Review of IFC’s Role in China’s Financial Sector Transformation Yanni Chen & Chaoying Liu Development Impact Department March 19 2013.

Review of IFC’s Role in China’s Financial Sector Transformation

Yanni Chen & Chaoying Liu

Development Impact Department

March 19 2013

Agenda

1. Context and Methodology

2. Key findings – Advisory Services

3. Key findings – Local Currency Financing

4. Key findings – Investment Operations

5. Conclusions and Lessons Learned

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Agenda

1. Context and Methodology2. Key findings – Advisory Services 3. Key findings – Capital market 4. Key findings – Investment5. Conclusion and Lessons Learned

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Context

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IFC’s engagement in China’s financial sector

China started financial sector reform in 1990s. Successful financial sector reform would have huge impact on the country’s economic development and poverty reduction

•1992 – IFC office in China•1995 - IFC's Operations and Strategy in China•2002 – IFC AS facility in Chengdu, Western region of China•2003 - World Bank and IFC’s country strategy for China•2007- IFC’s financial sector strategy for China

Operations •First investment to Bank of Shanghai in 1999, 50 Investments in FIs, valued at $1b •AS facility in Western of China - 46 Advisory services projects , valued at $50m •3 Bond issuances, valued at $300m

Objective of the review

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•To understand if and in what ways IFC has contributed to the financial sector reform in China

•To identify lessons learned for future strategy and operations

•First such review in IFC covering IS, AS and treasury operations - focusing on IFC’s contribution

Scope of the review

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•Advisory Services •Policy work relating to financial infrastructure (secured transactions and credit reporting system), Microfinance, Housing finance, Green credit, and sector-wide capacity building

•Investment Operations•Commercial bank investments and Microfinance

•Local Currency Financing •Renminbi denominated bond, Swaps facility

Data sources

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•Primary• Interview: unstructured interviews with over 30 key

stakeholders, investment clients, government agencies, and IFC staff

• Site visit and in-depth interviews with beneficiaries of IFC’s clients: SME banking, microfinance, RMB-denominated bonds

• Secondary • Project documents• Available evaluations and reviews • Media materials

Analytic Framework

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•Secured Transactions

•Credit Reporting

•Green Credit

•Capital markets

•Commercial banks

•MFs

•Energy Efficiency

•Sector-wide capacity building

IFC’s intervention

Results chain

•How IFC contributed to creating a favorable environment?

•How IFC contributed to building institution capacity?

•How IFC intervention helped improve business access to finance?

Storyline

Agenda1. Context and Methodology2. Key findings – Advisory Services

− Secured transactions reform− Credit reporting system− Green credit policy − Sector-wide capacity building

3. Key findings – Capital market 4. Key findings – Investment5. Conclusions and Lessons Learned

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Supported Secured Transactions Reform

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Context• 2005/2006 SME survey – 70% SMEs no access to finance due to

lack of acceptable collaterals • Lenders’ concern – no proper legal framework, no single registry • $9 trillion in dead capitals locked in SME sector

InterventionA 5 year collective effort of WB, IFC and Chinese government,

costing $1.6m• Legal framework – passed the property laws in 2007• Infrastructure – a centralized registry • Capacity building – regulators, bankers and public

Supported Secured Transactions Reform Results

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• Enabled a strong growth of movables financing −Loans secured by movable assets comprise 40% of the total loans in China

during 2008-10 vs 4% in 2005−$3.5 trillion cumulative value of accounts receivable financing as of 2012

• Increased SME lending portfolio - 7 large commercial banks reported 45% in 2008-10 vs. 20% in 06-08 period

• Removed barrier for SME access to finance – 68,575 SME received financing secured by accounts receivable over $1 trillion

• 60% of the surveyed SMEs believe that without their current access to accounts receivable financing, their business development would be severely impacted

Advised the establishment of Credit Reporting System

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Context• Before 2003, China had no consumer credit database

InterventionA 7 year effort, costing $400,000• Regulation – PBOC Regulation on Consumer Credit

Information Database; CBRC - administrative rules requiring all FIs to report credit information

• Infrastructure - Consumer credit information database

• International best practice, capacity building

Advised the establishment of Credit Reporting System Results

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•The largest credit information database in the world built in 2006. By the end of 2010, the database covered more than 777 million individuals

•2007 China was recognized as one of the top 10 reformers in Doing Business

•By the end of 2010, the cumulative number of inquiry for 812 million consumer database

•Credit reporting system helps enterprises and individuals build up their credit history, and facilitate loans to the lower-end of the market. From 2006 to 2009, the number of enterprises with bank loans increased by 50%; the number of individuals with bank loans increased by 145%.

Promoting Green Credit PolicyIntervention

• Started in 2007, Provided policy advice to and PBOC and CBRC on formation of Green Credit Policy, eg., Guidelines on Credit Granting for Energy Conservation and Emissions Reduction; Provided training and study tours.

Results• IFC’s PS and EP are now well established within key Chinese banks• Green Credit Guidelines launched in 2012 which specified how to

integrate energy-efficient financing practices into lending• Demonstration effect

The IFC-China Green Credit partnership model has been expanded to Vietnam, the Philippines, Malaysia and Indonesia

• South-South knowledge exchanges• Too early to tell the impact on the ground

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Sector-wide Capacity Building

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Institutions Training Topic

Number of workshops/training

Number of participants

Number of women participants

China Banking Association

Bank Certification and CCB (City Commercial Banks) Capacity 33 2654 356

China Banking Regulatory Commission

1. Reviewing drafts of leasing law;2. Low and Moderate Income Housing, Mortgage Lending, Mortgage Insurance, etc. 43 2868 290

People's Bank of China

1. NDTL(Non-Deposit-Taking Lending Institutions) Regulation, Microfinance Development and Mobile Banking2. Best Practice in Credit Registry, Credit Reporing, Legistration on Credit Information Services in China3. Legislation and Practice of Secured Transactions Law in China4. International Best Practices in Secured Transactions, Rural Collateral System Reform;5. Mobile Banking Market 91 11352 1463

Shanghai International Banking & Finance Institute

1. "Credit Analysis and Commercial Lending" Workbook 2. General capacity building topcis for banks 154

National Development and Reform Commission

1. International Experience on Promotion of SME2. Drafting the report of CSR (Corporate Social Responsibilities) in China3. Drafting the report of external financing regime in China 25 1228

Total 192 18256 2109

Agenda

1. Methodology2. Key findings – Advisory Services

3. Key findings – Local currency financing – Renminbi denominated bond– Renminbi swap facility

4. Key findings – Investment5. Conclusions and Lessons learned

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Local currency financing

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Intervention

Renminbi denominated bond•In 2005 IFC and ADB became the first foreign issuer of bonds on the Chinese domestic market through yuan-denominated “Panda Bonds.”

•From 2005-2011, in total IFC issued 3 Bonds at valued at $300m or RMB 2.15b.

Renminbi swap facility •In 2011 IFC signed a swap legal agreement with 2 banks and became the first multilateral institution authorized to conduct transactions with Chinese financial institutions in the domestic local-currency swap market

•In 2012 Board approved a lend of $50 million to Jiangsu Financial Leasing to be funded through the Swap Facility

Local currency financing Results

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•Opened the Chinese bond market to international financial institutions

•Improved and strengthen regulatory framework

•Introduced international good practice

•Supported high quality domestic companies with long-term local currency financing, with low interest rate

•Job creation, research development, GHG emission reduction

•Evaluation of impact on the local capital markets is underway

Agenda

1. Context and Methodology2. Key findings – Advisory Services 3. Key findings – Local currency financing 4. Key findings – Investment

- Commercial Banking- Microfinance

5. Conclusions and Lessons Learned

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Commercial Banking

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Context in the 1990’s

• Financial sector dominated by banks• Banking sector dominated by the “Big Four”

state-owned banks• High NPLs in banking sector: 25-40% • Regulation prohibits foreign investment in banks• No foreign banks were interested

• Bank loans most important source to firms• No access to finance for SMEs: 1% bank loans to

private sector•21

What Did IFC Do?- Investments

(Excluding CHUEE facilities)

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Category

IFC First Board

Approval Year

Total IFC Investment Amount ($) IFC Equity Share

IFC Appointed Director?

Latest DOTS Development

Outcome Rating

Bank of Shanghai City commercial Bank 1999 88,500,000 5% increased to 7% Yes SuccessfulBank of Nanjing City commercial Bank 2001 26,600,000 15% Yes SuccessfulBank of Nanjing City commercial Bank 2006 47,600,000 Loan - -Minsheng Bank Joint stock commercial bank 2001 27,000,000 0.92% increased to 1.1%

Nominated** Satisfactory***

Industrial Bank Joint stock commercial bank 2004 52,200,000 4% Yes Highly successfulXi'an Commercial Bank City commercial Bank 2004 3,250,000 2.5% Yes Mostly SuccessfulBank of Beijing City commercial Bank 2005 59,000,000 5% Yes Highly successfulHangzhou URCB Rural commercial bank 2006 27,630,000 5% Yes SuccessfulTianjin Binhai RCB Rural commercial bank 2007 63,930,000 10% Yes SuccessfulUCB China

Foreign invested commercial bank 2008 45,000,000 Loan - -

Deyang CCB* City commercial Bank 2009 31,000,000 15% - -Total 471,710,000

Data source: IFC project documentsData notes: *: pending Chinese government approval

**: IFC nominated an independent director***: IEG XPSR 2006 rating. DOTS rating not available.

What Did IFC Do?- Advisory

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Category

IFC Advisory Services

Amount ($)

AS - Strategic Planning

AS - Risk

Mgmt

AS - Credit

Training

AS - Corporate

Governance

AS - Int'l Accounting Standards

AS - SME

Banking

IFC Stress Test in

2005

Bank of Shanghai City commercial Bank 1,000,000 Yes Yes Yes Yes Yes Yes YesBank of Nanjing City commercial Bank 487,500 Yes Yes Yes Yes Yes YesMinsheng Bank Joint stock commercial bank 700,000 Yes Yes Yes YesIndustrial Bank Joint stock commercial bank - Yes Yes YesXi'an Commercial Bank City commercial Bank - Yes Yes YesBank of Beijing City commercial Bank 700,000 Yes Yes Yes Yes Yes YesHangzhou URCB Rural commercial bank 1,200,000 Yes Yes YesTianjin Binhai RCB Rural commercial bank - Yes Yes YesTotal 4,087,500 5 5 4 7 4 5 5

Data source: IFC project documentsData notes: This table was compiled using information from various IFC projects documents. It is possible that not all IFC advisory

services to these banks have been documented in the materials reviewed for this study.

+Sector level seminars and training programs

Presentations to the banking regulator

Results• Demonstration

effect

• Business strategy and risk management

• Corporate governance

• Strategic focus on SMEs

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11.1%13.6% 14.6%

10.5%6.5%

34.0%

19.9%16.0%

18.2%

25.3%

5.8%

23.0%

18.0%15.9%

24.0% 24.7% 22.8%19.3%

Bank of Shanghai

Bank of Nanjing

Minsheng Bank

Industrial Bank

Xi'an Commercial

Bank

Bank of Beijing

Return on EquityYear IFC Invested or nearest available 2007 2011

3.0% 2.5% 2.6%

22.2%

5.9%

1.3%2.41% 1.79% 1.15%

4.96%2.06%

0.79%0.98% 0.78% 0.38% 0.98% 0.53% 0.91%

Bank of Shanghai

Bank of Nanjing

Industrial Bank

Xi'an Commercial

Bank

Bank of Beijing

Hangzhou URCB

Non-Performing LoansYear IFC Invested or nearest available 2007 2011

73 24 361 341

25 233 309

76

920 851

41 354

656 282

2,229 2,409

102

956

Bank of Shanghai

Bank of Nanjing

Minsheng Bank

Industrial Bank

Xi'an Commercial

Bank

Bank of Beijing

Assets (RMB Billion)Year IFC Invested or nearest available 2007 2011

267 166 1,391 1,101 1,686 2,934 909

6,335 8,586

112 3,348

5,807 3,235

28,061 25,597

1,107

8,946

Bank of Shanghai

Bank of Nanjing

Minsheng Bank

Industrial Bank

Xi'an Commercial

Bank

Bank of Beijing

Profits (RMB Million)Year IFC Invested or nearest available 2007 2011

Structure of China’s Financial Sector

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Results - cont’d

IFC contribution limited in a few of the banks due to:

• Small stake• Less developed region• Heavy government influence• Management not receptive to international

investors’ influence

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Microfinance

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Context in late 2000’s

• ~ 300 NGO type programs, unsustainable• Regulatory environment, “formative” – no

clarity on which agency regulates and licenses MFIs

• Lack of professionally managed MFIs• Government experimenting different models,

including VTBs• Legal status of MCCs only established in 2008

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What Has IFC Done?- Institutional Level

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Existing InvestmentsInstitution

Type Type

IFC Board

Approval Year

IFC Investment Amount ($)

IFC Share of Total Equity

IFC Investment Instrument

IFC Advisory Services

Amount ($)

Latest DOTS Development

Outcome Rating

Zhong An Credit MFI Existing 2007 2,500,000 - C Loan 710,000 SuccessfulMicroCred China MFI Greenfield 2007 1,149,425 15% Equity 1,000,000 Mostly UnsuccessfulRenshou VTB * VTB Greenfield 2009 1,464,504 20% Equity 784,000 -Bayan VTB VTB Greenfield 2009 1,746,586 Equity 835,000 -CFPA MF MFI Transformation 2010 5,770,484 14% Equity 1,000,000 SuccessfulShenzhen VTB VTB Greenfield 2010 2,930,017 10% Equity - Too Early To TellBeichuan VTB * VTB Greenfield 2010 1,731,288 10% Equity 1,000,000 -XinJiang MCC MFI Greenfield 2011 1,050,000 10% Equity 2,050,000 -Fullerton Credits** MFI Existing 2012 50,000,000 - A Loan - -Total 68,342,305 7,379,000

Data source: IFC project documentsData notes: *: pending Chinese government approval

**: includes Fullerton Credit Sichuan, Fullerton Credit Chongqing, and Fullerton Credit Hubei.

Results• Most investments too early to tell yet

• Success story: CFPA Microfinance Co.:- NGO transformation- Strong business performance- Clear focus on poverty reduction- Opportunities for women

• Challenges faced:- Delayed government approval- Slow ramp-up - Funding constraints, partly due to regulatory issues

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Agenda

1. Methodology2. Key findings – Advisory Services 3. Key findings – Local currency

financing 4. Key findings – Investment5. Conclusions and Lessons learned

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Conclusion of the Review • China’s financial sector experienced transformational

changes in the past 20 years.• Many factors were at play, and an important force

behind the change was the Chinese government. • IFC has made significant positive contributions to this

progress by playing roles of- a catalyst- a strategic investor- and a technical advisor, facilitator, and knowledge broker.

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Lessons Learned

• Taking calculated strategic risk pays off• Remaining relevant to government’s priorities

and having strong client commitment help move forward agenda

• A programmatic approach and long-term view is crucial for delivering systemic impact

• Combining local knowledge and international expertise is critical

• Co-investing and collaborating closely with strategic investors enhances success chances

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Lessons Learned – cont’d

• Being supply-driven leads to less success• Better resource allocation within IFC would

help increase impact• Timing and mode of entering less-developed

region needs to be better planned out• Small stakes restrict influence

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Feedbacks from Clients

“Not just to Bank of Shanghai, but to the entire banking sector in China, IFC brought in international best practices in bank management.”

- Han Wenliang, Director of Board Supervisory Office, Bank of Shanghai

“There would not be today’s Bank of Nanjing without IFC. IFC was a pioneer in pushing through China’s financial sector reform.”

- Zhang Weinian, Head of Executive Office, Bank of Nanjing

“IFC was a pioneer. Since IFC’s investment in 2005, Bank of Beijing has seen improvement in all aspects. IFC has played an irreplaceable role.”

- Yang Shujian, Board Secretary, Bank of Beijing

“The most important contribution of IFC was to bring in the concepts of corporate governance and balancing shareholder interests.”

- Tang Bin, Director of Board Secretariat, Industrial Bank

“IFC contributed to the transformation of the bank from a rural cooperative to a rural commercial bank.”

- Long Yun, Chief, Office of Board of Directors, United Rural Commercial Bank

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Feedbacks from Clients

They also told us that IFC:

• Is bureaucratic, slow, and inefficient• Uses cookie-cutter approach, lacks customization and flexibility• Is big on ideas and concepts, weaker on implementation and technical support• Lacks continuity in relationship management sometimes• Was HQ-centric back then: meetings at 12am Asia time; no decision-making power in region

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Looking ForwardChallenges facing China and IFC’s Strategic Focuses

• Climate change• Access to finance• Balanced growth between urban and rural• Integration in the world economy

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•Lessons Learned: M&E Recommendations

Thank You!