Three Billion Dollars Down The Drain.....

Bank of America announced today that it was taking a US$2.5 billion dollar stake in China Construction Bank [CCB]. Additionally, BoA plans to take an additional US$500 million stake in the upcoming IPO bringing the total stake to 19.9%. BoA is being forced into investing outside of the US since it has 10% of all the deposits in the US, the most any one bank is allowed to have, therefore limiting opportunities stateside. Additionally, BoA has little or no presence to speak of in the China market and are probably trying to buy there way into the inner circle.

Chinese state banks are angling for foreign investment to bring credibility to an industry tarnished by loan fraud and corruption. The country has resorted to bailing out several institutions awash in bad loans to help create a sound banking system.

Obviously, having a minority shareholder of such prestige as BoA is a positive for the CCB, but I am afraid that very little will change with the corrupt cronistic business practices in China's banks. The BoA stake is more style over substance and a positive for those that want or feel more comfortable to see involvement by a large foreign institution. But I do not think that BoA will hold much power over the directors of the bank. A 19.9% stake does not carry enough weight to get practices changed since the people that run these institutions would prefer that they stay just the way that they are so that they can rob them blind.

Bank lending expanded by about 20 percent a year over the two years to the end of 2004, a period when annual economic growth exceeded 9 percent, according to government statistics.

Lending has been expanding so rapidly, that there will be lots more bad loans even if the economy doesn't slow down. The banking system has US$200 billion of bad loans and the economy has been booming for decades. So why is it going to be any different now?

"The big question is whether these new loans will remain good loans or become nonperforming loans down the road," said David Marshall, a Hong Kong-based financial institutions analyst for Fitch Ratings. "If things slow down after this investment boom, we worry that some of these investments will not be viable."

I wonder what BoA is really getting from this deal? Why are they convinced that what they are getting is worth anything at all?

Credit risk management at such banks remains a largely manual process, especially in the provinces, in a nation with at least US$200 billion in bad loans plaguing its financial system.

Credit risk management is the essence of what banking is and they still don't do it. Today's Standard has an interesting article on credit risk management in banks in China. Risk controls are practically non-existent and I seriously doubt if they will have anything workable in the next 5 years. I was involved with implementing credit risk management processes at various institutions around the world and I know a little about what is going on in Chinese banks these days. The biggest problem with implementing risk management systems and procedures is that the rank-and-file have to buy-into the process and be a part of its development. What this means is that decision making has to pushed down the chain of command and this is not something that Chinese companies and banks do very well. Banks are still feudal businesses and the bosses, whether they are the big shots at the home office or the local patricians such as the managers, still run these empires and will still practice central decision making. They may go through the motions of instituting or practicing global best practice credit risk management standards but will probably still run these organizations to benefit the few at the top.

I am just not very bullish on the Chinese banking system and it will be very difficult for them to adjust to the real world on such a large scale. My guess is that BoA will make very little money from their investment in CCB. The Chinese are probably laughing all the way to the bank. This is an old saying where someone gets ripped off the perpetrators laugh while they take the money stolen from you to the bank. But in this case, the criminals sold the bank, in this case probably a bank that isn't worth very much, so they are probably laughing at BoA's stupidity.