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Bank of China -Overvalued or Devalued?
By Liu Zongqi

On August 18, the Shanghai branch of Agence France Presse, issued a news release disclosing that, after a series of difficulties, the Royal Bank of Scotland finally decided to cooperate with Merrill Lynch & Co., Inc. and Hong Kong billionaire Li Jiacheng to pay $3.1 billion for a 10 percent stake in the Bank of China, thus becoming one of the major investors in China’s second largest state-owned commercial bank. Also, on June 17, the Bank of America announced that it would invest US$3 billion in the China Construction Bank to acquire nearly 10 percent of its shares.

Furthermore, there were quite a few competitors vying for a stake in the Industrial and Commercial Bank of China, which owns the greatest number of assets in China. Apparently, the share price of these state-owned Chinese commercial banks have suddenly become more valuable than ever before, creating a new focal point for investors and media coverage.

How much are China's state-owned commercial banks really worth? Economists often analyze them by means of capital assessment. Take the newly-merged Bank of China for instance. It has a history of nearly one hundred years, and its aggregate assets are worth US$470 billion, with 12,000 subsidiaries including traditional commercial banks, investment banks and multi-purpose banks with insurance businesses. After competing with several international banking institutions in vehement price negotiations, the Royal Bank of Scotland finally succeeded in acquiring 10 percent of the stake in the Bank of China at US$3.1 billion. In terms of market capitalization, the Bank of China is worth US$31 billion.

To make a comparison, let us take a look at a state-owned commercial bank that sold its shares to the public last July in Taiwan. This bank, the Changhua Commercial Bank, also has a history of nearly one hundred years, while its aggregate assets are worth US$41 billion, with 190 subsidiaries. By the same token, quite a few substantial domestic and foreign banking institutions vehemently competed in this bidding, and the Taishin Financial Holding Company, the eighth largest bank in Taiwan in terms of aggregate assets, finally paid US$1.1 billion to acquire 22.5 percent of the stake in the Changhua Bank, which is equivalent to a market capitalization of US$5 billion.

The Bank of China

Aggregate Value of Total Assets: US$470 billion Number of Subsidiaries: 12,000 Number of Employees: Not Available Date of the Bidding: August 18, 2005 Strategic Partner: Royal Bank of Scotland Aggregate Market Value: US$31 billion The Changhua Bank Aggregate Value of Total Assets: US$41 billion

Number of Subsidiaries: 190

Number of Employees: 6087

Date of the Bidding: July 22, 2005

Strategic Partner: Taishin Financial

Aggregate Market Value: US$5 billion When it comes to the average market capitalization of each branch, the amount of the Bank of China is US$250,000 and that of the Chang Hua Bank is US$26 million; on the other hand, the former has 12,000 branches with a market capitalization of US$31 billion, while the later has 190 branches with a market capitalization of US$5 billion. In other words, the average market capitalization of the Chang Hua Bank is over fifty times that of the Bank of China.

Modern marketing often emphasizes the value of products′ distribution network; however, this value cannot be reflected in China's banking system whatsoever. Thus, some have speculated that the Chinese Communist regime sold the bank’s assets, accumulated over generations, at such a low price, in order to create a false, good image of China’s banking market and to attract foreign investors.

Of course, some foreign professional analysts didn’t agree that "China’s banks were acquired at a low price." Most of them might think that the Chinese banking system’s existing bad loan ratio (or non performing loans, NPL) is the highest one in the world, and that, should we dispose of the existing bad loans in China’s banking system and apply the international general bad loan processing standard to recognize and amortize their losses now, many banks might immediately face the embarrassment of assets that are not enough to offset the debts and they might have to undergo liquidation. Therefore, they thought that acquiring 10 percent of the bank at US$3.1 billion is overestimating its market capitalization. In light of the on-going China-investment fever, many investors thus followed suit in order not to miss out on the potential business opportunities in China. This investment is counted as a buying an admission ticket.

Despite the fact that China’s banks have many problems, ranging from substandard management, corruption among high-ranking officials, serious staff redundancy, having too many branches, etc., as long as they are state-own banks, they are able to operate regardless of the market mechanism. It is only the government that has the final say over whether a bank should go bankrupt. Since the banks are in the most populous country in the world, and in the so-called, “last high-growth region on earth,” once they plan to sell some shares, investors might have to queue up to negotiate the price.

Last June, China’s fifth largest state-owned commercial bank, the Bank of Communications, was listed on the Hong Kong Exchange. It was China’s first state-owned commercial bank trying to raise capital on the Hong Kong market. However, many investors were very cautious about China’s state-owned banks due to their high bad loan ratios and frequent corruption scandals. As a result, major managing groups worried about whether the Bank of Communications could be successfully listed, and how many people would purchase its stocks. To encourage investors′ willingness to purchase the stocks, during the promotion period the managing group repeatedly emphasized that HSBC Bank owns a 19.9 percent stake in the Bank of Communications, and that HSBC might also increase its stake in the bank in the future. This move worked wonderfully. Many investors lodged their applications for purchasing the stocks before the expiration date.

After this deal, the capital market finally came up with an important rule: though China’s state-owned banks have long been baffled by serious bad loans, one can find some renowned international banking institutions and offer preferential prices for them to purchase their shares so as to become shareholders of state-own banks. And then, the Chinese banks make it public that they are going to push ahead with reforms according to free market principles. When it is time to raise capital from the public, those renowned international banking institutions will side with the Chinese banks.

By doing so, people can certainly raise a large sum of money. In this context, not only can state-owned banks successfully collect capital, but also leading international banks can also gain tremendously from it. Of course, it is the innocent ordinary investors that may lose money and the state-owned banks that may lose the assets accumulated over generations.

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