VZCZCXRO7648
RR RUEHCN RUEHVC
DE RUEHGH #0654/01 2780929
ZNR UUUUU ZZH
R 050929Z OCT 07
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6333
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHNSC/WHITE HOUSE NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 6815
UNCLAS SECTION 01 OF 04 SHANGHAI 000654
SIPDIS
SENSITIVE
SIPDIS
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN
FRANCISCO FRB FOR CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK
STATE PASS CEA FOR BLOCK
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/LOI/READE
USDOC FOR 4420
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN
TREASURY FOR EXEC - TSMITH, OASIA/ISA -DOHNER/BAKER/CUSHMAN
TREASURY FOR WRIGHT AND AMB HOLMER
TREASURY FOR SOBEL AND MOGHTADER
NSC FOR MCCORMICK AND TONG
E.O. 12958: N/A
TAGS: EFIN EINV PGOV CH
SUBJECT: SHANGHAI BANKERS ON RMB, PROTECTIONISM AND THE FUTURE
REF: SHANGHAI 504
SHANGHAI 00000654 001.2 OF 004
(U) This cable is sensitive but unclassified and for official
use only. Not for distribution outside of USG channels or via
the internet.
1. (SBU) Summary: China's weak and rigid exchange rate is
increasing costs and inhibiting innovation in China's financial
sector. Shanghai officials and banking leaders told a visiting
Treasury delegation that growing protectionism in the financial
services sector would make increased foreign penetration
difficult. Foreign banks that had incorporated locally are
facing increased regulatory interference and mixed results in
opening new branches, while a bank that opted not to incorporate
locally faces increased costs. Foreign banks are also facing an
increased cost in doing business due to recent reductions in
their foreign debt quotas. The ongoing need for China's central
bank to sterilize its foreign exchange purchases is placing an
increased burden on Chinese banks as they are forced to hold
more and more central bank assets. End summary.
2. (SBU) Visiting Treasury DAS Mark Sobel and Embassy Finance
Minister Counselor David Loevinger along with Shanghai ConGen
Pol/Econ Chief met with financial service sector officials and
banking leaders during a September 17-18 visit to Shanghai.
They met with Wachovia Bank Shanghai Branch Managing
Director/General Manager Ben Kinnas, JP Morgan Chase Bank Vice
Chairman Andrew Zhang, Bank of Tokyo-Mitsubishi UFJ, (China) Ltd
(MUFG) Senior Manager Ryan Hart, and Standard Chartered Senior
Economist Stephen Green on September 17. On September 18 they
met with Citibank CEO Richard Stanley and Shanghai Metropolitan
Financial Services Office (SMFSO) Deputy Director General Fang
Xinghai. Meetings with Chinese mutual fund companies'
representatives will be reported septel.
-------------------------------------------
Foreign Investment in the Securities Sector
-------------------------------------------
3. (SBU) SMSFO's Fang said that protectionism in China's
financial sectors is growing. A major source of this
protectionism is the feeling among some sectors of the Chinese
populace that banks, as state assets, have been sold too
cheaply. This feeling has been reinforced by the massive
profits generated by the recent IPOs of several state-owned
commercial banks. Wachovia's Kinnas separately agreed saying
that the Chinese Banking Regulatory Commission (CBRC) has
recently expressed concern at the purchase of stakes in city
commercial banks by foreigners.
4. (SBU) Fang said the increasing Chinese protectionism in the
securities sector comes from two sources -- domestic firms fear
increased competition and some public policy researchers believe
that opening to foreign competition threatens national economic
security. To assuage concerns of the second group, the United
States needs to show better how other countries have opened
their securities sector without losing domestic players, such as
in Taiwan, South Korea, Malaysia and Indonesia.
5. (SBU) Fang suggested that one remedy for this protectionism
could be new, post-WTO, framework agreement on financial
services. Making this agreement politically acceptable for the
Chinese would necessitate a quid pro quo where both sides would
make concessions. Fang suggested that the United States could
relax restrictions on high-tech exports in exchange for greater
RMB appreciation.
6. (SBU) Fang hoped that policies on equity caps in the banking
and securities sectors would change after the upcoming Communist
Party Congress that convenes in Beijing on October 15). These
caps, according to Fang, differ according to industry due to the
different personalities of the regulators. Upcoming personnel
changes could affect policy. USG pressure can be of help in
opening the sector, as long as it is "firm and consistent," he
said.
7. (SBU) Several firms voiced frustration with their ability to
enter the securities market. JP Morgan's Zhang said the CBRC
had turned down its petition to underwrite government bonds.
SHANGHAI 00000654 002.2 OF 004
Now that JP Morgan is locally incorporated, Zhang hopes that the
CBRC will reconsider its decision. However, he said,
regulations on underwriting corporate bonds unclear. While
foreign banks cannot trade commercial paper or long-term listed
corporate bonds, they can trade government bonds and bank debt.
Wachovia's Kinnas also noted his bank's interest in being able
to trade financial derivatives.
8. (SBU) Citibank's Stanley said that foreign firms want
securities licenses that allow for the provision of a full range
of investment banking and brokerage services. He noted rumors
that China might lift equity caps on investment in securities
firms, but expected this would only apply to joint ventures
(JVs) with licenses limited to underwriting stocks. He
expressed concern that, using China Construction Bank, Bank of
China and ICBC as models, the Chinese Securities Regulatory
Commission (CSRC) may meet its Strategic Economic Dialogue
commitment to allow foreign JVs to expand the scope of their
business only by allowing them to take minority stakes in the
largest Chinese brokerages. This would limit the ability of
foreign firms to gain management control of their JVs in China.
9. (SBU) Stanley also pointed to regulatory fragmentation as a
frequent obstacle to financial market development. Though
Citibank has received approval from the CBRC to issue debit and
credit cards, the People's Bank of China (PBOC) is pressing Citi
to move its payment processing system onshore, ostensibly due to
privacy concerns about having data on Chinese households stored
abroad.
-------------------------------------
Local Bank Incorporation: A Mixed Bag
-------------------------------------
10. (SBU) Both Citibank and MUFG have recently completed the
process of incorporating as local Chinese banks. Stanley
repeated his concerns that the regulators are being far more
intrusive than expected. (Reftel) CBRC is imposing a local
Chinese corporate structure on locally incorporated banks,
including a geographic management approach that conflicts with
Citibank's product line approach. The Chinese approach
increases the power of branch managers. Though Citibank's
application for a branch in Dalian was recently approved,
approvals of other new branches are "a slog," and continue to be
tied to the issue of Chinese banks' access to the United States
market. In an attempt to gain regulators' favor, Citibank will
open a modified village bank (only lending) even though it
expects it will lose money. (Note: Rural finance reform was a
primary focus of the National Financial Work Conference in
January 2007. Chinese banks, such as the Bank of Communications
(BOCOM), have also been asked to consider opening branches in
rural areas or to partner with one of the many failing rural
cooperative banks. A BOCOM official told Econoff in September
that any such venture would lose money and that Chinese banks
would be hesitant to pursue it. End note.)
11. (SBU) In contrast to Citibank, MUFG's Hart said that MUFG
experience with local incorporation had largely been positive.
It had benefited from an accelerated approval process for new
bank branches. MUFG, however, does not conduct retail RMB
banking.
12. (SBU) Wachovia, on the other hand, opted not to incorporate
locally and, as a result, was required by the CBRC to increase
its capital holdings. Wachovia's Kinnas said that the capital
requirement for non-locally incorporated banks "is far too high"
and acts as a major impediment to United States regional banks
who want to do non-retail banking business in China.
--------------------------------------------- ----------
Shrinking Foreign Debt Quota Slows Growth, Raises Costs
--------------------------------------------- ----------
13. (SBU) The State Administration of Foreign Exchange (SAFE)
March 2007 decision to reduce banks' foreign debt quotas in
order to clamp down on short-term foreign currency denominated
borrowing has raised banking costs and constrained growth of
their banks, said several interlocutors. This policy took
SHANGHAI 00000654 003.2 OF 004
effect at a time of rising demand for foreign currency
denominated debt and a shrinking supply of onshore foreign
currency deposits as Chinese households and firms adjust the
currency composition of their assets and liabilities to benefit
from expected RMB appreciation. The result, according to JP
Morgan's Zhang, has been to create a "dollar liquidity crunch,"
one that the PBOC has done nothing to solve. MUFG's Hart said
that banks are paying a premium -- over 100 basis points over
LIBOR -- to borrow U.S. dollars on shore.
14. (SBU) Stanley said Citibank's foreign debt quota will be
fully obligated by March 2008. He had also heard that SAFE was
considering a further reduction of foreign debt quotas. Stanley
said this would not necessarily be a disaster for the larger
foreign banks that are well-established in China, like Citibank,
since they have a proportionally larger RMB deposit base, but
smaller banks would be hurt.
15. (SBU) Wachovia's Kinnas noted that while SAFE's intent is to
limit speculation on the RMB and reduce capital inflows, the
reduction of foreign borrowing is adversely impacting financial
services, such as the financing of imports or re-lending to
offshore customers that have no net balance of payments impact.
16. (SBU) Zhang said that in terms of banks' financing RMB
denominated lending, RMB deposits are the cheapest means,
followed by the swapping of offshore dollar borrowing for RMB,
with inter-bank RMB borrowing being the most expensive. Thus,
restricting foreign borrowing raises the costs of RMB financing
and benefits Chinese banks who are the main suppliers of RMB to
the inter-bank market. Moreover, limits on foreign currency
borrowing, along with foreign banks' limited deposit base,
restriction on inter-bank borrowing (not more than twice their
capital) and inability to issue RMB bonds all serve to further
constrain the ability of foreign banks to grow.
--------------------
Exchange Rate Policy
--------------------
17. (SBU) Standard Chartered's Stephen Green said that he is
seeing a growing acceptance among Chinese decision makers, even
among the more conservative officials of the National
Development and Reform Commission (NDRC), that faster pace of
RMB appreciation is needed. However, the economy is not
slowing, and Green said he saw no consensus among high-level
leaders that there is a need to slow the economy, or that they
considered the current upsurge in inflation to be a major
problem. Continued large-scale sterilized intervention is
adversely impacting banks' income, with Citibank's Stanley
noting that PBOC assets (including sterilization bonds and
reserves) now account for 25 percent of Citibank's financial
assets in China.
18. (SBU) According to JP Morgan's Zhang, the lack of foreign
currency hedging instruments contributes to the Chinese
authorities' reluctance to allow a faster rate of RMB
appreciation. However, he noted, banks' inability to short
foreign currencies, except to offset the long position of a
customer with an approved underlying current account
transaction, limited the development of a liquid foreign
currency derivatives market.
----------------------------------------
The Future of Chinese Financial Services
----------------------------------------
19. (SBU) SMFSO's Fang said that a working group that includes
the Shanghai mayor, Shanghai's Financial Services Office, and
local regulators had recently formulated a three-part strategy
to turn Shanghai into a global financial center. The plan is
to: (1) Grow Shanghai's financial markets, making Shanghai the
place where prices of Chinese financial assets are determined;
(2) Attract more financial firms, especially large state-owned
enterprises currently located in Beijing; and (3) Create a
financial sector arbitration body. In Fang's vision, there
would be a division of labor between Hong Kong and Shanghai,
with Hong Kong being China's center of foreign-exchange-based
SHANGHAI 00000654 004.2 OF 004
financial services, and Shanghai acting as a hub for RMB
services.
--------------------------------------
Comment: The High Price of a Rigid RMB
--------------------------------------
20. (SBU) Conversations with financial sector firms in Shanghai
highlight how China's rigid exchange rate is increasing costs
and inhibiting innovation in China's financial sector. China's
large and rising balance of payments surplus and its rigid
exchange rate require the monetary authorities to maintain large
scale foreign currency intervention. This keeps the growth of
monetary aggregates high and its cost of capital low, resulting
in continued high rates of investment, particularly in the
tradable sector. This high rate of fixed asset investment
contributes to higher export growth, perpetuating the liquidity
induced investment cycle. To contain investment growth and the
rise in asset prices, monetary authorities are raising interest
rates. But to keep higher Chinese interest rates (and lower
U.S. interest rates) from inducing even more capital inflows,
SAFE is tightening restrictions on capital inflows and continues
to prohibit banks from taking short foreign currency positions,
constraining liquidity in the foreign exchange market.
21. (U) Embassy Finatt cleared this cable.
JARRETT