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Foreign Strategic Stakes in Chinese Banks

Will the financial crisis spell the end of strategic investments in China's banks?

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China's economy has been one of the fastest growing in the world. From 2003 to 2007, China's gross domestic product (GDP) grew 10.6% annually and by the end of 2007, China had became the fourth-largest economy in the world. The rapid economic growth has attracted many foreign investments to China's various industries. The banking industry has been one of the favorites, thanks to China's banking reforms and the process of opening up the financial industry. While legal restrictions make it difficult for individual foreign investors to invest directly in many Chinese banks, many Western banks have taken strategic stakes in Chinese banks over the last five years, and their shares offer an opportunity for investors to participate, albeit indirectly, in these banks' future growth. However, given the ongoing financial crisis, China's economy is facing the risk of a "hard landing," and GDP growth may slide to less than 8% in 2009. The economic slowdown will have a material, negative impact on Chinese banks. Do the sharp drops in share prices offer an opportunity for investors? Or, alternatively, will the market turbulence force foreign banks to reconsider their investments in China, as  UBS (UBS) did in late December when it sold its stake in Bank of China? How would this affect the cooperation among them?

Background on Chinese Banking
Until fairly recently, China's banking industry was policy-orientated, as opposed to business-orientated, and was dominated by state-owned banks whose primary purpose was financing state-owned enterprises. As a result, these banks had been poorly managed and accumulated a large portfolio of nonperforming loans and struggled to be profitable. For the past decade, the government has been striving to reform the banking sector, mainly through the state-owned banks, to build up a business-orientated marketplace. This has been partly driven by the prospect of increasing competition from foreign banks, as China has gradually opened up its banking sector since late 2006 under the World Trade Organization agreement. Introducing foreign strategic investors was part of the reforms, as Chinese banks aimed to take advantage of the Western partners' management and technology expertise, increase their own capital strength, and diversify their ownership structures. To prevent foreign investors from controlling China's major banks, the share of a single foreign shareholder has been limited to 20%, and combined foreign ownership can not exceed 25%. The shareholdings of foreign strategic investors also have a three-year lockup before they are tradable in the secondary stock market.

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Peter Liu does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.