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A special report on banking in emerging markets l May 15th 2010

They might begiants

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The Economist May 15th 2010 A special report on banking in emerging markets 1

Emergingmarket banks have raced ahead despite the �nancial crisisas their Western colleagues have languished. Patrick Foulis asks howthey will use their newfound strength

banks in the developing world now measure up. Not only are they well capitalisedand well funded, they are really big�andare enjoying rapid growth. By pro�ts, Tier1capital, dividends and market value theynow account for a quarter to half of theglobal banking industry. China’s lendershead the list of banks by market value, andBrazilian and Russian banks are among theworld’s top 25. At current growth rates India’s banks will catch up in a decade. Thecrisis in Western banking, still reverberating in southern Europe, seems to have accelerated the shift in banking muscle fromrich countries to the developing world.

This special report will argue that mostof that muscle will be needed at home. Tosupport the fast credit growth their populations and politicians demand, and the baddebts it may cause, emergingmarketbanks will need more capital than they cangenerate from retained pro�ts. They are thepreeminent gatherers of savings in theworld, a mirror image of Western banksthat became huge borrowers. But they willstruggle to use those excess depositsabroad without taking dangerous currency risks, so the job of recycling excess savings abroad will remain with central banksand sovereignwealth funds. The managers of emergingmarket banks have plentyto do as it is. Some of them already run organisations that are far bigger than the biggest Western banks. Most also expect tolose corporate customers to local bond

ALONG the breezy threekilometrestretch of Mumbai’s Marine Drive you

pass cricket pitches, destitute people, luxury hotels, plump joggers and advertisements for Indian multinational companies, but almost no bank branches or cashmachines. That absence, suggests O.P.Bhatt, chairman of State Bank of India, thecountry’s biggest lender, gives the visitor ahint of the potential for the banking industry. Marine Drive has been underbankedsince it was built in the 1930s. But nowthere is a palpable sense in India, as inmost other emerging economies, thatbanking is thriving�just as it has fallen intodisrepute in many Western countries.

The emerging world has a history of volatility and of baddebt problems�indeedChina is grappling with such a problem atthe moment. But developingcountrybanks now have got things right on a number of fronts. Antipoverty campaignerscan admire their e�orts to o�er bankingservices to the illiterate. Technology guruscan see new mobile applications and lowcost IT platforms, and industrialists cancount on banks that actually want to lendto their �rms. Regulation bu�s see an industry that is both armourplated andwrapped in cotton wool after the crises ofthe late 1990s and early 2000s. In mostemerging economies banks are viewed asengines of development rather than asrentseeking parasites.

But it is by the hard stu�, money, that

An audio interview with the author is at

Economist.com/audiovideo/specialreports

A list of sources is at

Economist.com/specialreports

The bigger and bigger pictureThe developing world’s banks are �ourishing. Page 2

Rambo in cu�sBalancesheets are less powerful than theylook. Page 5

Domestic dutiesCCB, China’s secondbiggest bank, exempli�es the size of the task at home. Page 7

Mutually assured existencePublic and private banks have reached amodus vivendi. Page 8

We lucky fewFor Western �rms the barriers to entry intoemergingmarket banking are daunting.Page 10

Breaking and enteringWhy it is hard to copy Santander. Page 12

Old friends onlyTo do well in China, Western banks need along history. Page 14

All the world’s a stageBut emergingmarket banks are still treadingcautiously abroad. Page 15

A door to AfricaStandard Bank reaps the bene�t of boldthinking. Page 16

Cross your �ngersEmergingmarket banks have done remarkably well, but they need all the luck they can get. Page 17

Also in this section

AcknowledgmentsIn addition to those mentioned in the text, the authorwould like to thank the following for their help inpreparing this special report: Shannon Bell, SanjivChadha, John Cheetham, William Cheng, CharudattaDeshpande, Paul Edwards, Peter Grei�, James Gri�ths,Paul Harris, Hu Changmiao, Angela Hui, Neeraj Jha, ErikLarsen, Ed Lin, Paul Marriott, Lucia Porto, Huw vanSteenis, Salina Tong, Jonathan Tracey, Milya Vered andRahul Virkar.

1

They might be giants

2 A special report on banking in emerging markets The Economist May 15th 2010

2

1

markets and to have to build up their consumer and investmentbanking operations to compensate. Many, too, are �ndinginnovative ways to o�er banking servicesto poor people without losing money.

If the crisis has transformed the statusof emergingmarket banks, it has alsotransformed the role of the state in banking. In China, which had been relaxing itsgrip on the industry for a decade, the government directed the banks to continuelending during 2008 and 2009�the mainreason why the economy continued togrow fast. In Brazil, India and Russia thestate banks have seen a sharp improvement in their fortunes, gaining marketshare at the expense of private banks.Some Western banks operating in developing countries have lived up to their reputation as unreliable partners. That is likely to have longterm consequences. Thebanking system most emerging economiesnow want is a mix of entrepreneurial private �rms and state banks, with a few wellrun foreign ones to keep the locals honest.

That has big implications for the longlist of Western �rms desperate to gainmore exposure to emerging economies.The crisis has underscored the attractionsof two business models. The networkbanks, such as Citigroup or HSBC, have apresence in lots of countries to make lifeeasier for their customers. The �gone native� ones, such as Santander, have big retail operations with large market shares injust a few countries where they act like,and by and large are treated as, local �rms.Both these models involve gathering deposits and operating branches on a largescale. The big investment banks are alsoactive in emerging economies but may�nd the going increasingly tough as localbanks get better.

Both those models are almost impossible to replicate now. The network banksare the products of a century of expansion.They are su�ciently entrenched for Citigroup’s nearcollapse in New York, for instance, to cause minimal damage to itsemergingmarket business. The �gone native� banks seized unique opportunities inthe 1990s and early 2000s as Latin Americasold o� banks after baddebt crises andeastern Europe privatised after communism’s fall. No such sello� looks remotelylikely soon in China, India or Russia. Eventhe traditional lastresort technique forbanks that want to become more international�setting up a few branches overseasand borrowing from headquarters orwholesale markets to fund lending there�has become much harder as regulators areclamping down on it.

The di�culty is mutualThe only consolation for Western �rmsthat cannot get in is that emergingmarketbanks are facing exactly the same set ofproblems as they try to expand abroad. Forthem the crisis came too soon. With another decade under their belt they might havehad the size, excess capital and skills toseize the moment and buy big bombedout banks at the peak of the crisis. As it is,most are having to embrace gradualiststrategies. All are building �strings ofpearls��branches in big partner countriesto help service customers at home. Someare also o�ering banking services to diaspora populations in rich countries.

The Western banks have found that establishing a light presence in lots of countries is a great way to lose money. The sameis likely to be true for emergingmarketbanks, so the smarter �rms are trying to develop a competitive advantage that they

can export. For the Indians that may belowcost technology; for the Brazilians, investmentbanking savvy. Some of the biggest emergingmarket banks are experimenting with small acquisitions in their�near abroad�. Going global requires thesuccessful integration of lots of acquisitions, which Western banks have foundhard to do.

This special report will show that theglobalisation of banking, which has driven the industry for two decades, is inmany ways on hold. If emerging economies are much more sceptical about unfettered �nance and the role of foreign banks,Western societies are much more hostile tobanks in general, let alone those run by foreigners or, worse still, foreign governments. Although emergingmarket bankshave far healthier business models thanWestern �rms do, many of them will face adi�cult tradeo�. They will need access toforeign countries in order to build the sortof largescale operations that make money.To get it, they may have to show that theyare at arm’s length, or even entirely detached, from their governments. Yet the crisis has pushed most banks in the developing world the other way.

These banks have been pitched into thebig league rather suddenly, helped by thewoes of Western banks and the continuedstrong growth in their own economies. Itseems inevitable that Mumbai’s MarineDrive will soon be decked with ATM machines, its joggers will be stabbing mobilebanking screens, the �rms on the billboards will be going on buying spreesoverseas and even the destitute will havesome access to �nance. Whether emergingmarket banks will soon punch theirweight in global banking, let alone dominate it, is another question. 7

THERE is only one thing that is still smallabout banks in emerging economies:

their bosses’ pay packets. The head of China’s ICBC, the world’s biggest bank bymarket value, received just under $134,000in 2009, a couple of decimal places shy ofhis Western counterparts. On all othermeasures these �rms are big enough tomake a Wall Street banker reconsider hisstatus in the universe. In terms of market

value they now account for almost half theindustry’s total worldwide, nearly twice asmuch as in 2005. That might re�ect an excess of optimism, but emergingmarketbanks are big by other measures too. According to Tab Bowers, a consultant atMcKinsey, they account for about a third ofthe industry’s global revenues, matchingthe emerging countries’ share of worldGDP. By the most solid measures of all,

pro�ts, dividends and Tier1 capital, listedbanks domiciled in emerging markets nowaccount for between 27% and 53% of theglobal industry (see chart 1, next page). China is responsible for about half of thisshare. Big Western banks’ pro�ts from developing countries add up to perhaps aquarter of the local �rms’.

Despite their large size, most emergingmarket banks are not household names in

The bigger and bigger picture

The developing world’s banks are �ourishing


2 1the West. Most richworld investors areaware of China’s �big three� banks, at ornear the top of the global rankings (see table 2), but know little about them. Asidefrom the Chinese banks, the global top 25include a handful of big Russian and Brazilian �rms, and lower down there is a longlist of smaller banks that together add upto quite a lot. The average listed richcountry bank in the top 150 has a market valueof about $36 billion, against $24 billion foremergingmarket �rms and just $15 billionif China is excluded. Many are statecontrolled and most were handsomely pro�table through the crisis and have good capital and funding pro�les. Few have muchbusiness overseas.

The numbers gameLeague tables in banking are dangerousthings. In 1990 all ten of the world’s largestbanks by assets were either Japanese orFrench. Such things can change quickly.The big emergingmarket banks shouldtherefore view their rise with a mixture ofpride and nervousness. China’s biggestbanks are all still statecontrolled. ICBC,spun out of the People’s Bank of China in1984, is run by Jiang Jianqing, a career banker. It has been making a �urry of investments in Asia and Africa. China Construction Bank (CCB) has its roots indevelopment banking. Its boss is GuoShuqing, who ran China’s foreignexchange fund before taking CCB public in2005 in the �rst big bank �otation. Bank ofChina has a grand pedigree dating back to1912. Traditionally China’s foreignexchange and trade bank, it still has the largest presence abroad. Bank of Communications is the only Shanghaibased big�rm, in which HSBC holds a 19% share.

Brazil’s two big private banks are widely admired. Itaú Unibanco was formedthrough a merger in 2008 which saw itovertake Bradesco by size. Both �rms arebattlehardened survivors and have big insurance, creditcard and investmentbanking operations. Listed but statecontrolled,Banco do Brazil is the country’s biggest �nancial �rm, with a �fth of total assets. Ithas increased its market share since 2007and is looking abroad.

Russia’s banking system is fragmented,with only two giant �rms, both statecontrolled. Sberbank controls almost a thirdof the country’s deposits and has a mixedloan book. Its newish management is trying to cut costs and spruce up its businessat home. VTB Bank started as a merchantbank but has gradually built up its branchpresence. About a quarter of its pro�tsnow come from retail banking.

India’s banking system is small butgrowing fast. About threequarters of theindustry is in government hands, with thelisted but statecontrolled State Bank ofIndia commanding about a quarter of themarket. It has been revived under thewatch of O.P. Bhatt, who became chairman in 2006. ICICI Bank, for a long timethe pinup of the private banks, paused forbreath in 2009, rejigging its strategy to target industry as well as India’s burgeoningmiddle classes. Its veteran boss, K.V. Kamath, became chairman in 2009, withChanda Kochhar taking over as chief executive. HDFC Bank is still a tiddler by assetsbut its market value has shot up, re�ectingcon�dence in its domestic strategy and itscombative chief executive, Aditya Puri.

Singapore, Turkey and South Korea alsohave banks with market values in the $20billion range. But perhaps the most notable�rm outside the BRIC group of countries isStandard Bank of South Africa, run byJacko Maree since 1999. Almost a quarter ofits pro�ts come from outside its domesticmarket, mainly the rest of Africa. It got a bigboost in 2007 when ICBC bought a 20%stake. A takeover, both parties say, is not onthe cards, but Mr Maree’s business cardsare now in both English and Chinese.

Just how big could such emergingmarket banks get? Any selfrespecting bankbull likes to whip out a chart comparingthe ratio of bank loans with GDP in poorand rich countries. The poor countries generally have much lower ratios. The hope isthat emergingmarket banks will enjoy adouble bene�t. Not only will their economies grow fast but �nancial activity willbecome more intense, allowing banks togrow faster than GDP. Today quite a few

banks in Asia, Africa and Latin Americaforecast that their loan books will rise by2030% annually over the next few years.Assuming that Western banks stagnate,that would mean China’s biggest bankwould take about two years to reach thesize of, say, JPMorgan Chase, measured byriskadjusted assets. The biggest banks inBrazil, Russia and India will take seven toten years.

The idea that banks are �GDPplus�businesses has obvious pitfalls. In 2008and 2009 the loan books of emergingmarket banks outside China grew relativelyslowly, at about 10%, although in Chinathey expanded by about 30%, and the paceelsewhere will pick up this year. And ifcredit grows too quickly for too long thesystem tends to explode, as America andsome other Western countries have found.

In central and eastern Europe too,

1Weight-lifting

Sources:Bloomberg;company reports;The Economist

*Based on 150 largest listed banksworldwide. Chinese banks’ market

capitalisation included from date of IPO,fundamental data included from 2003

Emerging-market banks as % of global* banks’:

0

10

20

30

40

50

60

2003 04 05 06 07 08 09

114

net income

market capitalisation

dividends

Tier-1 capital

loans

customer deposits

2The tops

Source: Bloomberg

Emerging-market banks and Western bankswith an emerging-market presenceAs of April 28th 2010

Market GlobalBank cap, $bn rank Country

Industrial and 226 1 ChinaCommercial Bankof China

China Construction 187 2 ChinaBank

HSBC 176 5 Britain

Bank of China 145 7 China

Citigroup 126 8 US

Santander 98 9 Spain

Itaú Unibanco 84 11 Brazil

Sberbank 58 20 Russia

Bradesco 54 24 Brazil

Standard Chartered 54 25 Britain

Bank of 53 26 ChinaCommunications

UniCredit 50 29 Italy

BBVA 47 32 Spain

China Merchants 45 33 ChinaBank

Banco do Brasil 42 34 Brazil

Al Rajhi Bank 33 43 S. Arabia

State Bank of India 32 44 India

China CITIC Bank 32 45 China

VTB Bank 27 48 Russia

Shanghai Pudong 26 50 ChinaDevelopment Bank

DBS Group 25 53 Singapore

Standard Bank 23 54 S. Africa

ICICI Bank 23 55 India

China Minsheng 22 57 ChinaBanking

United Overseas Bank 22 58 Singapore


2 where loans rose at twice the rate of nominal GDP between 2000 and 2007, they hit abrick wall in 2008 as overextended banksran out of funding and bad debts mounted. In much poorer Nigeria, talked up in2006 by Mayfair hedgefund managers asthe next great �frontier� banking market,credit as a share of GDP doubled in aboutthree years to around 30%. With smallbranch networks and relatively few people in the formal economy, this was toomuch. About a third of the system by assets is now distressed. The lesson from theAsian crisis of the late 1990s is that systemsgenerally shrink after a blowup.

Credit relative to GDP, then, does notgrow in a straight line, thanks to the economic cycle. But even in the longer term arising trend is not inevitable. According toCredit Suisse, domestic credit to the privatesector credit relative to the economy hasbeen �at or falling between 2002 and 2008in China, Mexico, Malaysia, Thailand andthe Philippines. And even if borrowinglevels are rising in the longer term, banks’role in supplying that credit is not assured.In America much of the work of �nancingcompanies is done through capital markets. Emergingmarket banks may face asimilar trend. Except in Brazil, most of theirbusiness consists of loans to industry. Fastgrowing local capital markets could takesome of this away. If so, the biggest part ofthe banks’ balancesheets would actuallyshrink relative to GDP.

Penetrating argumentsYet for all the caveats, emergingmarketbanks can count on vast untapped demand. McKinsey estimates that most people in Latin America, Asia and Africa lackaccess to formal banking services. Slowlythe supply is catching up. Bradesco in Brazil has recently opened the world’s �rst�oating bank branch (which sails downthe Solimões River in Amazonas) and the�rst branch in Heliópolis, a big favela(slum) in São Paulo. State Bank of India hasmore than doubled its number of ATMssince March 2008 without seeing a declinein transactions per machine per day, currently about 300. Most banks are trying toreach the �unbanked�. This is partly aquestion of technology�for example, providing biometric identity cards for illiteratepeople without papers. It is also a questionof organisation. Mr Kamath, the chairmanof ICICI, India’s biggest private bank, isthinking about appointing an agent ineach village who would be given the kit tolink up with the bank’s system. Indian government schemes to guarantee work for

rural workers for 100 days a year and to introduce identi�cation cards for all could bea catalyst for the spread of such schemes.Like most bank executives, Mr Kamath accepts that these will not make the industrymoney �for quite some time� but reckonsthat �no bank can a�ord not to be there.�Mr Puri, the boss of rival HDFC Bank, saysthat on a ��veyear horizon it can absolutely move the needle�.

But the real boon for many emergingmarket banks has been the rise of a creditculture among the middle classes. Wello�people behave in a way their parentswould �nd unimaginable, buying homesand cars not by saving up but by borrowing. The ratio of household borrowing toGDP points to this in all big developingcountries (see chart 3). If the world economy rebalances so that surplus countriessave less and consume more, mortgagesand consumer loans will become thebanks’ biggest source of pro�ts.

Although competition may put pressure on emergingmarket banks’ high margins, there are o�setting factors. People willshift their savings from deposits to investment products with better yields thatbanks can charge fees for. Lowcost technology too could boost pro�ts. India’sbanks say they have leapfrogged the expensive mainframe computers of theirWestern peers and expect a rapid move towards mobilephone banking among theyoung. In China people do not usecheques but can get textmessage con�rmations when they have used their creditcards, reducing the risk of fraud. Noel Gordon, a consultant at Accenture, jokes thatwhen Western banks were �ddling withrocketscience �nance, emergingmarketbanks were innovating more productivelyby opening up entire new markets that willmake sustainable pro�ts.

Emergingmarket companies also promise to give the banks lots of new business. This year there will be a boom inloans as they shrug o� the downturn. Inthe longer term banks will have to adapt aslocal capital markets develop and businesses expand abroad. Most lenders arebuilding up investmentbanking skills anda presence overseas that will generate income as more local businesses turn to issuing bonds and shares for �nance.

And even though all these opportunities still lie ahead, emergingmarket bankshave already taken a giant leap in size andpro�ts in the past decade. They have alsomaintained adequate capital ratios andample deposit funding. The combinationof growth and strength would appear togive them enormous advantages, heralding a rebalancing of power in global �nance. Yet are those rocksolid balancesheets quite what they seem? 7

3Modest borrowers

Source: McKinsey Global Institute

Debt as % of GDP

0 50 100 150 200 250

2000

2008

2000

2008

2000

2008

2000

2008

2000

Q2 09

2000

Q2 09

2000

Q2 09

Households

Companies

Russia

India

China

Brazil

Germany

Spain

UnitedStates


1

WESTERN bank bosses often suspendtheir critical faculties when discuss

ing their emergingmarket peers. Suddenlyit is not the next quarter that matters butthe longterm �ow of world historicalforces. �They think about time in a verydi�erent way,� says one, Zenlike, beforeadding: �History always follows a course.�What lies behind this mumbojumbo isthe recognition that emergingmarketbanks are not just getting bigger but alsohave piles of excess deposits because theyare based in countries with high levels ofsavings. This would appear to give them adecisive advantage over Western banksthat rely on �ckle borrowing markets to dobusiness. To add to richworld banks’ discomfort, developingworld banks tend tohave high capital ratios too. In banking, especially after the crisis, whoever has thedeposits and the capital usually wins.

The reality is a bit more complicatedthan that. Banks are indeed mirrors of theeconomy, so banks’ balancesheets re�ectthe fact that the typical Westerner is a borrower and the typical Asian a saver. Emergingmarket banks tend to have vast branchnetworks that suck in deposits from thriftyfamilies and companies. Only some ofthese get lent out again. Banks park the surplus with the state, by buying governmentbonds or keeping it in central banks. Thestate in turn acts as the international recycling agent for those excess savings: it lendsthem to Western countries through its foreign reserves or through a sovereignwealth fund, for example by buying US

Treasuries, mortgage bonds or moneymarket instruments.

Overextended Western banks do theexact opposite: they borrow from capitalmarkets to plug the hole created by havingmore loans than deposits. This shows upin the ratio of loans to deposits, which forrichcountry banks rose to alarmingheights in the runup to the crisis (thoughthey have since come down somewhat),whereas those for emergingmarket banksremained healthier.

Another way of measuring the di�erences is to look at the absolute fundinggaps. Although by and large rich and poorcountries’ banks are not lending to, or borrowing from, each other directly, there is a

symmetry to the �gures that is not entirelycoincidental. In 2008 the surplus of customer deposits over loans (ie, excess savings) at listed emergingmarkets banks wasabout $1.6 trillion, compared with a de�citof about $1.9 trillion at richworld banks(see chart 4). The imbalances of the world’seconomies are re�ected by their banks.

A Western bank with masses of excessfunding would be deemed to have a hugecompetitive advantage. Surely the sameapplies to entire countries’ banking systems? Emergingmarket banks could usetheir surplus funds beyond their borders,for example by lending directly to foreigners and taking market share from richcountry �rms. By doing so they would bebypassing central banks and sovereignwealth funds, recycling excess savings directly themselves. But this is not what happens. For a start, the funding position ofemergingmarket banks is less impressiveif China is excluded. And even in marketswith excess savings these are not alwaysevenly distributed, with a lot of them stuckin sleepy state banks. Some �rms are doingtheir best to change that: ICICI’s Ms Kochhar, for example, is setting up lots of newbranches to boost its deposits.

Banks that do gather excess depositsmay �nd the government wants to get itshands on them. This could be for prudential reasons. For example, China’s regulator requires banks to keep 17% of their deposits with the central bank and tinkerswith this ratio to control the economy. Or itcould be because the government needsthe cash. In India banks are obliged to useabout a quarter of their deposits to buygovernment debt, which helps the government fund its budget de�cit. Mr Bhatt ofState Bank of India says there is littlechance that this will change soon: �It is themodel in this country,� and allows the government to spend on development.

So complementary and yet so farBut suppose that when everything is saidand done banks still have piles of excessdeposits? This is broadly true of China’slenders. Can they �nd a way to marry theirsavingsrich �rms with the indebtedequivalents of the West? There is already areallife case study: HSBC. It has always

gathered more deposits in Hong Kong thanit lends out. In 2002 it bought a mirror image of itself, Household, an American consumer�nance �rm with $106 billion ofloans and no deposits. It announced at thetime that it was �bringing together one ofthe world’s top assetgenerators with oneof the world’s top depositgatherers�.Those labels could be applied respectivelyto America’s and greater China’s entirebanking systems.

The acquisition failed because of baddebts at Household, but the original premise was wrong too. HSBC’s regulators,like most around the world, did not wantdeposits in one country to be used to �nance a subsidiary overseas, exposing thebank to foreignexchange and counterparty risk. Michael Geoghegan, HSBC’schief executive, says it might have found�ddly ways of getting Asian customers tofund Household, perhaps by securitisingHousehold’s loans and selling them toHSBC’s Hong Kong subsidiary; but thebank chose not to do so because it felt thatwould disadvantage its Hong Kong depositors. He says the regulatory climate has gotmore di�cult since the crisis, and �it’s getting harder to move liquidity around�among subsidiaries.

For the moment China’s banks showlittle appetite for taking positions in riskyWestern assets. Bank of China did boost itsforeigncurrency lending in 2009 by astonking 47% to about $200 billion, or

Rambo in cu�s

Balancesheets are less powerful than they look

4Mirror image

Sources: Bloomberg; companyreports; The Economist

*Top 150 listedbanks worldwide

Banks’ excess of deposits over loans*, $trn

2

1

0

1

2

+

–

2003 04 05 06 07 08 09

Developed world Emerging markets


2 about a quarter of its loan book, but thiswas matched by $190odd billion of foreigncurrency deposits. The bank actuallyreduced its holdings of foreigncurrencysecurities by an eighth, �in accordancewith the global �nancialmarket situation��a polite way of saying in order toavoid dud Western assets. Its latest annualreport notes �growing concerns� over the�nances of southern European banks andgovernments.

Deposits don’t travelThere are other ways of utilising excess deposits abroad, says Anthony Stevens, aconsultant at Oliver Wyman. The most obvious ones are hedging, organising swaplines with foreign banks and encouragingdomestic customers to switch their deposits into foreign currency, thereby makingthem take the exchangerate risk. But noneof these are largescale options in countries with partially closed capital accounts.And in China in particular, given the undervaluation of the renminbi, the lastthing policymakers want is banks whoseasset bases would fall as the currency appreciated. Far better for the currency risk tobe borne by the central bank and sovereignwealth funds. In the medium term, ascustomers spend more and save less, thepool of excess cash in emergingmarketbanks may shrink. Until then it will behard to use that strength abroad.

What about the emergingmarketbanks’ capital positions? At the end of2009 these banks had a weightedaverageTier1 capital ratio of 10%, in line with richworld banks, but this probably understates their advantage. Excluding China’sbanks (which have been busy raising equity since), the ratio was 12%. And the newcapital rules known as �Basel 3� are likelyto be much less painful for emergingmarket banks, which typically have higherquality capital and smaller investmentbanking units (which will be heavily penalised by the new rules) than their richworld peers. At the same time they are likely to be more pro�table than banks inEurope and America, which will allowthem to create new capital faster.

Even so, emergingmarket banks willstill be short of capital. That is partly because of bad debts. In most places the cyclehas already turned for the better. In BrazilBradesco has said that the worst is over.Sizwe Nxasana, chief executive of FirstRand, one of South Africa’s big four banks,notes that impairments are falling o� andthe performance of loans to lowerincomecustomers has been �very good� during

the downturn. But in both India and Chinathe position is less clearcut. Indian bankshave lowish levels of nonperformingloans but have built up relatively small reserves against them. These reserves act asa bu�er against losses before capital is eaten into. Adjusting for that could knock apercentage point or so o� Indian banks’capital ratios.

China’s banks seem to have lots of reserves relative to the current level of nonperforming loans, but that level seems implausibly low given how much they havebeen lending. Baddebt reserves relative tothe size of total loans are smaller, especially compared with Western �rms that havetaken massive hits in anticipation oflosses. For example, Bank of China hasroughly the same size of loan book asJPMorgan Chase or Citigroup, but onlyaround half the level of baddebt reserves.

Still, assume the best: that after a lending boom of several years, bad debts atemergingmarket banks are under control.Surely, then, with their high pro�tability,they should be throwing o� plenty of excess capital? Not necessarily, for the fasterthey grow, the more capital they will need

to set aside to support new loans. And although emergingmarket banks generatedecent returns on equity, in aggregate theypay out about a third of that in dividends,limiting the amount that is retained andadded to their capital bases.

Less than meets the eyeThe maths of this can be pretty eyewatering. Assume that emergingmarket banksreally increased their riskadjusted assetsat, say, 20% a year yet maintained the samereturn on those assets, capital ratios anddividend payout ratios as they had lastyear. To back new assets, such as loans,they would need $4 trillion of new capitalover the next ten years, only $2.6 trillion ofwhich would come from retained pro�ts.They would need to raise $1.4 trillion fromexternal sources�about oneandahalftimes the total capital America’s 19 biggestbanks had at the end of 2008. Even assuming growth of 15%, the shortfall would besome $400 billion. One option would beto cut dividends, but neither private norpublic shareholders would like that.

At the same time Western banks are actually likely to release capital as they winddown bad assets. Royal Bank of Scotlandhas about $30 billion tied up in its �badbank� but will probably have to use that torepay emergency aid from the state, its current majority owner. Still, banks that haveeither largely paid back the government,such as Citi, or never accepted aid, such asHSBC, could eventually have capital coming out of their ears. Vikram Pandit, Citi’sboss, recently told investors that �nobodywants to talk about excess capital,� but �atsome point down the road we’re going tohave to �gure out what to do with� it.

The balancesheets of emergingmarketand richworld banks are like the coasts ofAmerica and Africa: they look like a good�t. One group of lenders is overloadedwith excess deposits but in need of capital,the other is short of deposits but likely togenerate capital. It would seem like a template for much closer integration, butbringing the two groups of banks togethermight be as di�cult as melding continents.That partly re�ects the problems emergingmarket banks face in shifting excessfunds into foreigncurrency assets, oramong subsidiaries in di�erent countries.But most emerging economies now alsohave less appetite than they did for lettingforeigners in, and much more for state involvement in banking. And far from beingready to take on the globe, most emergingmarket bankers are consumed by their colossal and growing businesses at home. 7


1

IT IS something of a surprise to �nd thatthe bank boss with the best line in dead

pan humour is Guo Shuqing, chairman ofChina Construction Bank (CCB). When it�oated in Hong Kong in 2005 Mr Guo reminded the assembled ranks of slick investment bankers and analysts that duringthe Cultural Revolution he had been acowboy. Five years on the bank has risen tobe the world’s secondlargest by marketvalue, after ICBC. Over that period its pro�ts have more than doubled to $16 billion,more than at any of America’s three mostpro�table banks, JPMorgan, Wells Fargoand Goldman Sachs.

CCB embodies the paradox of manyemergingmarket banks. It is huge and hasgrown phenomenally quickly, but the demands placed on it at home are also huge.Last year it expanded its loan book by 27%.The industry as a whole grew even faster,by 32%, partly thanks to the leading role thebanks played in the government’s economic stimulus. New loans made in Chinawere equivalent to almost a third of GDP.Roy Ramos, an analyst at Goldman Sachs,points out that in less than ten months China added the equivalent of India’s bankingindustry twice over.

The government is now working hardto ensure that the lending spree does notcause a baddebt problem that infects thebanks (which it had to recapitalise just under a decade ago). In April Liu Mingkang,the top banking regulator, said he hadasked the banks to submit �comprehensive� reviews of their loan books by June.Of particular concern are the infrastructure projects backed by local governments,

which accounted for perhaps a third of thenew loans. These projects often su�er frompoor cash�ow, no explicit guarantee fromthe state and limited transparency.

Mr Guo is optimistic about bad debts inthe banking system overall. �If we dealcautiously with this risk we will have a softlanding,� he says. However, he also cautions that there is no blanket guarantee forlocal infrastructure projects: �Not all canbe rescued by the central government.�The key, he reckons, is to improve the �owof cash to local authorities, which itself requires further reforms. The cap on theamount of bonds the central governmentissues on their behalf needs to be raised.But China also needs to �open the frontdoor� by allowing local governments toraise municipal bonds. At the same timethe government can enlist the help of China’s remaining fully stateowned banks,although their role needs to be de�nedclearly to avoid moral hazard. The samegoes for the plethora of smaller local banksthat can be encouraged to provide morecredit to local projects but must, he says, remain �independent institutions�.

Hungry for capitalChina’s banks are highly pro�table, whichgives them a bu�er to absorb potentiallosses. Still, in response to the rapid growthin loans and the risk of bad debts, thebanks are also busy raising capital. Bank ofChina, Bank of Communications andICBC have indicated that between themthey will issue up to $28 billionworth ofnew securities, bolstering their core capitalby about a seventh. CCB has yet to �nalise

its plans but it is likely to issue new equitytoo. Agricultural Bank of China, a giantfully stateowned lender, is considering�oating a minority of its shares on theShanghai and Hong Kong stockmarketsthis year.

China’s banks have a lot on their platesright now, thanks to the lending surge ofthe past two years. But even in the mediumterm the industry is likely to be quite achallenge to manage. Part of this relates tocapital. This year, for example, the government is still aiming for lending growth ofabout 19%. At the same time China’s banksare paying hefty dividends, limiting theamount of capital they generate internally.Mr Guo at CCB, which paid out 44% of pro�ts last year, explains that �according to international practice the ratio should beabout 30%.� But an absolute dividend cutis unlikely because Huijin, the state vehiclethat owns stakes in the banks, needs the income to pay interest on the funds it spentrecapitalising China’s banks back in 2003.Although the planned capitalraising maydilute Huijin’s stake, currently at 57%, thegovernment has �got some room�, Mr Guosays, to maintain a majority shareholding.

Other banks agree that more capitalwill be required over time. Yang Kaisheng,the president of ICBC, said recently thatthe big four banks could need $70 billionof outside capital over the next �ve years�about double the maximum they have indicated they might raise now. This was assuming loan growth of 15% a year. At somepoint the state will need to inject more capital into the banks or permit them to cuttheir dividend payouts. The third option,

Domestic duties

CCB, China’s secondbiggest bank, exempli�es the size of the task at home


2

1

of allowing its stake to be diluted below50%, looks unlikely, and the fourth, of developing a shadow banking system intowhich the banks can o�oad assets, seemsless attractive after the debacle in America’s securitisation markets.

It is not just the capital bases of China’sbanks that will have to adapt to continuedexpansion. The system already has all theregional complexity of America, from Hainan Island, a Floridastyle propertydevelopment hotspot, to pockets of conservatism such as Zhejiang Province, just southof Shanghai. And notwithstanding theheavy infrastructure lending of the pasttwo years, the mix of the banks’ lendingwill shift. Today only a �fth of all loans areto households. But as saving declines, consumer lending, including mortgages, willbecome more important. At the same timerapidly developing capital markets will offer big companies an alternative way toraise money and put pressure on banks’lending margins. Mr Guo reckons thatlending to consumers and small �rmscould rise to 40% of CCB’s loan book within �ve years, from about a quarter today.

If China’s banking system and its capital markets develop as planned, it will be

one of the biggest and fastest �nancialtransformations ever seen. If they do not,the result may be one of the world’s bigger�nancial headaches. There is little inclination to allow a sudden in�ux of foreignbanks that might make the system less stable. Chinese banking has interacted withthe outside world cautiously, lagging theexpansion of China’s big industrial �rms.Bank of China last year generated 22% ofits pretax pro�ts outside mainland Chinabut most of this was from Hong Kong andMacau. ICBC, which has shown the mostexpansionist instincts, derived only 4% ofpro�ts from abroad.

No adventuresMr Guo, for his part, advocates cautionabroad. Using domestic deposits to fundpurchases of foreign assets involves toomuch risk: �If the currency were to appreciate, how would we pay it back?� CCB

made 1% of its pro�ts from abroad last yearbut the idea of boosting this by buyingequity stakes in foreign banks is not enticing: �We don’t want to do that verymuchðwe want to establish a networkabroad for our customers but their requirements are limited.� Mr Guo says Western

politicians and regulators have been �verynervous� about Chinese lenders taking bigstakes in their banks, but adds that the crisis may have changed this a little. In anycase, Western economies are overbanked,suggesting limited growth potential.

In mirror image, the in�uence of foreign �rms in China is likely to be limited.Western banks, Mr Guo says, �don’t havemany opportunities� to build enoughbranches to rival the vast networks of thebig domestic banks. Through their minority stakes in Chinese banks Western �rmsget all the exposure to China they need.

In some respects China’s template forbanking seems rather conservative. It envisages a stable industry structure, withlimited entry for Western newcomers, ahigh degree of government coordinationand a cautious view of banks goingabroad. Yet at the same time it is dynamic,with vigorous competition among domestic banks, big shifts in the pattern of lending, plenty of product innovation and,most important of all, fast credit growth.This kind of �managed �nance� model isno longer con�ned to China. Since the crisis a milder version of it has gained fans allover the emerging world. 7

�INDIA is where China was ten yearsback,� says Mr Kamath, chairman of

ICICI. That is certainly true by size. India’sGDP amounts to about a quarter of China’s today and its banking industry just atenth. But in at least one respect India iswell ahead: it has several dynamic privately owned banks that over the past decadehave taken a �fth or so of the market fromthe statecontrolled banks. Until the �nancial crisis in the West the private banksseemed to o�er a template for the entire industry: within a decade or two, it seemed,the state would retreat signi�cantly. NowIndia’s mixed model of banking is likely topersist for longer.

Part of that re�ects the fact that Indiahad its own wobble during 2008. This wasnot a fullblown crisis; indeed, Aditya Puri,chief executive of HDFC Bank, the secondbiggest (and perkiest) private �rm, says todescribe it that way would be an �appalling misconception�. But there was a sharpspike in moneymarket interest rates after

the collapse of Lehman Brothers, a liquidity squeeze and a notable shift in deposits.At ICICI overall deposits, as well as thestickier category of savings and currentaccount deposits, dropped by about a tenthbetween June and December 2008. Saversshifted their cash to the governmentcontrolled banks, which were perceived to besafer. �Money was pouring out of ourears,� says Mr Bhatt of State Bank of India.

That experience has helped prompt achange of strategy at ICICI, which for along time was one of the most admiredprivate banks in the developing world.After a decade of spectacular growth, fuelled in part by wholesale funding (including bulk deposits), the bank recentlyslammed on the brakes. In 2009 its loanbook shrank by 17%.

Chanda Kochhar (one of several femalebank bosses in India), who took over aschief executive from Mr Kamath last year,says that the bank decided to focus onchanging its funding mix towards retail de

posits because as interest rates rise theseshould be cheaper as well as stickier thanwholesale funds. Current and savings deposits now make up 42% of total deposits,up from 27% before the crisis. Private banksso far lack the state banks’ huge branch networks, but they are working on it. ICICI

now has 2,000 branches, against only 755

Mutually assured existence

Public and private banks have reached a modus vivendi

5Looking for the right mix

Sources: Central banks andregulators; Raiffeisen; Andrei Vernikov

*Loans, September 2009†2008

Banking sector, % ownership of total assets, 2009

0 20 40 60 80 100

China

India*

Russia

Brazil

Poland†

Mexico

State Private Foreign


2

1

in early 2007. That should help it suck inmore deposits.

The state banks may hold on for a whileyet to the market share they have taken. Between June 2007 and December 2009,after a long period of genteel decline, theysaw their share of total deposits and loansrise from 73% to 77%. After years of �ercecompetition from the private banks, theyhave begun to get their act together. AtState Bank of India’s headquarters inMumbai visitors may still receive a smartsalute from a man in uniform, but, MrBhatt says, its technology and products arenow �comparable to the private sector�.Mr Kamath agrees that the state bankshave caught up on technology.

Learning to love state banksYet even if the private banks do go back onthe attack, attitudes towards the statecontrolled banks have changed for good. Afterall, they were the ones that continued tosupply credit to the economy during thedownturn. Before the crisis all banks wereexpanding their loan books at an annualrate of about 25% (see chart 6). Aftermid2008 there was a big divergence, withthe state banks (which come in three main�avours: the nationalised banks, StateBank of India and the regional rural banks)keeping credit growing fairly steadily. Theprivate banks more or less ground to a halt.The foreign banks went from expansion tosharp decline, with their share of loansdropping from a peak of 7% to a paltry 5.3%last December.

Most bank executives now also concede that oldfashioned regulation wasshown to have its merits. Indian banks arerequired to hold a big slug of their assets(typically just under a third) in government bonds and at the central bank. Now

Western regulators too are consideringpushing up liquidity levels. Indian bankersjoke that all the �ddly rules they face havebecome the envy of regulators throughoutthe world.

All this has led to a reappraisal ofwhether state banks should be fully privatised in the long term. HDFC Bank’s MrPuri says that �the world has changed andthe view around here has changed.� MrKamath takes a similar view, predictingthat in the new circumstances �India’s evolution will be more or less in line with China’s.� Mr Bhatt reckons there will be �nobigbang reform� and that over time thestatecontrolled banks’ share will droponly gently, to 5565% of the market.

A similar message is heard in Brazil. Inthe past �ve years Brazilian private bankshave risen to global signi�cance, helped bya frenetic 2007 and 2008 when an eighthof the system’s assets changed hands. Itaúbought Unibanco and Santander boughtABN amro’s Brazilian business.

But just as important has been the expansion of the state banks, Banco do Brasil(a listed commercial lender with a bias towards agriculture), Caixa Econômica Federal (a mortgage specialist) and BNDES

(which acts more as an investment company). Together their share of the �nancialsystem’s assets has reversed its earlier decline and now stands at 42% (see chart 7).Part of their increase in market share re�ects acquisitions, with Banco do Brasilbuying Nossa Caixa, a midsized stateowned �rm, in 2008 and a 50% stake inVotorantim, a car�nance specialist, in2009. But about twothirds of the rise hascome from lending more than the private�rms during the downturn.

That in turn has changed people’sviews of a mixed �nancial system. Domin

gos Abreu, chief �nancial o�cer of Bradesco, says the state banks �had a very important roleðin the government’s anticyclical policies�, adding that in adownturn �it makes a di�erence� to have amixture of state, private and foreign banks.He concedes that two years ago he mighthave answered the question di�erently,but now he had to acknowledge that thestate banks have their merits.

Alfredo Sáenz, chief executive of Santander, which owns the country’s thirdbiggest private lender, quips that Brazilkeeps an �artistic equilibrium� betweenthe private and the public sectors. PersioArida, a former governor of the centralbank and president of BNDES, and now apartner at BTG Pactual, Brazil’s leading independent investment bank, says that the�consensus� in the country is that the statebanks played a vital role. However, he cautions that until the extent of bad debtscreated by their lending is known, no de�nitive judgment can be reached.

Russia holds the lineIn Russia up to 54% of the system’s assetsare statecontrolled, according to AndreiVernikov, an economist, compared with45% in 2007. Foreign banks’ share stands at18%. The balancesheets of the three European banks that are most active in Russia,UniCredit, Rai�eisen International and Société Générale, together shrank by about aquarter in euro terms in 2009. Royal Bankof Scotland’s loans to Russian corporatecustomers dropped by 45% in sterlingterms. Net loans at statecontrolled Sberbank and VTB declined by only 4% and 10%respectively in localcurrency terms. Lastsummer the government took a largerstake in VTB to bring its holding up to 86%.Andrew Keeley, an analyst at Troika Dialog, an investment bank, says that although the government is likely to sell theadditional stake in VTB again, it intends tokeep majority control of both big banks.

But none of this means that a Sovietstyle banking system is about to emerge inany of these countries. In China the government did take control of credit duringthe crisis, but for other state banks it wasmore of a nudge and a wink. Mr Bhatt sayshe was left to his own devices. Most governments also want privatesector banksto raise the level of competition. Even inChina the state accepts some innovativeupstarts, such as China Merchants Bank, amidsized bank with di�use ownershipand no direct state control. And all emerging markets want some foreign banks in order to keep local �rms on their toes.

6State good, foreign bad

Source: Reserve Bank of India

Banks’ gross credit in India% change on a year earlier

Q1 Q2 Q3 Q4

2007Q1 Q2 Q3 Q4

08Q1 Q2 Q3 Q4

09

20

10

0

10

20

30

40

+

–

Regional rural banks Nationalised banks

State Bank of India Other commercialbanksForeign banks

7State banks can dance too

Source: BancoCentral do Brasil

*Banco do Brasil, BNDES and CEF;includes 100% of Votorantim in 2009

Brazilian financial system’s assets, % of total

0

10

20

30

40

50

2004 05 06 07 08 09

Big three state-controlled firms*

Bradesco ItaúUnibanco

Santander HSBC Citigroup


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1

So although the ratio of ingredients varies, the objective mostly seems to be a mixwith a strong state presence. This is seen asmore responsive to businesses, less vulnerable to �aky foreigners and more opento �soft� control by the state as it tries tomanage the economic cycle. Westernbankers see its merits too: HSBC’s MrGeoghegan, a veteran of banking in LatinAmerica, the Middle East and Asia, reckons that a healthy combination of foreignand local �rms leaves foreign banks politically less exposed.

Control freaksThe problem for state banks is that theyneed to �nd a way of raising capital without diluting the government’s holding.Most statecontrolled banks are listed because a quotation brings market disciplineto managers and provides useful informa

tion about the performance of the bank.But governments seem determined to holdon to a stake of at least 51%. For example,Banco do Brasil, now the country’s largestlender by assets, announced plans to raise$5 billion earlier this year, but its objectiveremains the �maintenance of the government’s shareholding control�. Turkey isthinking about �oating its largest lender,Ziraat Bank, but the state seems likely to retain control. It is the same story in China,says Bill Stacey, an analyst at Aviate Global,a brokerage �rm. The government is happyto sell shares in banks but wants to keep amajority stake. Likewise, in Russia the statewants to retain control of the two biggestbanks.

What happens when the state’s holding gets close to that crucial 50%? StateBank of India expects to receive a capitalinjection from the government this year. Its

chairman, Mr Bhatt, says it is still an openquestion whether the state might breachthe 50% threshold in the medium term, buteven then it would seek to have a bigenough stake to remain the dominantshareholder. Many governments are inbetter �scal condition than India’s andhave more scope to top up banks’ capital.

Emergingmarket banks’ hunger forcapital used to ensure that they would ultimately be sold o� to the market�or to foreigners. Not any more. So the prospectnow is of a fastgrowing, innovative banking industry that remains subject to conservative regulation and only gradualshifts in control. After the West’s experience with noholdsbarred banking, thatmay be a good idea. But for growthstarvedWestern banks desperate to do business inemerging markets it means they will �nd iteven harder to get in. 7

�YOU kind of needed to think aboutthis 30 years ago,� says Stuart Gulli

ver, who runs HSBC’s investment bank,when asked about Western banks expanding in emerging markets. He has a point.

There are only two kinds of Westernbanks that are big in developing countries,and both have been at it for quite a while.The �rst are the global network bankswhich have a limited presence in lots ofcountries which they use to tap internationally minded companies and consumers: Citigroup, HSBC and Standard Chartered. The second are the lenders that have�gone native� with a deep retail presence,most notably Santander and BBVA in LatinAmerica and UniCredit in eastern Europe.

These six �rms certainly pack a punch,with nearly $30 billion of pro�ts from developing countries in 2009 (see chart 8),about a quarter of what listed local banksmade. But replicating the �gone native�banks has become next to impossible (seenext article). And even the network bankshave historical advantages that make ithard to emulate them. By the end of the19th century HSBC was already big in Asiaand Standard Chartered’s predecessor�rms were doing well in Africa and India.Citigroup’s main constituent part, International Banking Corporation, was foundedin 1901. A year later, with an agent installed

in China, it advised shareholders that�matters are progressing favourably inShanghai��a message banks still intone.

The network banks have been througha few twists and turns. For its �rst 85 yearsHSBC concentrated on Asia, although it retained a presence in London. From 1949 itadjusted to the revolution in China andconsolidated in India, Hong Kong and theMiddle East. After 1978 it started to expandmainly in rich countries, which led to thepurchase of Britain’s Midland Bank in 1992and the shift of its headquarters to London,and in 2003 to the illfated takeover ofAmerica’s Household.

Standard Chartered had a turbulent

time from the 1970s to the early 2000s,with an expansion in America, a failed attempt to buy one British bank, a hostile bidfrom another, then the Asian crisis and about of boardroom bloodletting. Citigrouphas spent the past decade trying to be a �nancial supermarket.

The crisis has cleared their minds. Citigroup, notes its Indianborn boss, VikramPandit, �is going back to the core model ofwhat we had as a global bank�. After thebailout Citi realised that �it was the emerging markets that made us very special,� hesays, and that the dealmaking of the pastdecade had diverted a lot of energy awayfrom the �rm’s strengths. Shirish Apte and

We lucky few

For Western �rms the barriers to entry into emergingmarket banking are daunting

8In foreign fields

Sources: Company reports; The Economist estimates

Western banks’ net income in emerging markets2009, $bn

HSBC 9 8 4 2 1 0 <1 6

Citigroup 7 4 na na 2 na na -2

Santander 5 0 0 0 5 0 0 12

Standard Chartered 3 3 1 0 0 0 <1 3

BBVA 3 0 0 0 3 0 0 6

UniCredit 2 0 0 0 0 2 0 2

Total 29 15 5 2 12 2 1 28

Emerging Hong Stakes in Latin Central Europe Africa & GroupBank markets Asia Kong China America & Russia Middle East profit/loss

of which


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1

Stephen Bird, joint bosses of Citi’s business in Asia, say it has been largely untouched by the turmoil in New York. Onerival in the region says Citi’s business is�brilliant�. That resilience has echoes inhistory. When President Roosevelt closedAmerica’s banks in March 1933 to try to halta meltdown, the bank’s overseas depositbase shrank by just 2%.

America’s other large commercialbanks came late to the party. Because ofregulatory quirks most did not go overseasuntil the 1960s, and despite the huge advantage of their customer base at homefew were able to maintain the global presence they had aspired to.

HSBC’s Mr Geoghegan moved to HongKong in early 2010. His perks include ahouse on a leafy lane on top of the islandand a huge o�ce in one of the city’s mosticonic buildings. He says emerging markets are about �volatility�, something onlythe biggest and most experienced �rmscan handle. HSBC’s rethink began in 2006when it abandoned its e�orts to turn its investment bank into a bulgebracket contender and shifted its attention to developing economies. The blowup atHousehold, which HSBC is now windingdown, gave impetus to this move. After an$18 billion rights issue in 2009 it has landedon its feet. Its structure, with a surplus ofdeposits and its local operations ringfenced as subsidiaries, is a regulator’sdream. And at a time when emergingcountries increasingly do business witheach other, being everywhere turns out tobe pretty useful.

Standard Chartered has concentratedmainly on emerging markets for two decades but has recently changed its approach. When Mervyn Davies was chiefexecutive in 2002, he said the consumerbusiness would be �our engine forgrowth�. In fact the horsepower has comefrom wholesale banking, which now provides 80% of pro�ts, up from 60% sevenyears ago. Peter Sands, who became chiefexecutive in 2006, may have re�nedtastes�during an interview with your correspondent he received a note from his piano tuner�but his message to shareholders last year was anything but subtle:�Our role and position in the world ofbanks have changed dramatically. We didnot just weather the crisis, we turned it toour advantage.�

When the network banks have strayedtoo far from their core businesses�for example in consumer �nance�their recordhas been patchy. Their backbone is the international presence built up over decades

and their relationship with corporate customers which is based, in an oftrepeatedformulation, �more local than other international banks and more internationalthan the local banks.� Although this is often mocked by rivals as a way of dressingup small market shares in many countries,the case for geographic reach is gettingstronger as emerging markets trade morewith each other and the number of multinational companies grows. Citigroup saysclients that bank with it in 70 or morecountries spend twice as much as thosethat bank with it in 5060 countries.HSBC’s Mr Gulliver says that to win corporate customers in emerging markets,�you have to have a substantial presence inthe developed world� and the ability tolend on a substantial scale�something fewother �rms can o�er.

In praise of plumbingAll three banks also own bits of the global�nancial plumbing that governments,companies and other banks need to shipfunds around the world. That gets a foot inclients’ door and generates a slab of stablepro�ts and deposits. Some other banks, including Deutsche Bank, JPMorgan Chaseand Royal Bank of Scotland, have big transactionservices divisions, but about halfof their revenue comes from their homemarkets. In terms of pro�ts from emergingmarkets, the three network banks’ transactionservices units are much larger. Replicating Citi’s operation, Mr Pandit says,would be �a very, very di�cult thing to dobecause you’ve got to follow the genera

tional process� that saw the bank expandover a century.

Have the network banks been able totranslate their unique advantages into pro�ts? After all, ABN AMRO’s giant globalpresence became a liability when it produced too little revenue to cover its costs.That helps to explain why all three banksdeveloped consumerbanking businesses.Citi has been trying to attract wello� retailcustomers since 1976, but has not alwayssucceeded. Its Latin American creditcardbusiness lost money last year and its creditcard loans of $18 billion in Asia generated pro�ts of just $214m. Jonathan Larsen,who heads its consumer business in Asia,says bad debts are improving and Citi enjoys �an extraordinary brand awareness�that can be tapped. Urbanisation helps: thetop 85 cities in emerging markets generate10% of global GDP, so a small branch network can make a big di�erence. Mr Panditsays the business is there to stay.

HSBC is sticking with wello� customers but has gone o� massmarket consumer �nance. Mr Geoghegan notes that in developing countries �it is quite easy to lendand much harder to collect.� Instead HSBC

is bulking up, for example with a smalldeal in Indonesia recently that �solved ourproblem� of too few deposits. Critics pointout that almost half the bank’s $11 billionof pretax pro�ts from emerging markets in2009 came from mature Hong Kong and$1.5 billion from minority stakes in Chinese�rms. Yet many banks would love to be sowell placed in China. In theory HSBC hasthe right to increase its stake in BoCom to


2

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SANTANDER, the rich world’s fourthbiggest bank by market value, is a bea

con of hope and a source of despair forother �rms. Having started as a small regional bank, it pulled itself up by its bootstraps to become a big player in LatinAmerica (as well as in Britain). Yet copyingits strategy has become far harder now thatmost big emerging markets are in e�ectclosed to large takeovers by foreign �rms.Although the Spanish bank is dipping a toeinto Asia, for example through a cooperation agreement with China Construction

Bank, Santander’s boss, Mr Sáenz, is mildlyconcerned about the industry’s presentfrenzy to expand there. The region, he says,is �closed and expensive�.

Santander’s strategy is to build a deepretail presence with a large market share. Agood example of how this works is Brazil.By assets Santander has a market share of9% there, big enough to compete headonwith the big boys (see chart 9, next page).The network banks are one level belowthis: HSBC has a 3% share and Citigroup 1%.The investment banks are another step

down. Credit Suisse, which has a relativelybig Brazilian operation, having bought a local �rm, Garantia, in 1988, accounts foronly 0.6% of the �nancial system’s assets.Santander’s business is heavily skewed towards lending to individuals and smallbusinesses rather than to big �rms.

The same is true of the other �gone native� banks. BBVA has a market share ofabout a quarter in Mexico. In eastern Europe Italian and Austrian banks have pursued a similar strategy. UniCredit, for example, is a massmarket bank in Poland,

Breaking and entering

Why it is hard to copy Santander

40% if regulators approve, but it is far fromclear that they would. Mr Geoghegan saysthat HSBC has �chips on a number of different opportunities� in China and hadnever assumed that it might be able to gaincontrol of a Chinese bank. Bank of Communications is currently raising capital,and HSBC is planning a Shanghai listingthat could raise, say, $5 billion. Whateverthe sum, say Mr Geoghegan, �the moneywill stay in China.�

The time of SandsBoth Citigroup and HSBC have tilted awayfrom the rich world but their direction�consumer or corporate, China or the entireemerging world�remains in the balance.StanChart, for its part, has pushed the network model towards investment banking.Its success in Asia over the past three yearsraises big questions for the bulgebracket�rms. Mr Sands argues that the old paradigm�foreign banks with products andglobal reach on one side, local banks thathave cosy relations with customers andregulators on the other�is no longer valid.A successful bank needs to have all ofthose things now. The importance of a local deposit base has also grown, partly forregulatory reasons and partly because customers want banks that can lend to them.Richard Meddings, StanChart’s �nance director, says the base of branches hascreated a �very rare and advantaged business model�. All this has made the bank aperennial takeover target.

The reincarnation carries some dangers. The bank argues that on most measures, for example the extent to which itsloan book is backed by collateral, it has cut

risk over the past decade. It does, though,have some tricky positions, such as $10 billion of exposure to the United Arab Emirates. Trading on its own account reachedan uncomfortably high 30% of the wholesale unit’s revenue in the �rst half of lastyear. Yet the main warning light �ashingfrom StanChart may be a signal to investment banks, against which it increasinglycompetes. They typically generate only1020% of their business from outside therich world. Today most have a soft targetfor this to double within half a decade orso. The idea is to specialise in activities likeequityraising, derivatives and deal advice.Brady Dougan, the boss of Credit Suisse,reckons it is tough to compete on lending.He says that customers �compartmentalise�, expecting credit to come from localbanks and more sophisticated needs beingmet by global �rms. Kalpana Morparia,JPMorgan’s feisty boss in India, says that�we can’t be a mainstream� commercialbank in India, and that success is about�nding a niche.

But that may not be easy. There will begrowing competition not only from thenetwork banks but from local lenders too.Ms Kochhar at ICICI says that the bankrode the wave of consumer lending in India but that the next wave will be bankingfor companies. �Global banks are verycompetitive here,� says Mr Abreu of Brazil’s Bradesco, �but we have space to gainmarket share.� At BTG Pactual, the big Brazilian investment bank, which was ownedby UBS from 2006 to 2009, Mr Arida saysthe �ambivalent commitment� of foreigninvestment banks to the country has beentheir downfall. Unless this changes, he pre

dicts, the business will over time �bedominated by locals�.

Domestic bond and equity marketsshould grow quickly, with more securitiessold to local investors. Today the big Western investment banks dominate the leaguetables in most categories in places likeAsia. This is an o�shore business, concentrated in a few �nance centres. None has adecent grip on China’s local Ashare market, and in localcurrency bond and loan issuance in Asia the only foreigners that get alookin are the network banks.

Some investment banks have backtracked. During the crisis UBS foolishlysold Pactual. The best �rms are trying tostrengthen their local roots. Mr Dougan atCredit Suisse says he wants its emergingmarket units to liaise with each other directly, rather than act as satellites of headquarters, and looks to its private bank tohelp establish strong links with local business people. Gary Cohn, the Clevelandraised chief operating o�cer of GoldmanSachs, notes that a couple of layers downfrom the top his �rm’s demography haschanged and within a generation its topbrass will be less clearly Western.

Less clearly Western is what most richworld banks these days would like theirpro�tandloss accounts to look like, but itis not clear how they can achieve that. Network banking is not an option becausethey lack the historical connections. Theriskier business of investment banking,hard enough in rich countries, may soonget much more crowded in developingcountries too. And the strategy of �goingnative� no longer looks possible either, asthe next article will show. 7


2

1

Bulgaria and Croatia, where it has sharesof over 10% by assets. These banks arguethat being big in particular countries ismore pro�table than being widely spreadin the manner of the network banks. RonitGhose, an analyst at Citigroup, has benchmarked HSBC against local peers in its keyregions and concluded that, outside HongKong, it typically has a worse costincomeratio and return on assets, whereas Santander with its higher market shares in LatinAmerica and Britain does better than thelocals.

Establishing such positions of strengthin depth takes time. Santander made its�rst round of acquisitions in Brazil in 1997and its �rst gamechanging one, of BancoBanespa from the Brazilian government, in2000. Its buildup culminated in its purchase of ABN’s Brazilian unit in 2007. Noris it for the fainthearted. BBVA bought intoBrazil in 1998, but by 2003 it had concludedthat it was unable to achieve critical massand sold out to Bradesco. These days eventhe willing and able simply cannot �ndmuch to buy, because most developingcountries will sell big banks to foreignersonly from positions of weakness.

In the late 1990s and early 2000s Brazilwent through a period when it needed foreign capital, investors were still skittishand there was a political commitment toprivatisation. In Mexico the governmentnationalised the banking system in the1980s and refused to allow foreign �rms to

buy control when it privatised the systemin the early 1990s. The opportunity for foreign banks came after the devastating pesocrisis of 199495 which eventually causedthe rules to be relaxed. That led to BBVA’sacquisition of Bancomer (200002), Santander’s of Ser�n (2000), Citigroup’s of Banamex (2001) and HSBC’s of Bital (2002).

Something similar happened in SouthKorea. Citigroup and Standard Charteredbought their banks from privateequityfunds that had picked up controlling stakesin 1999 and 2000 from the wreckage left by

the Asian crisis. And in eastern Europe,where Austrian and Italian banks havecleaned up over the past decade, most ofthe original stakes were taken as cashstrapped governments auctioned banksafter the fall of communism. FedericoGhizzoni, who runs UniCredit’s centraland eastern European business, says themajority of its businesses were acquiredthrough privatisations.

Slim pickingsAre there equivalent opportunities forWestern banks today? Mike Smith, chiefexecutive of Australia’s ANZ and an Asiaveteran, says that in some countries in theregion smaller familycontrolled banksmay be up for sale as capital requirementsbecome more onerous. ANZ is also rumoured to be eyeing a bank in South Koreaowned by a privateequity fund. But thebiggest emerging markets, China, Indiaand Russia, are statedominated and no bigbanks are likely to come on the block.

Santander, �nding much of the emerging world outside Latin America closed toit, has shifted its strategy. It has expandedthrough the crisis in Britain, buying bitsand pieces (and bidding for some of thebranches Royal Bank of Scotland is selling)to add to the base it acquired with Abbeyin 2004, gradually building up marketshare�much as it did in Brazil. Mr Sáenzsays the bank has �faith in a business model more than a geography�, adding that�it’s more likely that in the near future wewill invest in more mature economies.�

That could include eastern Europe,which has changed from emergingmarketdarling to villain. Instead of the bullish stories three years ago, when the penetrationof banking services was expected to rise towestern European levels, there is nowdeep pessimism about the region’s adverse demographic pro�le and its lack of asaving culture. Poland is Santander’s kindof market, though: biggish and with distressed sellers. Allied Irish Bank, havingbeen bailed out by its government, is auctioning o� its operation there, which has a5% market share.

Other western European �rms active ineastern Europe su�ered during the crisisand are scaling back, for example KBC andDexia. The healthy banks are staying putand remain optimistic. Société Générale isreorganising its interests in Russia and willget a majority stake in what will becomethe �fthbiggest �rm by loans. It says it isconvinced of the longterm potential. UniCredit’s Mr Ghizzoni says the �process ofconvergence will continue�.

9Spot the foreigners

Source: Banco Central do Brasil

Brazilian banks’ assets, 2009, % of total

0 5 10 15 20

Banco do Brasil

Itaú Unibanco

Bradesco

BNDES

CEF

Santander

HSBC

Votorantim

Safra

Citibank

Banrisul

BTG Pactual

Credit Suisse

Deutsche Bank


2

CHINA’S big banks each �have almostmore branches than we have em

ployees�, says one Western bank boss. Heis only half joking. The big two have over15,000 branches each. Only a few hundred are owned by foreign �rms, whichon the mainland have a feeble marketshare of 2% of total assets. And althoughmany Western banks have been allowedto take passive minority stakes in Chinese�nancial �rms, being given permission tobuild up a biggish branch network is aprivilege granted to the very few.

Only four �rms have any scale, andthey have been in China for a century. Atthe end of 2009 HSBC had 99 branches, aswell as a further 38 through Hang SengBank, a subsidiary that is separately listedand run at arm’s length. Bank of East Asia,run by Sir David Li Kwokpo, whosegrandfather traded rice and silk in the late19th century, had 76 branches and Standard Chartered 54. Citigroup, with 29branches, is the only �rm on the list thatdoes not have lots of branches in HongKong, but at least it was exporting silverfrom San Francisco to Guangzhou in 1904.Sir David says, with wry understatement,that the Chinese authorities �look at thehistorical position of a bank�.

By virtue of its size, China is the �holygrail� of banking, says Jonathan Larsen,

who runs Citi’s consumer business inAsia. But all of these �rms are subject torestrictions on their branch expansion,loantodeposit ratios and localcurrencybusiness. Bank of East Asia’s loan book ismade up mainly of loans to Hong Kongcompanies that are active on the mainland. Getting large amounts of businessfrom stateowned Chinese �rms is moredi�cult. Mr Larsen reckons China mightfollow Singapore’s model of development, gradually opening up corporatebanking to outside competition �rst andretail banking later.

Some argue that ultimately China islikely to cede only about 15% of the marketto Western banks, but even such a comparatively modest share could make ahuge di�erence if it were concentratedamong a handful of �rms. HSBC made apretax pro�t of just $111m from its fullyowned operations in China in 2009, butbullish analysts reckon that could rise toover $1 billion within a few years. MrGeoghegan, its chief executive, says China �will remember for a very long time�that some banks, including UBS and Bankof America, sold part or all of their stakesin Chinese �rms during the �nancial crisis. What about the long tail of other �rmskeen to grow in China? Sir David grins:�Good luck.�

To do well in China, Western banks need a long history

Old friends only

Mr Sáenz believes that when countriesinvite in big banks from overseas it �putslots of pressure on the competition�, forcing it to raise its game and allowing economic development to move at a fasterpace. Partly because of that, he thinks thatin the longer term countries such as Indiaand China might open up somewhat. �Do Ithink this will be the situation for the next20 years? I believe something will happento these economies that will make themchange their mind.� He points to Mexico’ssudden opening up in the 1990s. �My experience is never say that it is closed for ever.Things can change a lot.�

Time is what we don’t haveBut taking the long view is a luxury thatless successful banks cannot a�ord. Waiting for India and China to fall to their kneesis hardly a strategy. That leaves thosebanks with few choices. One is to buildbranches rather than buy a bank, whichmight work in some places. Standard Bank,its South African rival FirstRand and someof Nigeria’s healthy banks are expandingtheir networks across the rest of Africa,where there is little competition.

It might also work for banks with privileged access, for example in China (seebox). ANZ is building a bigger presence inAsia, having been ambivalent towards theregion for years. Its boss, Mr Smith, explains that Australian businesses are nowfar more integrated with Asia and that thiscustomer base gives ANZ an edge to expand its business abroad. Still, in mostmarkets local bank bosses are pretty sceptical about Western �rms building Romebranch by branch. �I don’t think they willbe major players� is about the politestcomment your correspondent heard.

There is a traditional last resort, used,among others, by Japanese banks in California in the 1980s and more recently by

desperadoes in eastern Europe. The formula is to set up a few branches, or pay astronomical prices to buy them, then use funding from your parent or from wholesalecredit markets to lend through them. Bysome estimates half of foreign banks’loans in central and eastern Europe camefrom such sources. But regulators are cracking down. The new Basel 3 rules will penalise banks with too much wholesale orcrossborder borrowing, and with goodreason. A recent IMF brie�ng contrastedthe sharp slowdown in foreignbank lending in emerging Europe with the muchmore stable picture in Latin America (seechart 10), where foreign banks typicallyhave bigger branch networks. It concludedthat �foreignbank lending funded by domestic deposits and denominated in localcurrency is likely to be more resistant to ex

ternal �nancial shocks.� The days of building up a big loan book without botheringabout deposits or branches may be over.As Mr Ghizzoni puts it: �Some banks hadan opportunistic approach. It’s a game thatis at the end.�

So what are traditional banks in Europeand America to do if they want to expandabroad? They face stagnant home markets.They cannot replicate the presence of�rms such as Citigroup or HSBC. Theyhave no opportunity to buy dominant positions in attractive geographic markets, asSantander did, and no tradition of competing in sophisticated niches such as investment banking. Even the cheapskate strategy of buying a paperthin presence isbeing closed o�. Their only consolation isthat emergingmarket banks face the samedilemmas as they venture abroad. 7

Asia Pacific

Africa &Middle East

10Two takes on the crisis

Source: IMF

Foreign bank lending, % change on a year earlier

Q1 Q2 Q3 Q4

2006Q1 Q2 Q3 Q4

07Q1 Q2 Q3 Q4

08Q1 Q2

09

20

0

20

40

60

+

–

EmergingEurope

Latin America& Caribbean


1

FROM the rubble of Western banking it iseasy to conclude that emergingmarket

banks are already big, getting bigger, andare coming to get us. Most emergingmarket banks do have a sense that they are destined for great things. Mr Kamath at ICICI

speaks for many when he says that in themedium term �we will see a clutch of Indian banks among the top 15 banks in theworld.� Chinese and Brazilian �rms are already there and Russia’s biggest bank is notfar o�. For all their scale and ambition,however, emergingmarket banks mostlystill derive only a tiny share of their pro�tsfrom their foreign operations (see chart 11).How quickly might that change?

Seen from the hot seat of an emergingmarket bank, the world is a dangerousplace. Western �nance faces an onslaughtof regulation and is likely to stagnate. Thefew investments that emerging countrieshave made in Western �nancial �rms havetended to turn out badly�think of ChinaInvestment Corporation’s decision to putmoney into Blackstone’s bubbleera �otation, or Ping An Insurance’s stake in Fortis,which it was forced to write down after theBelgian bank failed. Those who declinedinvitations to bail out Western �rms wereproved right. �I did think I might do a bigacquisition,� says Mr Bhatt of the time

when he took over as chairman of StateBank of India in 2006. �Then the sky fellin.� He says he has had �a lot of o�ers but Ihave not taken them�.

An emergingmarket bank boss alsohas huge demands placed on him at home:to supply credit, to �nd capital and to survive the political jungle. And there are thelessons learnt since banking started to goglobal in the 1970s: the mediocre performance of American commercial banksoverseas, the Japanese �asco, multiple horror stories of commercial banks buying investment banks, and, as the boom peaked,a ruinous hostile acquisition in the form ofthe RBSled takeover of ABN AMRO. Mostemergingmarket banks have plenty of humility. Mr Guo of China ConstructionBank says that in rich countries �we cannotcompete with local banks� for local corporate and retail business.

Instead most banks in the developingworld are establishing a �string of pearls�abroad to service domestic customers asthey expand internationally. At its most basic level this involves setting up branches.Often this expansion is aimed at otheremerging economies, not just Western �nancial centres. Sberbank is opening abranch in Delhi and Itaú has a presence inShanghai and Dubai as well as the usual

o�ces in London and New York. In Indiathe local banks �nd it hard to compete oncrossborder deals these days. In BhartiAirtel’s recent $9 billion acquisition the African assets of Zain, a Gulfbased mobiletelecoms �rm, Standard Chartered andBarclays led a syndicate of �nancing banksthat included only one local �rm, StateBank of India. This is something the localshope to change. ICICI’s Ms Kochhar saysher bank wants to set up an infrastructureabroad to service Indian �rms. Mr Bhatt

All the world’s a stage

But emergingmarket banks are still treading cautiously abroad

11Homebodies

Source: Companyreports

*Based on pre-tax profit †Or latest‡Based on net income §Based on

revenue **Based on loans

Foreign business as % of total*, 2009†

0 5 10 15 20 25

Standard Bank‡

Bank of China

VTB Bank§

ICICI Bank§

Bradesco

Banco do Brasil**

State Bank of India§

ICBC

Itaú Unibanco

CCB

Sberbank

HDFC Bank§ nil


2

1

TO UNDERSTAND where StandardBank is today, says its boss, Jacko Ma

ree, you have to go back to South Africa inearly 1987, when Standard Chartered, itsoriginal parent, sold out completely. MostSouth African �rms were not welcome inthe rest of Africa, he says, and �it wasn’tentirely obvious� that Standard Bank’spriority should be there or indeed inemerging markets at all. When South Africa moved to majority rule in the 1990s,plenty of South African �rms shifted theirdomicile to London and tried to diversifyinto developed markets, but StandardBank stuck to its guns. Something of thisdetermination is re�ected in its choice tokeep its headquarters in downtown Johannesburg even though most �nancial�rms moved to Sandton, a safe but dullsuburb where adventure is a bar namedthe Bull Run.

Mr Maree, at the cuddly end of thespectrum of South African bankers, hasbeen pretty astute. He became chief executive in 1999 after a failed takeover bid forhis bank, which he says �was a big kick upthe backside�. That meant making moreof its main activities abroad: an Africanpresence built from branches bought fromAustralia’s ANZ in 1992; an investmentbanking unit in London (originally putthere because of foreignexchange controls in South Africa); and small operations elsewhere, including Russia, wherenaturalresources banking, an obvious

specialism for African �rms, is important.The result has been solid, with com

pound annual growth in pro�ts per shareof 8% since 2003 and only a small dent inearnings from the �nancial crisis. In 2009almost a quarter of pro�ts came fromabroad, either the rest of Africa or indirectly linked to the continent�for example,currency trades executed in London.

South Africa has had two lendingbooms since the end of apartheid. The�rst was driven by the opening of theeconomy to foreign capital, the second bylending to the rising black elite over thepast decade. As a market it is fairly mature.But Africa as a whole is set for a �tectonicshift�, says Goolam Ballim, StandardBank’s chief economist. The proportion ofAfrica’s trade with China, Brazil, India andRussia rose from 5% in 1993 to 19% in 2008.Much of this, inevitably, is in resources,but governments are getting better at saving the proceeds of the good times for theless good ones, reckons Mr Ballim.

Old Africa hands who used to roll theireyes at this kind of analysis got a surprisein 2007 when ICBC, now the world’s largest bank, spent $5.5 billion on a 20% stakein Standard Bank in what was then China’s largest ever corporate foreign investment. Mr Maree and Mr Jiang, ICBC’schairman, stitched the deal together afterspending a day in Cape Town together.There is still a wow factor about it, says MrMaree. Although the revenues generated

from working with ICBC are modest�some $78m in 2009�cooperation is beingstepped up. Standard Bank has 30 bankersin Beijing now, as well as a main board director in an o�ce close to ICBC’s, whohelp clients of the Chinese bank interested in expanding in Africa.

For China’s banks the deal is a test caseof whether �treading softly� overseas willwork. The combination ticks every box,bringing a presence in key markets forChinese clients and exposure to a sophisticated foreign �rm with skills in areas likeinvestment banking and foreigncurrencyfunding. Yet ICBC has limited in�uencewith Standard Bank, with only a couple ofdirectors on its board. A full takeoverlooks unlikely. ICBC would need permission from Standard Bank’s board to buymore shares, and South Africa’s government would probably not approve.

For Standard Bank the merits of thedeal are clear: more capital, and kudos, tobuild a bigger presence in Africa and elsewhere. It is mulling buying a bank in Nigeria (where the government is opening upmore to foreigners). And it is eyeing India,which Mr Maree says is �the missing link�,given that Standard Bank already has anoperation in Brazil and a stake in a Russianinvestment bank, Troika Dialog. WithStandard Bank’s complex history and relatively isolated position, explains Mr Maree, �we’ve had to think in a much moreoutofthebox way.�

Standard Bank reaps the bene�tof bold thinkingA door to Africa

notes that India’s banks need to expandwith their corporate customers, or �sooneror later you will be irrelevant.�

Forming alliances with local �rms isone way of strengthening a string ofpearls. In South Africa FirstRand has a pactwith China Construction Bank. Sizwe Nxasana, FirstRand’s chief executive, says hisbank was working with them on a numberof ad hoc transactions, so a formal agreement �became a very natural step�. In onecase this has blossomed into an even closer relationship, with China’s ICBC taking astake in Standard Bank (see box). Emergingmarket banks hope that such cooperation will hone their skills. One consultantwho has led workshops for Chinese bank

ers in international corporate banking saysthey soak up knowledge �like a sponge�.

A complementary strategy is to provide�diaspora banking�. Emergingmarketbanks have a competitive advantageamong compatriots who live in Westerncountries. ICICI, for example, has small retail operations in Britain and Canada, andBanco do Brasil plans to open 15 newbranches in America to target Braziliansliving there. The deposits these operationsgather are also handy as a foreign fundingbase. Still, even diaspora banking is notriskfree. In 2007 China Minsheng Bankbought a 10% stake in UCBH Holdings, aSan Franciscobased bank that served ChineseAmericans. The bank failed and Min

sheng wrote o� its investment. Its chairman recently said: �We’d like to focus onmatters at home now.�

Yet the rules of banking overseas do notchange just because a �rm comes from adeveloping country. Stringofpearls strategies do not have a great track record. Theexperience of the Western network banks,most notably ABN, is that relying on expatriate customers to cover your costs doesnot work. In 1959 First National City Bank(Citigroup’s predecessor �rm) was aiming,in the words of one executive, to put abranch into �every commercially important country in the world�. Yet by the late1960s the strategy had run into trouble.John Reed, who eventually became head


2

1

BANKERS in many rich countries failedtwo tests over the past decade. The �rst

was the test of the marketplace, which exposed many banks that proved unable tocommand the con�dence of their investors and counterparties or even to make apro�t during a downturn. In the end theyrequired government help to fund themselves and get hold of capital.

The bigger test was that of being �socially useful�, in which the whole systemgot poor grades. Too much energy was putinto speculation and complexity. Ratherthan being a source of stability, banks intensi�ed the economic cycle, with �rmsshowing little discipline during the boomand no humility afterwards.

Compared with their Western peers,emergingmarket banks are mostly A

grade pupils. As businesses they are ingood fettle, partly because of their youthand their natural advantages. They haveplenty of funds because the societies theyoperate in have high saving rates. Theirpro�ts are stable, not least because theircapital markets are small and volatile investment banking is not a big business yet.Yet much of their success re�ects goodmanagement and good regulation. Supervisors learnt from the many crises inemerging markets over the years and madesure that banks had decent capital ratiosand plenty of liquid assets. These �rmstend to keep a good balance between oldfashioned banking values and innovationin customer products and technology.

On the wider test of performing a useful economic role, emergingmarket banks

have come out of the crisis well. Most ofthem genuinely believe in the importanceof providing more people with access to �nancial services. The banking system as awhole continued to extend credit throughout the crisis. Statecontrolled banks didthe heavy lifting, lending freely through2008 and 2009, but private �rms too performed reasonably well, whereas someWestern �rms in emerging markets provedunreliable, cutting credit or even shuttingdown or selling out.

This special report has argued that theexperience of emergingmarket banks willhave a lasting impact. A fairly traditionalbanking business model has worked. Thatmeans Western �rms without big local deposit bases and serious intentions to growdeep local roots will be less welcome. The

Cross your �ngers

Emergingmarket banks have done remarkably well, but they need all the luck they can get

of Citi, once said of its overseas branchesthat they �didn’t really know how muchthey earned�. The network banks eventually succeeded because they widenedtheir customer base to include locals aswell as expatriates.

There are sceptics even among banks indeveloping markets. Aditya Puri of HDFC

Bank doubts that the number of Indian�rms going abroad is big enough yet tomake it worth following them: �We willmove when we see a migration of ducksrather than just a single swallow.� He is ofthe Santander school of overseas expansion: �Unless you are a big player in a market, it is not of much use.� At Santander itself Mr Sáenz says he is not planning toexpand his network abroad to service Brazilian corporate clients there. That is asmall part of the pro�t pool in Brazil, hesays. �It is not our core business at all.�

Two ways inThe spreading of emergingmarket banks’branches across the world is simply acatchingup process that in itself has littlesigni�cance. After all, even thirdrate European banks have o�ces in New York andHong Kong. In the longer term there aretwo possible approaches that could provemore important.

One is to try to �nd a competitive advantage. For India’s banks this could betheir lowcost technology��the edge�, as

Mr Kamath puts it. A big test of this will beState Bank of India’s expansion in retailbanking in Singapore. Mr Bhatt says thebank is catering to the whole population,not just Indians, and will keep the back of�ce in lowcost India. Many bankers inMumbai speculate that this might producea new twist on Western �rms outsourcingto India: Indian banks will buy richcountry banks to get a shop front, then move theback o�ce to India. Brazil’s banks, meanwhile, are betting on investment banking.Bradesco’s Mr Abreu says: �Brazil is stillwhere we have the best opportunities. Butwhat we are really focusing on abroad is toexpand our investment bank.�

The other possibility is to make acquisitions. There are very few, if any, examplesof Western banks building a big presenceabroad branch by branch. The way allcommercial banks, even the networkbanks, went global is through deals. But acquisitions in banking are harder than inmost industries. The politics are controversial. The �nancial risks are high because ofleverage. And because banks have nophysical plant beyond their branches, theirvalue rests in their sta�, who might wander o�. To do this well, you need practice.

China’s banks have been practising intheir �near abroad�. ICBC has boughtsmall banks in Indonesia, Thailand andMacau. China Construction Bank has acquired bits of Bank of America and Ameri

can International Group in Hong Kong.These are small deals by value but, saysCCB’s Mr Guo, �very signi�cant� becausethey will help improve the bank’s capabilities. Sberbank has bought small operations in Belarus, Ukraine and Kazakhstan.Banco do Brasil has just bought a controlling stake in a midsize Argentine bank,and Itaú already has a presence in neighbouring countries. Even Bradesco, less expansive by instinct, recently bought asmall bank in Mexico. Mr Abreu says it is avery cautious �rst step.

Will such �rst steps lead to greater leapsabroad? Certainly stories of giant dealsmake the rounds: your correspondentheard a yarn about a Chinese bank boarddiscussing whether to bid for MerrillLynch. And if the crisis had turned out differently, some emergingmarket banksmight have taken the plunge. During itsdarkest hours Citigroup considered sellingBanamex, Mexico’s secondbiggest bank.Had it done so, the new owner might havebeen one of Brazil’s banks.

Yet the expansion of emergingmarketbanks into the rest of the world dependson two things. One is that they grow evenbigger and accumulate more capital andmore skills. This seems all but inevitable.The second condition is that the globalisation of banking, a trend that has governedthe industry for two decades, continues.And that is far from certain. 7


2

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few American and European �rms that already have solid emergingmarket businesses have been very fortunate, and thereis little chance that others will be able toreplicate their model.

It also means that a mixed banking sector�with stateowned and private �rms, aswell as some foreign ones�will stay inplace. This balance is now seen as a goodthing in its own right rather than just astage on the road to full market ownership.Big privatisation programmes are not onthe cards. That will make it hard for Western �rms without emergingmarkets exposure to get established.

Big and getting even bigger, well runand well regulated: the emergingmarketbanks seem to have a lot going for them. Atthe same time their Western peers aredazed, under attack and shrinking. Yet forall their success, emergingmarket banksface two big challenges.

The ifs and butsThe �rst is coping with exceptionally rapidgrowth without blowing up. The absolutevolume of loans many banks are adding ina year now is often bigger than the entirebank was a decade ago. Growing at a rateof 20% a year will impose colossal pressures on everything from sta�ng levels torisk control. And to sustain it, these �rmswill have to plunge headlong into productsthey know little about, such as mortgages.Yet if their economies keep roaring ahead,the stodgy business of lending to companies will su�er as alternative means of �nance for businesses open up. Emerging

market banks say this activity is not verypro�table anyway, but they are bound tomiss it if it goes.

The second challenge is the greater involvement of the state in the past fewyears. Although this has served emergingeconomies well, it brings its own problems. There is ample historical evidencethat government control over banks’ lending can breed cronyism and misallocationof funds. China will be a test case after itsbig lending spree of the past 18 months. Atleast in other developing countries thegovernment’s role in bank lending hasbeen much less overt. Still, statecontrolledbanks, which hold the majority of assets inthe �nancial system in China, Russia and

India and over 40% in Brazil, will have tojuggle their dual personalities as independent agents (often with minority stockmarket listings) and public servants.

Most emergingmarket banks are pursuing a cautious stringofpearls strategyabroad, but the lesson from Western banksis that this is a quick way to lose money. Tosucceed in expanding abroad, banks needscale and a local deposit and customerbase. New regulations will make this evenmore important.

As emergingmarket banks begin toconsider bigger acquisitions, they will �ndthat being statecontrolled will be a seriousdisadvantage. This is partly because banking in the rich world has become more politicised. But it is also because the conservative culture of many state banks is illsuitedto foreign takeovers, and because manycustomers would prefer to deal with a privately owned bank. That means India’sand Brazil’s private banks, although smaller than China’s, may have an easier timeexpanding abroad.

Emergingmarket banks are not aboutto take over the world. They have far toomuch to do at home: double the size oftheir business every �ve years or so, avoidbad debts, �nd more capital, cope with rapidly shifting patterns of corporate lending,bring banking to millions of poor peopleand deal with the politicians. Can theyreally do all this? Most have already performed miracles over the past few decades, from surviving political earthquakes to coping with hyperin�ation, andprospered throughout a crisis that felledWestern banks. But if the strength ofemergingmarket banks today is impressive, the task they face is also huge. 7

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