council.

In February 2000, Zhu and central bank Governor Dai Xianglong summoned Liu back to Bank of China. His job comes with the rank of vice minister, and a senior govern- ment official says Liu frequently visits Zhongnanhai—the Beijing compound where President Jiang Zemin lives and works—to set policy with Zhu and other leaders.

Liu says he decided to disclose the bank’s level of bad debts to make a point about how he would manage. “Transparency is far more important than anything else if you want to build up a healthy commercial bank,” he says. “A true story is the essence of trust.” He says it will take about three years to reach his goal of reducing nonperforming loans to 15 percent.

He also set up checks and balances so that no official—him included—can make policy loans. Due diligence and risk management committees in the head office and branches now assess all loans. Liu has no seat on those committees. “If the committee says no, I can- not say yes,” says Liu. Conversely, if the committee approves a loan, he can veto it. At the same time, Liu is trying to ensure that each loan application gets approved or rejected within 10 working days compared with as long as several months in some cases before he took over.

Liu regularly descends unannounced on branches in China to get rid of inefficient and corrupt staff and reward the best per- formers. “We have done a carpet-bombing evaluation of the general managers of all the 32 domestic provincial branches,” says Liu, who won’t disclose the exact number of people he’s fired during the visits. By year-end, he will have closed 1,700 branch offices in rural areas and fired 19,000 people, he says. Those steps have already helped cut costs by $800 million, he says.

On the surface, Bank of China looks like it’s in much better shape than it was a decade ago, when many of its branches still used abacuses. “Back then, I could spend all morning queuing to get served,” says Alan Reid, an Australian-born business consultant who’s lived in Beijing for 15 years. “Now, I just have to pop down to a modern branch located in my office build- ing, and it’s as quick and easy as banking in the West.” Though big-city branches use automated teller machines and computers now, Liu found 1,000 different systems in use at the bank when he took over. He’s reduced that number to five.

The services Bank of China offers are still inferior to those of many foreign banks, analysts say. China’s banks are heavily regulated; interest rates are fixed at about 1 percent for deposits and 16 percent for credit cards.

Bank of China is already facing competition at home. The four big state-owned banks have seen their market share eroded by a new breed of smaller Chinese bank. According to a report on China’s banking market prepared for clients by consulting firm McKinsey & Co. in November, one of the big four banks has lost 20 percent of its customers since 1999. “Government regulations make the product offerings and interest rates of Chinese banks virtually identical, so these churn rates suggest deep dissatisfaction with the incumbents’ service standards,” the report says.

Under WTO rules, China will have to completely open its market of 1.3 billion consumers to foreign competition by 2007. Citigroup is likely to be one of the first foreign banks to enter, analysts say. “Citigroup is deeply committed to China,” says Roy Ramos, Goldman Sachs’s managing director of Asian investment. Citigroup’s Citibank unit currently has four branches and two representative offices that are restricted to such activities as cash management and trade services for foreign companies. “Like every other foreign bank, we have our eyes on consumer banking,” says a Citibank executive who asked not to be named. “Thanks to the WTO, that is the holy grail.”

Ramos estimates that Chinese consumers have $1.4 tril- lion worth of assets. “In residential mortgages, you can build a nice, steady business,” he says. “Credit cards and lending to small and medium-size enterprises is another business.”

Liu says he’s aware of the threat. “We have to upgrade our service to satisfy the increasing demand of the Chinese peo- ple and the investors coming from abroad,” he says.

Liu says consumer credit is a key growth area as China’s new middle class of some 30 million people seek residential mortgages; home improvement, automobile, education and travel loans; and loans for other consumer goods. As of 2000, 19 million Chinese had a Bank of China Great Wall debit card. As of 2001, some 4.6 million had a Great Wall credit card that can be used only in China. That gives Bank of China more than 10 percent of the country’s total bank cards outstanding.

BoC also says it’s the largest issuer of credit cards that can be used internationally, but that’s not saying much. Just 110,000 people in 2001 had a Great Wall international card, which uses both the Visa and MasterCard networks.

Even sooner—by 2004—Bank of China will have to bat- tle foreign banks for its best corporate customers. Liu says he’s targeting them with new products, including a global line of credit for multinationals, drawable wherever BoC has a branch. Tsingtao Brewing Co. took out a $5 billion line last year, and two South Korean companies also requested the credit line—the first such deals by a Chinese bank: Hyundai Motor Co. took out $500 million and LG Electronics Inc.took $200 million. In March, Eastman Kodak Co. took out a $2.1 billion line of credit in China.​

The bank’s also diversifying into the insurance business, from which the government barred it on the mainland until recently. Only last year did the government give it permission to open its first life and property/casualty operation in China—in wealthy Shenzhen, just across the border from Hong Kong.

Under WTO rules, China will have to open its market of 1.3 billion consumers to foreign banks by 2007.

Liu’s most important task, as far as investors are concerned, has been restructuring the commercial banking businesses in Hong Kong and the former Portuguese colony of Macao. This past October, Liu merged the Hong Kong retail branch network with 11 smaller banks BoC controlled to form BoC (HK), the entity he plans to take public. BoC (HK) takes deposits, makes mortgages, issues credit cards and lends to local companies. Some 2.9 million of Hong Kong’s 6.7 million residents are customers. The bank has $105 billion of assets, second only to homegrown giant HSBC. (See “HSBC: Still Not the Champion,” page 38.)

With a pretax profit of $871 million in 2000, BoC (HK) earned more than 60 percent of the entire Bank of China group’s profit. Still, like its parent, it suffers from a high level of nonperforming loans. They totaled $4.7 billion as of June 2001, or almost 10 percent of the amount outstanding. That’s more than twice the Hong Kong average of 4.74 percent, according to the Hong Kong Monetary Authority.

Bank of China’s Hong Kong investment bank, Bank of China International, is already competing successfully with major foreign rivals. Headed by 38-year-old former Goldman Sachs and Lehman Brothers banker Li Shan, BOCI is Hong Kong’s largest retail brokerage and also ranks No. 1 in syndicated loans, with a 70 percent market share, the bank says. Last year, BOCI underwrote the biggest IPO in Hong Kong, the $1.2 billion listing of oil company CNOOC Ltd. The previous year, it had advised Pacific Century CyberWorks Ltd. on its $28 billion acquisition of Cable & Wireless HKT Ltd.—the biggest M&A deal in Asia, excluding Japan.

“It’s a great franchise,” says Li of BOCI’s Hong Kong business. In April, BOCI is set to be granted a license by the government to operate on the mainland and is planning to move its headquarters to Shanghai from Hong Kong as soon as it can.

In Hong Kong—where the 70-story Bank of China build- ing symbolically towers over HSBC headquarters—many analysts say BoC will one day overtake the homegrown bank. “They’re already challenging HSBC,” says Keith Irving, longtime banking analyst at Merrill Lynch & Co. in Hong Kong. “One day, it could happen, especially with their connections to China.”

Liu is stepping up training for his bankers on the main- land. He signed an agreement with his alma mater, London’s City University Business School, to provide a custom-made English-language MBA course for his senior executives, start- ing this year. As part of the two-year course, the 25 BoC staffers selected annually will spend three months working in Europe at British banks.

Even with the higher salaries and better training, the human capital of the parent is thin outside Hong Kong. “It’s a huge bank,” says Wei Yen, senior Hong Kong credit officer at Moody’s. “And they don’t have enough people of the right caliber and with the international experience.”

One reason is that Bank of China has been unable to pay to attract top talent. Even after pay raises, bonuses and incentives introduced by Liu, senior BoC managers in China earn from $7,400 to $8,600 a year, according to one of them, who asked not to be named. When posted overseas, bankers get free apartments and other perks, but their salaries are still well below those of their Western counterparts, says a senior foreign-based Chinese official.

Some of those underpaid BoC managers, unable to resist temptation, have stolen from, or laundered money through, the bank. “Some staff think, ‘If I am doing the same work as the CEO of a private bank in Hong Kong, why should I not have the same rewards?’” says S&P’s Chan. “They have a sense of injustice.”

Some investors are concerned about the scope of the recent scandals. “A big sum of money is involved in these scandals, and there may be more coming out,” says Sam Ho, who helps manage $500 million at Hong Kong–based East Asia Asset Management. “We will not consider buying any shares in an IPO until we get a clearer picture.”

Others take a longer view. “Having dealt with these scandals will make them more competitive and therefore more attractive for investors,” says Vincent Duhamel, chief executive in Hong Kong of State Street Global Advisors Inc., which manages $10 billion of Asian institutional funds.

Liu says he’s seeking a foreign partner that will help modernize the bank. “We want to learn from them and synergize with them,” he says. “A lot of investment bankers are now helping us to diagnose our problems in streamlining our business.” Liu says Goldman Sachs is one of them.

Even so, cleaning up the bank will take time, Liu says. “In five to seven years, the Chinese financial institutions, including the Bank of China, will be much cleaner,” he says. With investors watching on the sidelines and potential com- petitors waiting to jump in as the WTO deadlines near, that may not be quick enough.

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