It’s the dawn of a new age in China.
One of the most tightly controlled economies in the world has been transformed into a rapidly emerging capitalist marketplace. American companies and investors are finding lots of opportunities to buy and sell goods, and to launch business ventures.
While the nation continues to move away from a sluggish, centrally planned socialist economy to a market-oriented system, it’s still an economic mish-mash. China’s massive bureaucracy, inefficient state-owned enterprises and unskilled agriculture sector of 330 million people (45% of its workforce) can be maddening to investors.
About 200 banks have offices in China, but only a handful can conduct business in the local currency, the renminbi, and they only can serve foreign companies.
As a condition of its entry to the World Trade Organization, however, China agreed to pry open its large banking sector by the end of 2006.
There are opportunities for domestic banks, and some dangers, too.
Letters of Credit
Perhaps the most basic function in doing business with China is the financing of imports and exports, a process that local banks facilitate through letters of credit.
These documents are irrevocable guarantees of payment. Nearly all banks in the U.S. can wire payments to China and remit funds instantaneously for their customers with few, if any, hassles.
East West Bancorp had a 25% increase in letters of credit in the first six months of this year, compared with the like period a year earlier. East West is a large Los Angeles-based ethnic Chinese bank that has offices in Irvine, Westminster and Anaheim.
Like most U.S. banks, East West has a correspondent banking relationship with the four largest state-owned banks in China: Bank of China, China Agricultural Bank, China Construction Bank and Industrial and Commercial Bank of China.
“The great thing about the letter of credit business is that it’s one of the few things that everybody abides by,” said Dominic Ng, East West’s chairman and chief executive.
There are essentially two types: One is a site credit, in which the buyer arranges a letter of credit that is payable to the exporter and collected from the issuing bank. The second is a so-called usance letter of credit, essentially a short-term loan at a pre-negotiated interest rate that is payable in 90 to 180 days.
“The bank is just one dot in a series of dots along the supply chain,” said Walt Trask, regional vice president for global trade services at Union Bank of California, a unit of San Francisco-based UnionBanCal Corp., which is majority owned by Bank of Tokyo Mitsubishi, one of Japan’s largest banks.
Local banks deal primarily with letters of credit and wire transfers because they are not allowed yet to have fully-functioning bank branches in China.
That is changing gradually.
The China Banking Regulatory Commission allows foreign banks to open representative offices in China, although they cannot accept deposits or conduct any banking transactions.
Foreign banks and securities firms have rushed to open offices as they jockey for position when China relaxes its banking rules in two years.
“Our main job is to keep relationships with government officials. As a representative office, we cannot do any kinds of business,” said Leonard Gang, branch manager in Beijing for Far East National Bank, a unit of Los Angeles-based SinoPac Bancorp. Far East has branches in Irvine and Newport Beach.
China also restricts individuals from sending more than $2,000 out of the country, though there are as many as 20 exceptions to that rule.
Non-Performing Loans
By far the biggest issue affecting China is its state-owned banks, which are trying to unload between $300 billion and $1 trillion in non-performing loans made to state-owned manufacturing companies in the past decade.
Compounding the problem is that the Chinese government refused to allow state-owned banks to dispose of the loans at less than their full value, for fear of forcing the borrowers into bankruptcy.
The country’s economic growth and its banking sector are highly interdependent.
Last year, the government gave two of the largest banks $22.5 billion each from its foreign exchange reserves to boost their balance sheets in preparation for pending public offerings.
Though U.S. investors see tremendous upside potential in buying China’s real estate assets, the process itself has been arduous. Most of the bad loans have been transferred to state-owned asset management companies that are selling them off at auction to foreign investors.
Jack Rodman, a partner and managing director at Ernst & Young in Beijing, evaluates and packages pools of loans for China’s asset management companies.
He estimates the country has roughly $414 billion in bad loans on its books. But so far, China has completed only a few auctions.
“There is nobody in China to say you have to reduce these loans, so there’s a lot of personal risk to approve selling them,” said Rodman, noting that eight or nine government agencies must approve the auction.
Tom Barrack, founder of Colony Capital LLC in Los Angeles, wants to buy the half-built hotels and office projects throughout Shanghai that have run out of financing. Colony has about $4.5 billion in real estate investments.
He complains that “no great wins have come out of China,” because of inherent problems plaguing the auction process.
“The legal system is untested and land ownership is arbitrary,” Barrack said. “So you may buy a loan with a description of the property but when you show up, the borrower or another state agency steps in and says someone else owns the title. Ninety percent of the time you end up doing nothing. These are the kind of nightmares that make investing difficult.”
Berry is a staff writer with the Los Angeles Business Journal.
