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China Crossroads:Competitive Prioritiesfor Chinese Banks September 2002

THE BOSTON CONSULTING GROUP

China Crossroads: Competitive Priorities for Chinese Banks1

China Crossroads: Competitive Priorities for Chinese Banks

The Boston Consulting Group is a generalmanagement consulting firm that is a globalleader in business strategy. BCG has helpedcompanies in every major industry andmarket achieve a competitive advantage bydeveloping and implementing uniquestrategies. Founded in 1963, the firm nowoperates 54 offices in 34 countries. Forfurther information, please visit our Web siteat www.bcg.com.

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Copyright 2002 by The Boston Consulting Group, Inc.All rights reserved. Published in September 2002.Report designed by BCG Greater China marketing team.

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Hong KongThe Boston Consulting Group International, GmbH34th Floor, Shell TowerTimes Square, Causeway BayHong Kong, CHINATelephone: 852-2506-2111Facsimile: 852-2506-9084E - m a i l : [email protected]

ShanghaiBoston Consulting (Shanghai) Company Ltd.21st Floor, Central Plaza227, Huangpi Bei LuShanghai, 200003 CHINATelephone: 86-21-6375-8618Facsimile: 86-21-6375-8628E - m a i l : [email protected]

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Preface

Executive Summary

1. Where Is China’s Banking Industry Today?1.1 Reforms underway: shift occurring to market-driven environment

1.2 Market is large but still in a nascent and emerging phase

1.3 Three key challenges facing the industry

1.4 Banking industry is at a major crossroads today

2. What Competitive Scenarios Are Likely To Play Out?2.1 Landscapes - defined by geography and product

2.2 Five possible competitive scenarios

2.3 Inferences for China and the banks

2.4 What should the banks do now?

3. What Are The Priorities For Chinese Banks To Compete?3.1 Priority #1 : Strengthen organization and corporate governance

3.2 Priority #2 : Develop a segmented service capability

3.3 Priority #3 : Build a strong risk management framework and culture

3.4 Priority #4 : Maximize operational efficiency

3.5 Priority #5 : Use partnerships for competitive advantage

4. How Should Banks Begin To Create Winning Game Plans?4.1 The importance of strategic planning

4.2 Key strategic planning challenges in China

5. What Are The Key Implications For Management?

6. Conclusions

CONTENTS

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Preface

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Giles BrennandVice President and DirectorThe Boston Consulting Group34th Floor, Shell TowerTimes Square, Causeway BayHong Kong, CHINATel:852-2917-8236Fax:852-2506-9084E-mail: [email protected]

Tjun TangManagerThe Boston Consulting Group21st Floor, Central Plaza227, Huangpi Bei LuShanghai, 200003 CHINATel:8621-6375-8618Fax:8621-6375-8628E-mail: [email protected]

China’s accession to the World Trade Organization (WTO)marked a new era in the global economy. For the first timeafter more than forty years in a controlled market, Chinatook the step towards fully opening its doors to foreigntrade partners. Step by step, these partners will establishtheir bases in China, enjoying equal access to one of thebiggest and fastest growing economies in the world.

This is both good and bad news for the Chinese banks.On the one hand, this market stimulus will intensifyeconomic growth, opening more opportunities for them.On the other hand, the Chinese banking industry haslimited internal capabilities and is still heavily burdenedby massive non-performing loans. Foreign competitionis hardly welcomed.

With the market transforming, fierce competition looming,and significant opportunities ahead, China’s bankingindustry is at a crossroads of change. Standing still is notan option as institutions confront both the onslaught ofnew competitors and the equally daunting challenge offinding the right direction for themselves.

This paper discusses the uncertainties facing the Chinesebanking industry and identifies some strategic prioritiesthat banks must address. Although the paper’s primaryaudience is the senior management of Chinese banks, the

insights may be equally enlightening to foreign bankingexecutives who contemplate entering the Chinese market.Drawing on experience from other markets that haveundergone sweeping banking reforms, the paper will alsoexplore five plausible competitive scenarios in China.Banking players are urged to monitor regulatory directionsand market forces closely to gain early insight into thechanging landscape and to set their priorities.

The paper is based on The Boston Consulting Group’s(BCG) broad experience in advising banking clients inChina and globally, supplemented by publicly availableinformation. Special thanks go to the project team, ledby Sean Jiam, and to many BCG colleagues who developedmuch of the thinking in this report. They include MinCao, Jie Feng, Joseph Kwok, Sin Beng Ong, Connie Yu,Simon Yuen, and Vivian Zheng. We would also like tothank the BCG officers who contributed their insights:Thomas Achhorner, David Gilmour, Jim Hemerling, DavidMichael, Roman Scott, Peter Wetenhall, and John Wong.

“China Crossroads: Competitive Priorities for ChineseBanks” provides an in-depth look at the Chinese bankingindustry at a momentous time in its evolution. Wewelcome your feedback and encourage you to contactus.

China Crossroads: Competitive Priorities for Chinese Banks5

Executive Summary

Far-reaching reforms have rippled through the competitivelandscape of China’s banking industry. The country’sentry into the WTO will likely catalyze further change.Chinese banks need to re-evaluate their business models,set clear strategic agendas for the future, and strengthentheir internal capabilities in order to survive in a newcompetitive order.

Set against this context, the goal of this paper is to setout plausible scenarios for future competition, and todefine the keys to success. The paper also seeks to providea prescriptive strategic agenda for senior Chinese bankingexecutives so that they might better identify and developthe capabilities they will need. Obviously, the prescriptionmust be tailored to the specific aspirations, heritage andcondition of each institution.

* * *

China’s financial regulators, over the past two decades,have set in motion a series of market-oriented reformsthat have edged the banks closer to true competition.The country’s entry into the WTO will further lowerbarriers into its banking markets. Foreign institutions arealready poised to enter, attracted by strong growthpossibilities. Some Chinese banks are also raising thecompetitive bar, having learned from internationalpractices and the disciplines of free markets.

What remains unclear is the timing and pace of reforms,which makes it difficult to forecast the future shape of thefinancial services industry with any certainty. However,based on developments in other markets around the world,several scenarios can be identified for how the competitivelandscape might evolve.

Five Scenarios For Future Competition

Banking markets can be described along two dimensions:

product scope and geographic reach. Within thesedimensions exist five competitive structures that warrantanalysis for a better understanding of China’s futurebanking landscape.

Specialists Rule: Market specialization acrossproductsEra of the Warlords: Geographic fragmentationBlossom of a Hundred Flowers: Market specializationand geographic fragmentationAny Model That Works: Selective market specializationand fragmentationWar of the Giants: National universal banking

Clearly, it will take several years for the new landscape toform and stabilize. In the meantime, Chinese banks mustarm themselves with the capabilities to competeregardless of how it actually takes shape.

Key Priorities for Chinese Banks

BCG recommends that Chinese banks focus on fivepriorities to strengthen their competitive capabilities:

Priority #1:Strengthen organization and corporategovernance

Priority #2:Develop a segmented service capabilityPriority #3:Build a strong risk management

framework and culturePriority #4:Maximize operational efficiencyPriority #5:Use partnerships for competitive

advantage

Key Success Factors For Implementation

BCG suggests six principal factors for successfulimplementation of these initiatives:

A. Develop a compelling vision for action


B. Have visible, committed leadership willing to tackletough issues

C. Use rigorous project management techniquesD. Actively obtain the support of key stakeholdersE. Fill gaps in capabilities and cultureF. Put in place the right support infrastructure

Preparing For The Road Ahead

Over the past few years, Chinese banks have successfullynavigated a difficult environment. However, theroadblocks will now be larger and the stakes higher. Thereare three practical steps that the banks can take to preparefor the future:

1. Make sure the entire senior management teamrealizes the imminent challenges ahead, and feelsthe urgency to acquire the capabilities needed todeal with them

2. Develop a realistic plan to move beyond thecrossroads

3. Pursue implementation of the plan with appropriatevigor and flexibility

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1. Where Is China’s BankingIndustry Today?

China today is one of the largest banking markets in theworld. Total bank assets amounted to US$1.9 trillion in2001, comparable to advanced markets such as the UnitedKingdom, Germany, and France. Assets have beengrowing at an annual compounded rate of some 15% forthe past five years. The level of bank assets relative togross domestic product (GDP), at over 160%, is alsoamong the highest in the world. Sustained growth andthe long-term potential of the Chinese market, set againsta stagnant global economy, is attracting many foreignbanks.

The rapid growth of the Chinese banking sector over thelast decade has been assisted by a relatively stablemacroeconomic environment and Chinese households’high propensity to save. The high degree of bankintermediation also reflects the relative underdevelopmentof Non-Bank Financial Institutions (NBFIs) and thesecurities market in China. While large, China’s bankingsystem suffers from a large overhang of non-performingassets, conservatively estimated at 25% or more of totalloans. Still, despite mounting internal problems, theChinese banking industry is expected to grow in globalimportance.

(1) CAGR 1997-2002(2) Data as of year ended 2001Source: World Competitiveness Report, 1998-2002

Exhibit 1.0.1China’s Banking Market Sizeable and Growing Fast

Bank AssetsGrowth Rate(1)(%)

India

Bank Assets Asof GDP(2)(%)

20%

15%

10%

5%

0%

-5%

-10%

0% 50% 100% 150% 200% 300% 350%250%

GDP US$ Bn

15001000500

GreeceU.S.

China

Hong Kong

France Japan

GermanyChile

South Africa

Philippines

IndonesiaThailand

PortugalMalaysia

SingaporeU.K.

7


1.1 Reforms underway:shift occurring to market-drivenenvironment

The transformation of China’s financial sector began inearnest around two decades ago, commencing withregulatory reform and culminating with marketderegulation. There are five key stages:

Pre-1991: Building of the banking infrastructureIn 1984, People’s Bank of China (PBOC) relegated thelending business to the newly established state banks,marking the creation of the modern financial system. Overthe following decade, the PBOC built on this foundation,gradually introducing legal structures and encouraginginterbank transactions.

1991 to 1995: Acting as cashiers to economic transformationTo preserve control over capital allocation during thetransformation of the economy, the state banks maintainedtheir traditional role as state treasurers, directing capitalfrom households to both State-Owned Enterprises (SOEs)and emerging shareholder enterprises. Only toward theend of this period did the banks themselves recognizethe need to become more profit-driven. Subsequently,

they applied more rigorous risk management measures.

1996 to 2000: Embracing market reformsDuring this period, through a series of reforms, policy-mandated lending gave way to a more market-driven formof lending. Economic reformers recognized that effectivecommercial credit disciplines were crucial to appropriateallocation of capital among newly restructured enterprisesin all sectors of the economy. At the same time, interestrate deregulation and limited entry of foreign institutionscatalyzed competition. These changes prompted theintroduction of increasingly diverse products, such asconsumer financing.

2001 to 2005: Preparing for free market competitionIn late 2001, China entered the WTO. This momentousstep is expected to create a more level playing field forboth domestic and foreign banks. Under its WTOcommitments, China agreed to liberalize its commercialbanking sector in a phased approach. In anticipation ofcompetition, the authorities continued to implementaggressive plans to enhance the strength of domesticplayers. Accordingly, the authorities are expected to floatownership of the state banks within 5 years, leading themtoward full independence.

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Exhibit 1.1.1Transitioning Toward Market-Oriented Environment

Bankingbusiness

Supervision

Currency

Stage 1:Building of thebanking infrastructure

Stage 2:Acting as cashiers toeconomic transformation

Stage 3:Embracing of marketreforms

Stage 4:Preparing for freemarket competitions

Stage 5:Free marketcompetition

PBOC relegated itslending business to thenewly established statebanks

Unification of RMBexchange rate

RMB currentaccountconvertibility

RMB capitalaccountconvertibility?

Passage ofBanking lawCommercialbank lawFinancial bill law

Establish nationalinterbank marketStart of interestrate deregulation

Securities andinsuranceregulatory bodiesindependent fromPBOC

Consumerlendingpromoted

Intermediary businesslegitimized

New regulationof corporatebond?

Lending ratefurtherderegulation?

Full operationsof foreignbanks will beallowed

WTO1984 1991 1994 1995 1996 1997 1999 2000 2001 2003 2006

Source: Literature search; BCG analysis


2006 and onwards: Free market competitionBeyond 2006, product and geographical limitations onforeign banks will be completely phased out. The Chinesebanking industry will for the first time follow the rules oftrue open markets.

* * *

1.2 Market is large but still in anascent and emerging phase

Despite its size, the Chinese banking industry remains atan embryonic stage of development. Its keycharacteristics are laid out below:

The Chinese banking market is significant andevolving

Large market, dominated by corporate bankingHealthy growth expected in retail bankingMarket is more geographically fragmented than inEurope

Players are heterogeneous, but all have profitabilityproblems

Top four state-owned banks dominate overall marketSignificant opportunity for profitability

improvement

Market conditions are primitive and immatureSimple, basic products are the normCorporate governance still insufficientInadequate capabil i t ies and weak coreinfrastructureRegulatory environment still developing

The Chinese banking market is significant andevolving

Large market, dominated by corporate bankingThe legacy of state-directed lending created withinthe state-banks a large stock of corporate loans worthsome US$760 billion, making up around 91% of theirtotal loan portfolios. However, recent moves towardmarket reform have slowed growth in corporatelending. Consumer loans are now driving growth inthe state banks’ loan portfolios.

Healthy growth expected in retail bankingIn contrast to weak growth in corporate lending,consumer credit has grown by around 114% per yearover the last three years. (Exhibit 1.2.2) Despite stronggrowth, retail lending represents only about 9% of thestate banks’ loan portfolios, a small share comparedto developed markets such as the U.S., where retaillending often occupies nearly half of banks’ creditportfolios. Strong growth in consumer lending isforecast to continue, fueled by the following factors:

Government policies: To maintain the growthmomentum of the economy, the government hasadopted supply side “pull” macroeconomic policiesby stimulating private consumption and encouragingconsumer lending. Accordingly, consumer demandis anticipated to rise from its current low level. (Exhibit1.2.3)

Expansion of customer base: Broad-based economicdevelopment is expected to create a growingcontingent of urban middle and upper classes withstrong purchasing power and sophisticated needs.According to the Economist Intelligence Unit (EIU),only 6% of Chinese households had disposableincomes of over US$3,000 in 2000. By 2006, this figureis expected to increase more than six times to 40%.

9

Exhibit 1.2.1Solid Industry Growth Likely ToContinue In Medium Term

26

24

22

20

18

16

14

12

10

RMB TrEstimated

assetsbalance

(RMB Tr)24.8

23.0

20.7

CAGR(00-05)(3)

10%

8%

6%

1997 1998 1999 2000E 2001F 2002F 2003F 2004F 2005F

Excluding post office finance, urban and rural credit cooperatives2000 figure is an estimate, assuming ICBC, CCB and BOC accounted for 60% of thebanking sector asset; 2005 figure is a forecastEstimation methods: Policy driven scenario: assume projected growth announced by PBOC;

Historial trend: based on 1997-2000 growth rate;Global comparison: based on comparable countries by GDPper capita

Source: Almanac of China’s Finance and Banking; IMD; Literature search; BCGanalysis

(1 )

(2 )

(3 )

Banking(1)Assets Balance(2)

Policy d

riven

Historica

l trend

Global compariso

n

12.2

15.5


As this happens, the emerging rich will likely demanda wide range of banking products such as mortgages,automotive loans and other credit facilities, therebydriving the overall growth of consumer credit.

Lower risk profile: In general, consumer loans aremore transparent than corporate loans and defaultrates are lower. As consumer credit informationdevelops, and as banks are mandated to improvetheir asset quality, they will likely continue todiversify into the lower-risk consumer loansbusiness.

Market is more geographically fragmented than inEuropeChina contains many regional markets. Economicdevelopment has run at different rates, and the highvariance in incomes across cities reflects this unevengrowth. Income in the coastal regions, for example, ismarkedly higher than in inland areas. (Exhibit 1.2.4)Further, the nature of industry also tends to differ byregion. Banks, particularly foreign entrants, need tobe aware of differing customer needs and differentbanking economics in each area, and adapt theirbusiness models appropriately.

Players are heterogeneous, but all haveprofitability problems

Top four state-owned banks dominate overall market

1 0

Exhibit 1.2.3Private Consumption Low ComparedTo Developed Markets

Private Consumptionas % of GDP in 2000

Signifi-cantroomforgrowth

80%

70%

60%

50%

40%

30%

20%

10%

0%US UK Germany Hong

KongKorea Japan China

Source: EIU

68% 65%

58% 58% 57% 56%

48%

Exhibit 1.2.2Corporate Lending Dominates But Retail Leads Growth

1% 2% 6% 9%735 781 768 840100%=

99% 98% 94% 91%

1998 1999 2000 2001

114%5%

2%

3-year CAGR

Retaillending(2)

Corporatelending

Growth Drivers

Encouraging government policiesRising urban middle and upperclassesLower risk profile

Expanding client basesBroader product offeringsShift in balance between bankloans and direct financingRisk averse to risk management

(1) Corporate and retail splits of ICBC, and 2001 loan data of ABC estimated(2) Including residential mortgage,auto financing, consumer goods financingNote: Four major banks estimated to account for more than 75% of the total individual lendingSource: Annual Reports; Almanac of China’s Finance and Banking; Literature search; BCG analysis

4 Major Banks-Year End Loan Balance(1)

(US$ Bn)


Exhibit 1.2.4China Not OneBut Many Markets

BeijingTianjin

Shanghai

Xiamen

GuangzhouShenzhenGDP per capita of provinces:

RMB 8,000RMB 5,000 & RMB 8,000RMB 5,000

Source: China Statistical Yearbook 2001; BCG analysis

In terms of market share, the four state banks dominate,collectively controlling more than 85% of bank assets.The remaining market is highly fragmented withregional joint-stock and foreign banks making up some15% of the market. (Exhibit 1.2.5) The industry hasthree major groups of commercial banks with differentcharacteristics:

Major state banks: These institutions, with theirextensive branch and distribution networks,represent a major force in mass-market retailbanking. Their geographic dispersion has createdsignificant decentralization. Head offices oftenhave limited knowledge and low operational controlover activities of provincial branches.

Regional joint-stock banks: These banks focus onlarge urban centers and coastal regions, with anemphasis on corporate banking. They generally practicestricter controls over risk and are more cautious inextending their balance sheets. Strong local networksand organizational flexibility are their key advantages.

Foreign banks: Existing restrictions currently limittheir business scope. Relatively more active inproject financing.

1 1

Significant Opportunity for ProfitabilityImprovement

As a whole, Chinese banks lag behind their foreigncounterparts along performance measures such asreturn on capital and return on assets. (Exhibit 1.2.6)State banks, handicapped by years of mandatedlending, perform the worst.

Clearly, Chinese banks must bridge significantcapability gaps if they are to compete successfullyagainst foreign institutions.

Market conditions are primitive and immature

The Chinese banking market is still evolving with thefollowing characteristics:

Simple, basic products are the normProduct innovation has historically been curtailedby stringent regulatory restrictions. The market hasalso been sheltered from competition. Key customerprofiles have been homogenous (state-ownedenterprises) and their needs basic, with little impetusfor sophisticated products.

Exhibit 1.2.5Four State Banks Dominate OverallBanking Market

29%

16%

21%

19%5%

8% 2% 100%

ICBC ABC BOC CCB BoCom Otherregionalbanks

Foreignbanks

Total

85%

(1) Not including policy banksSource: Almanac of China’s Finance and Banking 2001; BCG analysis

Share of Bank Asset(1) (As of the End of 2000)


Consequently, over 90% of the four major banks’revenue is derived from interest-related income,which generally yields lower risk-adjusted returnsthan fee-based products. Fee-based services accountfor less than 5% of revenue. This ratio isconsiderably lower than in developed markets suchas the U.S. and Japan, where fee- or commission-based services make up a much higher percentage ofrevenue. (Exhibit 1.2.7)

Further, regulators often obstruct productdevelopment. For example, to introduce a new creditcard, new product specifications such as terms, ratesand features have to be submitted for approval.These specifications can be disclosed to otherplayers, and the new products are often copied evenbefore they are rolled out into the market. Thissignificantly diminishes the strategic advantage ofproduct innovation, and lowers the incentive toinvest in this capability.

Corporate governance still insufficient

Historically, policy-driven environment andstate-controlled ownership have limited developmentof corporate governance in China’s banking industry.

1 2

(1) Data as of year ended 2000Source: Top 1000 World Banks 2001 report by The Banker

Exhibit 1.2.6Chinese Banks Have Considerable Upside Potential in Profitability

Return onAssets(%)(1)

3

2.5

2

1.5

1

0.5

0

-0.5

-5 5 15 25

Agricultural Bankof China

Industrial andCommercial

Bank of China

ChinaEverbright

Bank

Bankof

China

GuangdongDevelopment Bank

ChinaConstruction

Bank

ChinaMinsheng

Bank

Fujian IndustrialBank

Shanghai PudongDevelopment Bank

ChinaMerchants

Bank

CiticIndustrial

Bank

Hua Xia Bank

Royal Bankof Canada

ANZ BankingGroup

ABNAMROBank

Bank ofCommunications

Bank Profitability

Profit on AverageCapital(%)(1)

35 45

HSBCHoldings

BNP Paribas

StandardChartered

BarclaysBank

Citigroup

Asset size(1) (US$Bn)500

100

Foreign banks

Chinese banks

Exhibit 1.2.7Significant Upside for Fee-basedBusinesses in China

(1) Data as of year ended 2001(2) Federal Reserve Bulletin June 2002(3) Bank of Japan Bulletin Nov 2001; Data represents all non-interest income(4) Average of 4 state banks; Almanac of China’s Finance and Banking

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

Revenue(1)

Fee-based

Non fee-basedbusiness

US(2) Japan(3) China(4)

34%23%

2.8%


Management decisions have been driven by policymandates, and initiatives to promote accountabilityhave been rare. Gaps in corporate governance remainwidespread: unclear roles and responsibilities,ineffective performance evaluation and poorincentives are common practice.

As more joint-stock banks seek public listing and asstate banks undergo “commercialization,”responsible corporate governance is becoming animperative.

Inadequate capabilities and weak core infrastructureMost Chinese banks have not yet developedcapabilities that are commonly found in moredeveloped countries. Concepts such as customersegmentat ion and customer re lat ionshipmanagement are only starting to gain recognition.Fundamental infrastructures, such as information andrisk management systems, are sorely inadequate.

Regulatory environment still developingRegulations often focus too much on basic input orcompliance issues, rather than on more complexprocess issues or outcomes.

Important questions such as “Are there appropriateinformation, skills or tools to achieve compliance?”or “What level of capital adequacy, return of capitalor non-performing loans has the bank achieved?”are rarely addressed in the current environment. Thisincomplete framework often reduces the effectivenessand impact of regulations.

Moreover, unclear, inconsistent, and sometimesseemingly random interpretation of regulations addsto the uncertainty, reinforcing the view of manyforeign players that they should tread carefully.

* * *

1.3 Three key challenges facingthe industry

Major structural changes are reshaping the Chinesebanking landscape today, posing three challenges to allplayers.

Reforms are creating a market-driven environmentCustomers will be more demanding as the Chineseeconomy progressesThreats loom from foreign players, post-WTO

Reforms are creating a market-drivenenvironment

Intensifying competition from capital marketsOne of the side effects of reform has been theincreasing volume of capital raised through equityand bond issues. This has threatened the commercialbanks, since credit borrowing is no longer the onlyavenue to raise funds. Financial disintermediationposes a real threat to them in retaining and developingtheir corporate client base.

Banks face similar challenges in securing their supplyof capital. Households previously had almost nochoice but to place their money into saving accounts.But current options include stocks, unit trusts, andinsurance vehicles. These alternatives often offermore attractive terms and flexibility, and arecompeting directly with the banks for capital.

Path towards commercialization demandsfundamental changes at state banksThe state banks started as institutions whosepurpose was to supply credit to state-ownedenterprises. But they now need to tackle uniqueproblems associated with their pasts. The authoritieshave begun the process of “commercializing” thesebanks, hoping to reduce and eventually eliminatetheir dependence on the government.

This commercialization has included removal ofmandatory quotas for disbursing loans, which hascreated incentive systems that make banksaccountable for their loan decisions and for extendingtheir customer bases.

While these developments are positive, state banksare still burdened with massive non-performing loans(NPLs), which in turn inhibit full commercialization.The government began to address this problem in1999, transferring RMB 1.4 trillion of bad loans frombalance sheets of the four state banks to four newlycreated Asset Management Corporations (AMCs).

1 3


Despite these measures, non-performing loans of thebig four state banks still totaled RMB 1.8 trillion, or astaggering 26.6% of their loan portfolios, as ofSeptember 2001.

Interest rate deregulation

The first stage of interest rate liberalization started in1996, when restrictions on the interbank lending ratewere relaxed. Gradual deregulation in other areasfollowed, such as in bond repurchase rates, treasury-bidding practices, and foreign currency rates. China’saccession to the WTO is expected to introduce anotherround of deregulation. The ceiling for loan rates shouldbe liberalized in two to three years, while deposit rateswill be fully deregulated in five to ten years.

Since more than 90% of revenue is generated frominterest income, ongoing deregulation is likely to havea profound impact on the way banks think abouttheir businesses. They will experience significantdownward pressure on interest margins, forcing themto explore new revenue lines. Similar interest ratederegulation in Hong Kong several years agointensified competition in the mass affluent and creditcard markets for new revenue sources.

At the same time, interest rate deregulation will likelybring more volatility to the money markets. Bankswill have to introduce more effective risk managementpractices.

Customers will be more demanding as theChinese economy progresses

The rapidly improving economy is changing the needs ofbanks’ customers on two fronts. On the corporate side,increasingly multilateral and global trading relationshipswill generate more complex financing needs, such as tradeguarantees, foreign exchange, and subsidiary capitalmanagement. On the consumer front, increasingly affluentand demanding customers will force change in bothproducts and distribution channels.

Fee-based services are necessary to remain competitiveExpansion into fee-based services has been a naturalevolution in banking industries around the world. InChina, the competitive environment in the bankingmarket has engendered the need for these services.For example, the Bank of Communications recentlydeveloped a personal financial services program,which provides customers with customized financialplans for a fee of between RMB 200 and 1,000.

1 4

Exhibit 1.3.1Chinese NPLs Significantly Higher Than International Levels

40

35

30

25

20

15

10

5

00 100 200 300 400 500 600 700 800 900 1000

NPL as of Loans(1)(%)

Assets(1) (US$ Bn)

ChinaEverbrightBank

Bank ofCommunications

China MerchantsBank

Shanghai PudongDevelopment Bank

ChinaMinshengBank

Agricultural Bank of China

Bank of China

Industrial andCommercialBank of China

China Construction Bank

Chinese statebanksChinese joint-stockbanksForeign banks

Credit Lyonnals

Standard Chartered

Royal Bank of CanadaWells Fargo

Bank of Tokyo-Mitsubishl

Bank of America HSBC Holdings

Deutsche BankCitigroup

(1) Data as of year ended 2000Source: Top 1000 World Banks 2001 report by The Banker; Almanac of China’s Finance and Banking 2001; EIU; BCG analysis

China Crossroads: Competitive Priorities for Chinese Banks1 5

Customers want “Universal Banks”

Closely related to the strategy of developing morediverse revenue streams is a trend toward “UniversalBanking,” which provides one-stop shopping forcustomers and meets their various needs with a broadportfolio of products.

In China, customer demand is paving the way foruniversal banking. Emerging consumer segmentsare already providing opportunities for cross-sellingfinancial products. The rapid growth in mortgages,for example, provides an opportunity to bundle otherproducts such as insurance and wealth managementservices. Direct spending through bankcards reachedRMB 128 billion by 2001, and is expected to grow asbanks standardize their cards. Banks can alsoleverage opportunities from existing bankcarddistribution and introduce additional services.

While customers are demanding that banks providea wider range of products, regulations prevent banksfrom venturing too far into other offerings such asinsurance and securities. These restrictions reflect abroader concern that regulators may not have the

ability to monitor such diverse institutions. However,major banks are bypassing these obstacles througha l l i a n c e s t h a t e n a b l e t h e m t o o f f e rcross-sector products and services. (Exhibit 1.3.2.)

Apart from the demand for more product variety,technological advances have also created demandfor more convenient channels with broader coverage.Online banking and ATMs are examples of theseemerging channels.

Threats loom from foreign players, post-WTO

Foreign banking institutions are currently restricted interms of product offerings and geographical scope inChina. However, under its commitment to the WTO, Chinahas agreed to phase in liberalization. This approach willgive foreign banks limited access to the Chinese domesticmarket in the near-term, and complete access in the longerterm. In anticipation of this, foreign banks have alreadybegun to aggressively establish representative officesand branches in China.

Experience suggests that new entrants try to “cherry-pick”attractive segments, such as high net worth customers

Exhibit 1.3.2Partnerships To Expand Into Other Financial Services

Banks

CCB

ABC

ICBC

CITIC

ChinaMerchants

Bank

Insurance Securities and fund Mobile operators

Source: Literature Search

Selected Examples of Announced Bank Alliances

Everbright

Minsheng

Hua Xia

Insurers

PICC

Ping An

Pacific

Taikang

China Life

Sun Life

New ChinaLife

Taiping

Banks

CCB

ICBC

BOC

BoCom

ChinaMerchants

Bank

Securities

Nanfang

Guoxin

Ping An

Xinan

Haitong

Guotong

Banks

CCB

ABC

ICBC

BoCom

ChinaMerchants

Bank

Mobile

Unicom

Netcom


Number of:

Branch

Rep. office

JV

Xiamen Dalian Others

103 2

100

7

31 31

15

Exhibit 1.3.3Foreign Competition Already Waiting Round The Corner

Shanghai Beijing Guangzhou Shenzhen Tianjin

47

67

717

106

2

14 18

2 28

23

50

14

Source: Almanac of China’s Finance and Banking 2001

Foreign Bank Presence In Major Cities

Exhibit 1.3.4Many Foreign Banks Already Have RMB Licenses

Shanghai(21) Shenzhen(10) Dalian(5) Tianjin(4)

ABN AMROANZBank of AmericaBank of East AsiaBank of Tokyo-MitsubishiCitibankCommerzbankCredit Agricole IndosuezCredit LyonnaisCredit Suisse First BostonDBSDresdner BankHSBCKorea Development BankMizuho BankOCBC BankShanghai-Paris Int’l BankStandard Chartered BankSumitomo-Mitsui BankUFj BankWoori Bank

Bank of Tokyo-MitsubishiBank of East AsiaCitibankMizuho BankHSBCNanyang Commercial BankUFJ BankStandard Chartered BankUnited Overseas BankWing Hang Bank

Bank of East AsiaKorea Exchange BankChohung BankIndustrial Bank of KoreaShinhan Bank

Korea Exchange BankChohung BankIndustrial Bank of KoreaShinhan Bank

Note: Data as of June 2002Source: Almanac of China’s Finance and Banking; literature search

1 6


and corporations with complex financial needs. Indeed,few will have the appetite for small-to medium-sizebusinesses where local knowledge and large branchnetworks are important. Moreover, valuable multinationalclients are widely expected to defect to banks that arebetter able to serve them, which will almost invariably bethe foreign banks. The recent transfer of thetelecommunications company Ericsson’s account fromMinsheng Bank to Citibank illustrates this.

As foreign banks move into local markets, incumbentsface a real threat of losing share in certain key segments:

State banks: Mass affluent households and foreignexchange market at risk

For state banks, the most vulnerable segments aretheir mass affluent retail customers and their foreigncurrency business. Foreign players offer acompelling value proposition to the mass affluent,including their vast experience from other markets indelivering cross-sector financial services, theirservice capability, and their strong brands.

With China’s accession to the WTO, foreign playersare now allowed to conduct foreign exchangebusiness with individuals and enterprises in all ofthe country’s major cities. Foreign players hadalready captured more than 20% of the foreignexchange market before the WTO move, despiteholding only some 2% of total assets.

Moreover, foreign banks are also moving intorenminbi lending including project financing, whichhistorically is the stronghold of the state anddevelopment banks. For example, DBS Bank recentlysecured a mandate to arrange a RMB 1.2 billion loanfor a joint venture project.

Regional joint-stock banks: Corporate clients andurban markets at risk

Joint-stock banks will face direct competition in thelarge corporate segment and also in urban markets.Foreign banks can leverage their strengths in lowerforeign currency funding costs, more sophisticated

product offerings and extensive worldwide networks.These attributes are increasingly important tocorporate customers as their scope and scaleexpands.

At the same time, as state-owned banks becomeincreasingly commercialized, they will graduallyreallocate more of their resources back to the moreprofitable urban markets, competing in the samesegment as the joint-stock banks. Joint-stock banksthus face being squeezed from two fronts – by foreignbanks, with their strong brand equity, and by statebanks, with their strong branch networks.

* * *

1.4 Banking industry is ata major crossroads today

All players in the Chinese banking sector share a commonset of challenges, from changes in regulation and shiftsin customer demand to pressures from post-WTOcompetition. Different groups of banks face uniqueuncertainties, stemming from differences in ownershipstructure, role in the industry, and the size and diversityof their businesses.

Each bank must therefore decide on which direction totake and how to shape its own strategic path.Uncertainties may abound, but neither time norcompetition will stand still. Now is the moment to makethose tough decisions and take the next step forward.

* * *

1 7


2. What Competitive ScenariosAre Likely To Play Out?

custodian services). New channel-based pure-playsfor e-banking and e-payments have also emerged,though their long-term success is uncertain. The keydrivers here are regulatory policies and market forces.

* * *

2.2 Five possiblecompetitive scenarios

The evolution of banking in other markets suggests thatChina could evolve into one of the following competitivescenarios:

Specialists Rule: Market specializationEra of the Warlords: Geographic fragmentationBlossom of a Hundred Flowers: Market specializationand geographic fragmentationAny Model That Works: Selective marketspecialization and fragmentationWar of the Giants: National universal banking

Specialists Rule

In “Specialists Rule”, a limited number of players in eachfinancial sector or product segment dominate thenational market. Since sector/product boundaries aredistinct, alliances and joint ventures are common toextend product distribution channels.

1 8

With market reforms underway, it is worthwhile to explorehow different competitive scenarios might play out. Inthis context, the past experience of other countries canhelp us envision the possible future of China’s bankingindustry.

This chapter presents hypotheses for market evolution.

2.1 Landscapes - definedby geography and product

Historically, the banking landscape in internationalmarkets has evolved along two major dimensions:

Geographic diversity: from fragmented market tonational dominanceThis refers to whether market leaders are regional(fragmented) or national players. The key factorsdriving this dimension are government policy andeconomic and geographic variances.

Product scope: from specialized market leadershipto universal banking dominanceMarkets can also be defined along products lines,ranging from those dominated by universal banksthat engage in cross-sector services, to specializedmarkets with few products. Specialization can besector-based (e.g., commercial banking, investmentbanking, securities brokerage, and insurance); orproduct-based (e.g., credit cards, mortgages,


In developing markets, sector specialization is drivenmainly by regulatory restrictions, as banks are prohibitedfrom engaging in other sector services. In more maturemarkets, product specialization usually develops to“cherry pick” lucrative segments such as credit cardsand mortgages.

National market dominance often exists in tightlycontrolled, developing markets, where market leaders maybe state-owned and supported national banks. In openmarkets, leading players can also leverage network andscale advantages to dominate national markets.

China’s market today can be viewed as a classic exampleof “Specialists Rule,” with some specialists in banking,securities, and insurance sectors and the four major statebanks dominating national banking. In this early stage,typical product specialists such as credit card monolinesor mortgage providers have not yet developed. It is

interesting to note that banks are currently locked out ofthe automotive financing market by regulation, indirectlynurturing a major specialist opportunity in China today.

Era of the Warlords

In the “Era of the Warlords” scenario, geographicboundaries are the dividing lines. Typically, the bankingindustry is fragmented and regionalized, largely due tovast differences in geographic markets or to regulationsprohibiting cross-region business.

Consequently, competitors in each region have developedinternal capabilities to offer comprehensive services, andtheir homogeneity leads to intense competition acrossproduct lines. Since most competitors offer universalservices, alliances are less common.

Due to the heterogeneity across markets (e.g. regional

Exhibit 2.2.1Five Possible Competitive Scenarios

National market dominance Fragmented market

“Universalbank”model

dominance

Specializedmarketmodel

leadership

War of the Giants

Specialists Rule

Era of the Warlords

Blossom of AHundred Flowers

Any Model that Works

Geographical Segments

Prod

uct S

egm

ents

A few national universalbanks dominate


Prod

uct S

egm

ents

Specialists are significantplayers in attractivesectors/products


Product Segments

Regional universal banksdominate their home

markets


Product Segments

Highly fragmented markets insectors/products and

geographies


Prod

uct S

egm

ents

Players compete inselective sectors/products

1 9


industry focus), local knowledge and network effectspresent significant barriers for new entrants. Strongincumbents may resist pressure to consolidate, so themarket remains fragmented.

The Italian retail banking industry, especially prior to1990’s, resembled the “Era of the Warlords,” with marketsdominated by regional, universal (retail) banking players.Bank of Italy had limited branch openings before 1990,causing the markets to remain concentrated and limitingbanking system evolution. By 1997, eight of the sixteenlarger provinces were dominated by provincial players.Each player occupied more than a third of its market, andsix of them had market shares of over 70%. Suchconcentration prevented consolidation or nationalbanking. Inefficiency was common.

Blossom of a Hundred Flowers

“Blossom of a Hundred Flowers” reflects a landscapethat is highly fragmented across both product andgeographical dimensions. This is often the result of bothmarket specialization and regulatory constraints. Anumber of dominant local and regional specialists emerge.Alliances with other market specialists are common.

This situation is possible in very immature markets wheresmall regional players focus on specific sectors/productsegments, partly as a result of regulatory demarcations.Generally speaking, “Blossom of a Hundred Flowers” is atransitional state. In the long run, scale and focusadvantages will induce cross-product or cross-regionconsolidations. Hence, this scenario is not observed inadvanced markets.

Any Model That Works

“Any Model That Works” is characterized by truly freemarket competition. When faced with potentialcompetition, incumbents defend selectively in profitableand strategic markets, allowing new competitors to takeover other segments. In this model, universal banks existbut are not usually dominant, and some market specialistsexpand nationally. Alliances across markets are common.The United States is a good example of this scenario.

The U.S. banking sector until the 1990’s was highlyinfluenced by regulatory factors. The Glass-Steagall Act(1933 and 1935) barred commercial banks from investmentbanking activities. Interstate banking was largelyprohibited by the McFadden Act of 1926.

But key regulatory changes in the late 1990’s dismantledthe sector barriers from the Glass-Steagall Act and allowedinterstate banking. This triggered mass cross-sectorconsolidation. Notable examples included mergersinvolving Citibank (retail and commercial banking),Salomon Smith Barney (investment banking), andTravelers’ Group (credit cards and insurance); JP Morgan(investment banking), Chase Manhattan Bank (retail andcommercial banking), and Hambrecht & Quist (investmentbanking). These mega-mergers created giant banksacross major sectors. So far, however, they have not yetachieved complete dominance, and significant regionalplayers and sector specialists remain.

At the same time, maturing customer needs and newchannels have led to new specialists in the United States.Successful examples include MBNA and Capital One incredit cards, and StateStreet Bank in custodian services.In particular, MBNA, a pure-play credit card issuer, wassecond to Citigroup in 2001 in terms of outstanding creditbalance. New online channels have also given rise topure e-banking players such as Juniper and the e-payments leader Paypal, which was recently acquired bythe online auctioneer EBay.

War of the Giants

In “War of the Giants,” a few national players with broadproduct offerings dominate the market. This scenariohas often begun with universal banks evolving througha process of cross-sector and cross-region consolidationinto large national banks. Well-established productmarkets by major universal banks forestall furtheropportunities for specialization by niche players.

The Australian banking market currently resembles the“War of the Giants.” The big four banks – NationalAustralia Bank, ANZ Banking Group, CommonwealthBank of Australia and Westpac Bank – dominate almostevery region and offer a very broad product range. They

2 0


participate extensively across sectors such as investmentbanking, retail banking, and combined banking, insuranceand securities services.

* * *

2.3 Inferences for Chinaand the banks

So what do all of these scenarios truly mean for China?Can banks influence the outcome of this transformation?

This section discusses how China could evolve againstthese five scenarios in the coming five to ten years, andwhat the state and joint-stock banks should do toproactively shape the landscape. Since regulatory policyis the biggest driver of market evolution, one can gainearly insights into future scenarios by examining policytrends. Chinese banks should be wary of foreigncompetition in all cases, although the degree of the threatswill vary with each scenario.

Scenario I: Staying as Specialists– Life Almost as Usual

This scenario is likely if the Chinese government largelymaintains its current policy bias, which:

Restricts the banking industry from non-bankfinancial servicesSupports state banks’ dominance, or allows a fewmajor regional banks to expand nationally

In this scenario, both major state and joint-stock banksshould focus on:

Defending existing businesses from furtherspecialization and disintermediationExtending products by striking alliances with otherfinancial services players

This means aggressively growing key product marketsand strengthening needed capabilities, such as customerrelationship management, to discourage the rise ofspecialists such as credit card monolines and mortgage

agencies. Banks can also proactively partner with otherfinancial services players to expand their product scopeby serving as distribution channels.

Scenario II: Blossoming of a HundredFlowers – Weakening of the State Banks?

This scenario can happen if the government purposelydownsizes the state banks’ network and influence, and ifregional banks dominate the market. This is notimpossible, as branches of state banks are being closedand commercialization plans signal less reliance on thegovernment.

State banks should gear up for market competition aheadof this vulnerable transition period. All other players,foreign banks included, are urged to look for geographicexpansion or market specialization opportunities duringthis unstable time.

In other markets, such as Indonesia, changes in thegovernmental stance on state banks have been known toreverse the balance of power among competitive players.(Exhibit 2.3.1)

Banking sector deregulation from 1988 to 1990 in Indonesiapromoted fair competition among banks, reduced statebanks’ reliance on the government, and abolished theguideline that had previously forced state enterprises todeal specifically with state banks.

Exhibit 2.3.1Changes in Market Dominance Due toBanking Reforms in Indonesia

Banking reform

Asian FinancialCrisis

80%

70%

60%

50%40%

30%

20%

10%0%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

StatePrivate nationalJoint and foreignRegional Govt

Share of Loans

Source: Bank for International Settlements

2 1


Using “Share of Loans” as a proxy, the private banks’market shares rose steadily following the deregulation,surpassing the state banks’ lead by late 1994 andcontinuing through 1997 until the Asian financial crisisstruck. Since then, the strengthening of state banks andthe entry of foreign banks, both largely orchestrated bythe Indonesian government, have changed thecompetitive landscape yet again.

Scenario III: Emergence of the Giants– Dawn of Universal Banking

This scenario is similar to Scenario I (Life Almost as Usual)with minimal changes in regulations, except that theChinese government would eventually allow banks tooffer cross-sector services such as investment banking,securities brokerage, and/or insurance. This is not unlikely,as even advanced markets such as the United States areallowing more crossovers of businesses.

But this landscape would require a new set ofcompetencies. “Building scale and capabilities fast” wouldbe the motto, leaving mergers and acquisitions a likelystrategic option. Banks that might wish to be among thegiants in this race could start by aligning themselves withother financial services partners now, while exploringcloser affiliations later. Smaller banks could positionthemselves for acquisition by local or foreign players.

Scenario IV: Entering the Era of theWarlords – Everything Changes

This scenario is a combination of Scenarios II (Weakeningof the State Banks) and III (Dawn of Universal Banking),resulting in regional market dominance and cross-sectorbanking services. This is less likely to be a near-term scenario.

The Chinese government, cognizant of the shock that majorchanges may bring, will be unlikely to introduce drasticregulatory reforms in the near term, at least until the NPLissue is resolved. Moreover, unless artificial barriers areimposed to prevent national expansion, this scenario willnot be sustainable since full-service universal banks willlikely extend their scale and networks nationally. Underthis scenario, Chinese banks should position for similarstrategies highlighted in the two previous scenarios.

Scenario V: Any Model that Works– Free Market Reigns

This scenario is similar to Scenario IV (EverythingChanges) above, which involves transitioning to regionalmarket focus and cross-sector services. The keydifference here is that regulatory changes actuallypromote free market competition, allowing many playersto compete in different dimensions simultaneously in aheated economy.

In this scenario, without dominant “universal” players,domestic and foreign players alike will have the mostopportunities to shape the landscape. Major Chinesebanks need to be selective in their market focus, as it willbe difficult to defend from all fronts. Alliances will beneeded to fill the capability gaps. Smaller banks areadvised to direct their energy to selected regions orspecialized markets where they have the strongestadvantage. Strategic leadership to guide the bank’sdirection and organizational flexibility will be particularlyimportant in this scenario.

* * *

2.4 What should the banks do now?

Competition is coming to China– both domestic and foreign

In addition to post-WTO regulatory changes, theastounding growth of China has convinced many foreignbanks to place the Chinese market at the top of theirpriorities. A case in point is HSBC, which became thefirst foreign bank to take a strategic stake in a Chinesebank, buying 8% of Bank of Shanghai in early 2002. HSBCalready has roughly twelve branches and representativeoffices in China, in addition to major back-officeprocessing centers in Shanghai and Guangzhou. It alsoplans to expand across sectors from retail banking andcorporate finance into insurance, asset management anddomestic investment banking over the next few years.

Universal banking may be surfacing as well. There areearly signs that the government might eventually removethe regulatory barriers that separate banking, insurance,

2 2


Exhibit 2.4.1First Get Out of the Swamp, Then Make for Paradise

Get started first bydeveloping the basics

1

Work on progressivecapability building

2

Improve view of whatvision looks likeover time

3

Long-term vision is stillhighly uncertain

4

BCG’s view on how to get started

Market today is highly immature and rapidly changing nosense in spending too much time on the vision

Significant capability gaps exist better to focus on thesegiven resource constraints

Practical and economic approachGet some sort of basic vision togetherDevelop capabilities progressivelyRevisit vision annually as more clarity on what it looks likeis gained over time

and securities brokerage. One signal has been theapproval for CITIC, a state-owned trust and investmentcompany, to set up a holding company to unite itsbanking, securities, insurance and fund managementoperations. The prospect of “financial supermarkets”promises to draw heated competition from all financialservices players.

Banks need to work out how to get ahead inthis new competitive order

As increasingly sophisticated domestic and foreignplayers elevate the rules of competition, Chinese banksneed to reassess their strategies and upgrade theircapabilities. There is still time for them to decide on theirroles. The key is to close capability gaps by firstdeveloping the basics, then by progressively enhancingcapabili t ies and improving long-term vision.(Exhibit 2.4.1) The following chapter discusses prioritiesfor building the capabilities to compete.

* * *


3. What Are The Priorities ForChinese Banks To Compete?

Two key traits are needed to win in the new competitivelandscape: the initiative to foresee potential changes, andthe ability to act and respond to those changes.Understanding scenarios on how the market mightdevelop is just a first step. It is also vital to strategicallybuild internal capabilities in order to seize opportunitiesquickly, and to respond to challenges brought about bymarket developments.

BCG believes that all Chinese banks will need to buildand strengthen capabilities in five specific areas. Clearly,the degree and emphasis will differ by institution.

3.1 Priority #1:Strengthen organization andcorporate governance

BCG Insight: Status quo is no longer an option. Strong,committed leadership and clear corporate objectives areneeded to set the right direction for change.Implementing any strategy requires a flexible, engagedand market-oriented organization.

Management of top state banks has been constrained bystate policies, with limited leeway to exercise conventional

business management and organizational leadership. Thissituation also exists, though less acutely, in joint-stockbanks, which are partly under state control.

With the recent push for commercialization from centralgovernment, Chinese banks have limited time to enhancetheir competitiveness against increasing domestic andforeign competition. Strong leadership and clear corporateobjectives are required. Chinese banks need to:

Establish world-class corporate governanceEffectively manage human resources and capabilities

Establish world-class corporate governance

The recent collapse of several major corporations hasbrought the issues of corporate governance andaccountability to the world’s attention. These issues areeven more pressing for the Chinese banking industry withits historical lack of governance, trends towards market-driven competition, and a desire to attract capitalinvestments. World-class corporate governance involvestwo key components: active management oversight bythe Board of Directors, and strong organizationalleadership with a clear role-of-center.

Active management oversight by the Board ofDirectorsMany Chinese companies, including state banks, donot have formalized or independent Boards ofDirectors due to state control or traditional familyownerships. Typically, in large organizations, theBoard of Directors is needed for three roles: (i) toprovide vision and strategic direction; (ii) to overseecompany performance including strategy and

2 4

Priority #1: Strengthen organization and corporategovernance

Priority #2: Develop a segmented service capabilityPriority #3: Build a strong risk management

framework and culturePriority #4: Maximize operational efficiencyPriority #5: Use partnerships for competitive

advantage


compliance; (iii) to oversee executive appointmentsand assess management performance.

Based on client work, BCG has identified four basicdrivers of good performance. An effective Board ofDirectors:

1) Defines clear roles for its members, makes thenecessary time commitments, and understands itsmission

2) Selects capable and committed directors who haverelevant experience and the intellectual capacityto represent all stakeholders fairly

3) Establishes procedures that enable it tounderstand the company’s business issues

4) Promotes constructive behavior duringdiscussions and debates, and defines efficientprotocols to interact with company management

Strong organizational leadership with clear role-of-centerMajor Chinese banks, particularly the state-ownedinstitutions, have enjoyed considerable autonomyat the provincial level. They often operate like afederation of independent businesses that share thesame name, rather than as part of a regional or nationalcompany.

This leads to two types of problems. Firstly,provincial decisions at state banks can be heavilyinfluenced by provincial government policy, ratherthan by business economics. Secondly, significantdifferences can exist in financial performance, servicequality, product offerings, and pricing acrossregions, considerably weakening the overall brand.

To prepare for market competition, banks need tostrengthen the “role-of-center” and establishcorporate leadership. The key is to ensure that theorganization works toward common strategicobjectives and agreed business plans. The corporateheadquarters should:

Clearly define and communicate its vision, values,and strategyEstablish an effective framework to ensure closemonitoring of accounting practices andperformance of branches and business unitsReform human resources policy (includingperformance evaluation and incentives) to attracttalent and motivate its workforce

Branches and business units should participateactively in planning, and be empowered to executestrategic directives with sufficient autonomy.Effective communications are critical to ensuredissemination of corporate directives and feedbackof branch issues.

Exhibit 3.1.1Corporate Governance Important forAttracting Foreign Investments

Important in Advanced Markets

Important to Attract Foreign Investments

Question: Is the quality of corporate governancepractice a consideration when makinginvestment decisions?

Percentageresponding‘extremely’or ‘veryimportant’

Percentageresponding‘extremely’or ‘veryimportant’

USA UK France Australia

63%

45%

54%

74%

USA UK France Australia

55%

76%

29%

51%

Source: Russell Reynolds 1998 International Survey ofInstitutional Investors

2 5

Question: Reluctant to invest in a foreign company withpoor corporate governance practice?


Effectively manage human resourcesand capabilities

In BCG’s experience, human resources (HR) managementis one of the least adopted management practices amongChinese banks.

Employee morale, loyalty, and effectiveness are oftenhampered by:

Compensation and career advancement systemsbased on tenure (and other non-transparentfactors) rather than meritInadequate performance management (e.g.,performance tracking, incentives, and clearobjectives and targets for staff)Missing links between the five important areas toHR: business planning, requirement definition,recruiting, performance management andemployee development

Chinese banks should adopt a comprehensive HRmanagement strategy to attract, motivate, and retain aneffective workforce. The BCG Human Resource Wheelprovides a framework for this process.

As a crucial first step, banks need to translate theircorporate business plan into a needs analysis. Thisshould outline how improvements in HR can help thecompany achieve its corporate objectives. This analysisenables firms to optimize their investments in peoplepractices and to make truly strategic, rather than merelytactical, changes. Corporate and business strategy mustdrive HR strategy.Exhibit 3.1.3

Cascade Targets Down The Organization

5 year business plan

Annual business plan

Annual Divisional/functionalplans and budgets Performance objectives

Group

SBU

Region/function/product

OperativeIevels

Role

GM

Head Of BusinessDevelopment

Regional KeyAccount Manager

Key AccountManager

Sample Objectives(KPI) Sample Measures(KPI)

Maximise growth ofprofitable business in

chosen segments

Profit before tax andoverheads

New business targets

Achieve growth targets

New business unittargets

Expense managementwithin budget

Achieve sales targets Regional new businesstargets

Manage assigned keyaccounts

Operative unit salestargets

2 6

Exhibit 3.1.2Good People Practice Involves a Numberof Different Elements

Businessstrategy

Needsanalysis

Key ValueLevers

Sourcing and placementRecruitmentPlacementTransfers

Requirementdefinition

SizingJob definitionOutsourcing

Performancemanagement

PerformancemeasurementFeedbackCompensationRewards

1

2

3

4

Practices need to be continually evaluated andrevised to match business strategy

BCG Human Resource Wheel

Employee developmentTrainingCareer management

Leadership


BCG’s Human Resource Wheel specifies four ways toimprove HR effectiveness:

1) Clearly define human resource requirements.Each institution should create a human resourceplan with specifications on employee numbers andskills, both for today and for the future. The planshould be based on the needs analysis describedabove, and be fully aligned with corporate strategy.It will include elements such as job definitions,capability definitions and competency sets. Insome cases, the plan will include contingenciesfor staff retraining or retrenchment.

2) Strengthen sourcing and placement. A war fortalent for good banking personnel has alreadystarted in China. Competition for quality staff willincrease as more foreign banks enter the fray. Inaddition to their international reputations andworld-class training programs, foreign banks alsooffer considerably higher salaries, as well asincentive programs such as employee stockownership. In one example, the annual salary of aforeign bank’s local business unit manager in Shanghaiwas RMB 150,000, whereas that of a general managerin a state bank was only RMB 40,000. Chinese banksneed to strengthen recruitment and retentionstrategies to build and compete for human capital.This can only be done through understanding andsatisfying the long-term needs of their employees,which is not an easy task. In parallel, banks mustlook at alternatives such as temporary recruitmentor outsourcing.

3) Institute performance management. To alignemployee behavior with corporate strategy andobjectives, Chinese banks must establish effectiveperformance management. This means creatingmeaningful metrics, setting appropriate targets andincentives, and instituting robust feedbacksystems. Targets need to reflect a cascading ofcorporate plans down the organization as set outin Exhibit 3.1.3. They also need to be fair andbased on what the individual can actually control.Performance indicators should encourage out-performance, rather than just the meeting ofminimum goals.

4) Promote employee development. Careerdevelopment and training is another motivatingforce for employees, and is crucial in ensuring thatthey improve their skills in line with changes ininternal and external demands. Employeedevelopment is linked to performance managementin translating feedback into actionable, effectivetraining and career management steps.

* * *

3.2 Priority #2:Develop a segmentedservice capability

BCG Insight: A segmented service capability is a keysustainable advantage. This starts with understandingcustomers in detail and working out how to best servethem through targeted product development, maximizedimpact from pricing, and effective distribution.

Recent trends toward “universal banking” and retailbanking have created demand for new products andservices. Product innovation is a prerequisite to winmarket share, but does not create sustainable advantagesince it can be easily copied. However, it is not easy toreplicate the segmented service capabilities that arerequired to effectively innovate, develop and deliver theseproducts. This can presently be a source of truecompetitive advantage in China.

Developing requisite segmented service capabilitiesrequires Chinese banks to:

Understand the customerUtilize pricing strategyEnsure effective use of distribution channels

Understand the customer

International benchmarks show that around 80% of abank’s income is typically derived from the top 20% of itscustomers.

In China, the top 10% of premium customers reportedlycontribute about 60% of profitability. At the other end ofthe spectrum, the bottom 10% of the country’s bankaccounts possibly more, many with balances of less

2 7


Buying behavior: number of bank relationships,financial sophisticationClient relationship: number of products sold,length of relationshipValue creation: gross income, net profit, return onequity, capital employed

Segmentation allows banks to:

1) Maximize return through targeted products andservices. Banks can prioritize and develop specificvalue propositions for each segment, andrestructure their product portfolios to increasesegment profitability. Targeting products beginswith analyzing and identifying unmet customerneeds, and then addressing those needs throughnew product development or enhancing existingofferings.

2) Channel customer segments to different servicevenues. The goal is to service customers at a levelcommensurate with their revenue potential. Inmany advanced countries, banks are replacing theirgeneral service branches with lower-cost, 24-hourself-service ATM centers to serve the simpletransaction needs of its less valuable customers.At the same time, they are staffing upscale centerswith knowledgeable account managers to bettermeet the needs of their premium clients.

3) Minimize low-value customers through accountfees. Despite the unpopularity of banking fees inChina, foreign players such as Citibank and HSBChave initiated minimum account fees to discouragecustomers with low balances, and to offset thecost of serving them. The Chinese BankingAssociation has reportedly also submitted anapplication to government authorities to allowChinese banks to charge account fees on balancesbelow RMB 100.

Customer Relationship Management (CRM)

Currently Chinese banks do not fully understand theneeds of its customers. To better understandcustomer preferences, Chinese banks need toimprove their Customer Relationship Managementpractices to collect integrated customer information.

than RMB 100 are loss making. These accountscreate a heavy cost for the banks and also draw resourcesaway from servicing high value customers.

Clearly, state banks have a community service to fulfill thatmight prevent them from eliminating these unprofitablesegments. However, BCG has seen many ways in whichunderstanding the value of the customer can help banksre-direct unprofitable business to more cost-effectivechannels or services. Exhibit 3.2.1 illustrates how a bankmight tailor customer strategy by combining product usageinformation with segment profitability.

It is imperative to develop a good understanding ofcustomers’ profitability, and segment them accordingly.The overall objective is to develop better and moreprofitable products and services. This can be achievedthrough the following segmentation and customerrelationship management strategies:

SegmentationCustomer segmentation allows banks to tailor theirproducts and focus their resources to better servemore profitable segments. It also enables banks todevelop more cost-effective ways to serve segmentsthat are unprofitable today (e.g., shifting low valuecustomers to electronic channels).

Segmentation criteria should reflect current clientportfolio and target client characteristics, such as:

Client data: industry, region, size

2 8

Exhibit 3.2.1Tailor Customer Strategy Based OnSegment Profitability

CumulativeContrlbution Margin

Cllents with investmentproducts

Mortgage only clients

Clients withoutmortgage andinvestments

Clients with only onesavings account

Inactive clients

Customer Strategy

Minimize cost and/oridentify high potentialinactive clients

Defend

Cross-sell

Cumulative Clients

140%

120%

100%

80%

60%

40%

20%

0%20% 40% 60% 80% 100%0%

Profitability of Segments By Product Usage

Illustrative


Effective client relationship management will providethe foundation for Chinese banks to:

improve segment profitability through productportfolio optimizationexpand product usage through effective cross-selling across channelsenhance sales effectiveness through systematicorganization cooperationselectively retain high-value clients

Exhibit 3.2.2 outlines how banks can realize significantvalue creation by knowing what customers are lookingfor and translating this into a clear understanding ofthe economics of serving them.

Utilize pricing strategies

BCG’s global client work on bank pricing strategies revealssignificant untapped revenue potential. However, mostbanks overlook pricing as a lever to boost value.Moreover, the simple product mix in China fosters aperception that there are limited pricing opportunities. Inreality, a multitude of pricing opportunities exists. Exhibit3.2.3 shows that price can have the highest impact onbanking returns for Chinese banks.

2 9

Exhibit 3.2.2Successful CRM Program Starts With Deep Client Insights

Client insight:1 CRM objectives:2

Clients’ needs and wants... ...With clear understanding of client economics ...Drive clear value creation

Basis for segmentation?

White space opportunityby segment?

Clients’ needs and driversfor action?

What connection will leadto growth?

AggregateClient Lifetime

Value

Average LifetimeValue Per Client

# TransactionsPer Client

Average ClientLifetime

Profitability PerTransaction

# Clients Customer acquisition

Strategic Pricing

Lower cost to serve

Cross-sell

Share of wallet

Customer retention

BCG’s Pricing Framework offers a number of innovativestrategies to capture value and strengthen product/serviceofferings along multiple dimensions. Banks need to:

1) Align pricing strategy with business strategyFor example, bundling correctly priced productstogether can assist banks in expanding into thewealth management market.

2) Price to customer valuePricing structure can be changed to influence priceperception and to help locate the “sweet spots” ofcustomer value. One example is Washington Mutual(WAMU) in the United States. By focusing chargeson “acceptable” penalties such as bounced checkcharges, and by pricing to remove transaction,minimum balance and monthly fees, WAMU was ableto offer free checking accounts. It managed toincrease its annual fee income by 30%, and added514,000 new checking accounts in 2000.

3) Use pricing to create efficiencies and manage riskRisk characteristics can be used to further differentiatepricing, and encourage low-cost channel use.


4) Optimize the price-volume tradeoffBy understanding how price changes will impactdemand, prices can be raised without affectingdemand. For instance, one BCG global banking clientwas able to reap a 10% increase in fee income byincreasing prices for payment products with minimalimpact on volume.

5) Improve price realizationPrice realization consists of two levers: complianceand performance. Compliance refers to the degreethat specified prices are being realized (e.g. whetherprice schedules set centrally are being violated, andwhether fees are enforced). Performance refers tothe extent the sales force is maximizing profits in theway they charge customers. BCG client work revealsthat banks regularly discount or waive charges,particularly in wholesale and private bankingproducts. What’s more, such discounts are often notknown to the customers.

6) Organize for better pricingBanks need open price communication andcoordination across different business units toensure that pricing decisions are maximizing

profitability. Organizations often operate in businessunit “silos,” and random or uncoordinated pricingoccurs. Typically, there is no account manager ordepartment that manages pricing and profitabilityacross all products and services that any singlecustomer is buying.

3 0

Exhibit 3.2.3Price Improvement Has Highest Impact On Banking Returns

ROE

% Change of ROE(1) by 1%Improvement of Driver

State Banks(5) Listed Banks(6)

ROA

Leverage

Assets

Earnings

Income

Price(2)

Bad DebtBurden

Volume(3)

Cost(4)

15.2 5.0

2.6 1.8

4.5 2.2

1.5 0.3

(1) ROE for the year ended 2000; calculation uses equity average of 1999 and 2000(2) Assumes no impact on volume. Assumes increase in both interest and non-interest income(3) Assumes increase in net interest income, fee income and bad debt burden(4) Assumes decrease in operating expenses only, not interest expense(5) Average of BOC, ICBC and CCB(6) Average of 4 listed banks including China Merchants, China Minsheng, Shenzhen Development and Shanghai Pudong DevelopmentSource: Almanac of China’s Finance and Banking; Annual reports; BCG analysis

f

Banking ROE Driver Tree

Exhibit 3.2.4BCG Pricing Framework

Align pricingstrategy with

businessstrategy

Organise forpricing

Price tocustomer

value

Use pricing to createefficiencies and

manage risk

Improveprice

realisation

Optimise theprice-volume

trade-off

Price, Cost

Quantity

MarginalCost

Demand

BCG Framework: Pricing Opportunities For Value Creation

61

3

2

5

4


Ensure effective use of distribution channels

A bank’s distribution channels are the primary interfacebetween the institution and its customers. Theeffectiveness of these channels directly impacts customersatisfaction and future value potential. Existing bankingnetworks also present the most formidable weapon againstforeign competitors, which have limited local presence.

BCG case experience has identified several factors thatinfluence channel effectiveness:

Optimizing channels to enhance customer serviceand reduce costThis involves redesigning service channels to betteralign customer preferences and bank objectives;reconfiguring branch networks and layouts toincrease sales and minimize manual transactions; andenhancing customer reach through multiple channelssuch as call centers and e-banking.

Promoting cross-selling across business units andchannelsMany customers hold multiple accounts and utilize

diverse services across different banks. But bankscan considerably increase their share of the customerrelationship through effective cross-selling amongdifferent contact points. The key is to identify cross-selling opportunities, provide training about differentproducts and cross-selling techniques, and offer theright incentives to motivate cross-selling practicesacross the organization.

Creating new revenue opportunities from cross-selling third-party productsBanking involves frequent interactions and is amongthe most trusted of all business relationships. Hence,third-party products can be efficiently cross-sold inthis sector. While cross-selling investmentproducts such as unit trusts and insurance arealready common practices in advanced countries,Chinese banks are just beginning to explore theserevenue opportunities. For example, a recent pushfor the open-end fund “Peng Hua” includedIndustrial and Commercial Bank of China as adistributor. The bank’s involvement increased dailyfund inflows from several million RMB to over ahundred million RMB. In the end, ICBC reportedly

3 1

Exhibit 3.2.5Align Current and Future Channel Options with Segment Needs

Today Tomorrow

Customer

Branch

ATM

Telephone

EFTPOS

PC

IVR

CSO

Touch points X 75 times

Customer

Premier SuiteTraditionalSupermarketsKiosksAgencies

Segmented salesand services

ATM

EFTPOS

Telephone

PC

CSO

CSO

IVR

Premier

Convenience

SegmentedCustomer Care

Premier

Convenience

SegmentedCustomer Care

New ChannelsOffice kioskSmart CardMobile PhonePersonal DigitalAssistantVendingMachines


contributed to approximately 80% of fundsubscriptions.

* * *

3.3 Priority #3:Build a strong risk managementframework and culture

BCG Insight: Integrated risk management is one of themost pressing issues for Chinese banks. A phased andpragmatic approach is needed. A strong riskmanagement culture will be crucial for sustainableprofitability.

Risk management is among the most critical issues forChinese banks, especially in view of significant bad loanportfolios, increasing regulatory pressure, and recent fraudissues. As such, BCG has identified three imperatives thatcan help Chinese banks remedy the situation:

Manage existing book of non-performing loansCreate an integrated risk management systemNurture a risk-return employee culture

Manage existing book of non-performing loans

One of the biggest challenges facing Chinese banks todayis how to deal with the staggering levels of non-performing loans on their balance sheets. Even withAMCs handling a large portion of the NPLs for the topstate-owned banks, all are still left with a sizable amountof post-1995 bad loans. Joint-stock banks do not faremuch better with NPLs, and they do not have the benefitof government support.

Stricter loan loss provisioning and capital adequacyrequirements are expected to tighten pressure on banksto clean up their balance sheets. State banks also need tostrengthen their balance sheets to prepare for futureprivatization.

In general, there are three options for dealing with NPLs:

Write-off: Demands financial strength, as this incurs“major” accounting losses; not a preferred optionExternal workout group: Sell off loan (often atdiscount) to an external financing bank or

government-related entity; frees balance sheet ofNPLs and creates a healthy” bankBalance sheet restructuring: Delay paymentschedules, issue subordinated bonds or hybridsecurities, or securitize loan portfolio to strengthenthe balance sheet

The ultimate success of the effort depends on strongmanagement support to push the process, clearcommunication to all participants to generate enthusiasm,and a good tracking system (e.g., key performanceindicator reports) to pinpoint laggards. There is also aneed for valuation, negotiation and asset managementskills.

Create an integrated risk management system

Sound integrated risk management systems are built onthree building blocks: methodology and tools;organization and process; and systems and infrastructure.

3 2

Exhibit 3.3.1Three Options for Dealingwith Non-Performing Loans

Write them off

External workout group

Balance sheet restructuring

12

12

1

2


Such a framework allows banks to address threecategories of risk:

Market risk. Most Chinese banks do not properlymanage market risk, due to the absence of well-definedprocesses, centralized technology infrastructure,appropriately set-up organizations, and timely capital-market data. Moreover, they are often unknowinglyexposed to market risk in the form of asset-liabilitymismatches and unmanaged proprietary trading in marked-to-market risks. While market risks today might be smallin comparison to credit risks, they could growsubstantially if appropriate efforts are not made.

BCG has observed the following market risk managementgaps with Chinese clients:

Minimal or untimely monitoring of asset-liabilityand trading marked-to-market risksNo consistent measure for comparing andaggregating riskSubjective control mechanisms and conflictingroles between investment and controlNo risk optimization to maximize risk-adjustedreturns

Credit risk. BCG’s global risk management surveyreveals that credit risk is viewed by the majority of the

banks as the most important risk category. While Chinais in the process of developing a credit culture, it has yetto deeply penetrate Chinese banks. Many have neitherthe institutional history nor the tools and methodsnecessary to evaluate credit risk in a systematic fashion.Common pitfalls include:

Fragmented roles and responsibilities: oversizedand ineffective loan committees

Limited and inconsistent account managerinvolvement: limited cooperation between creditand account departments to enforce customer riskmanagement

Overlapping and duplicated processes: wastedresources in overlapping roles, duplicatedactivities and multiple sign-offs throughout theloan approval process

Limited financial, commercial skills: staff areoften technical engineers rather than credit,financial and business analysts with the skills tomanage customer risk

Major gaps in credit risk management system:absence of integrated systems on both thecustomer and management information level

Indeed, Chinese banks are handicapped by a lack ofsystematic consumer and industry credit historyinformation, and by inadequate data for collateralevaluation. Industry and governmental efforts have beeninitiated to address the credit history issue, and it is timeto start planning for integration with these data resources.Meanwhile, close cooperation between credit andaccount management is vital to provide separate risk andpolicy/customer perspectives.

Operational risk. This is a significant problem for mostbanks globally. Issues range from unclear definition ofthe risks involved to difficulties in quantifying them.Most banks recognize operational risk as specific-eventrisk and strategic business risk, including inappropriatebehavior, defective processes or technologies, externalevents, and the risk of failure to produce returns.Inadequate operational controls have contributed tohundreds of millions of U.S. dollars in hidden trading

3 3

Exhibit 3.3.2BCG Integrated RiskManagement Framework

. Methodology and tools . Organization and process

. Systems and infrastructure

Categorize risks

Market riskCredit riskOperationalrisk

ExposuresizeFrequency

Controllable

Non-controllable

Customized toolsReturn on Risk-adjustedcapitalRisk capital allocationOthers

Measurement

Monitoring

Management

OrganizationRisk taking vs. riskcontrollingBU vs. centerRole of treasury

Internal processesRisk planning andcapital allocationRisk control onreportingTarget setting andperformancemeasurement

Risk reporting and ITRisk reportsData requirementsSystem support(PC-based/mainframe)


losses by rogue traders at Allied Irish Bank and Barings,costing not only the jobs of some banking officials, butalso the demise of the banks themselves. Significantefforts continue to be made to address these risks globally.

Chinese banks also face problems in managing operationalrisk. Indeed, some observers might argue that this is oneof their most vulnerable areas, given the limited focus onit to date and the organizational challenges that doingbusiness in China presents. The key to early-stageoperational risk management is to focus on pragmaticapproaches. This requires:

Clear definition of operational risk within thebank, measured as a bank-specific combination ofspecific-event risk and strategic business risk

Creating an internal loss database. Specificprocesses and business units are analyzed for risk;possible effects are estimated and capital isreserved for potential losses

Implementation of clear functional control andprocedures to limit risk exposure

Building an integrated risk management system is not aneasy task. It is not something that can be accomplishedovernight, but rather takes shape through a multi-stageprocess. Chinese banks need to implement such aframework, gradually adding to their systems andcapabilities. Having a rules-based business will not beenough, however. It is also paramount to nurture a risk-return employee culture.

Nurture a risk-return employee culture

The key is to create a corporate culture in which theprinciples of avoiding risk and generating returns are notdiametrically opposed. Employees must be trained withthe simultaneous consideration of risk and return, andempowered with tools to make risk-adjusted returndecisions, which need to be reinforced by managementand by incentive policies. Getting there takes time.

* * *

3.4 Priority #4:Maximize operational efficiency

BCG Insight: Chinese banks should not overlookday-to-day operations amid long-term strategicinitiatives. There are many opportunities to improveoperational efficiency, which can bring direct andimmediate profit impact through cost savings.

Operations are very complex, yet fundamental to the dailyfunctioning of a bank. Operational expenses aresometimes equivalent to over half a bank’s revenue. Anysavings here can significantly reduce costs. BCG believesit is crucial for Chinese banks to:

Develop cost management and budgeting controlsAlign IT initiatives with business prioritiesOptimize branch network efficiencyReengineer people and processesReduce cost through strategic sourcing

Develop cost managementand budgeting controls

Cost control management is vastly inadequate in China.Recent surveys of Chinese banking executives conductedby BCG reveal a general lack of oversight andaccountability, plus an absence of well-defined expenseapproval processes. These executives also expressedconcern over the effort needed to capture costinformation, the difficulties in selecting an appropriate ITsolution, and the lack of benchmarks for target setting.

More fundamentally, there is limited awareness of whatcost control management entails. In Chinese banks, it isoften handled haphazardly rather than through an orderlyprocess, such as laid out below, of integrated planning,approval, reporting and monitoring.

1) Budget Planning. Capital budget planning is aprime driver of the cost control process. It isderived from the annual business and operationalplan that defines revenues, costs, and capitalexpenditures for the period. Headquarters andbusiness units need to work closely in settingstrategic priorities and appropriate budgets.

3 4


2) Expense Authorization. Expense authorization isnot just a simple process of assigning signatureauthority against expenses. The system needs tobalance the need for adequate fiscal governancewith the need to avoid excessive bureaucracy.Setting expense limits also depends on otherfactors such as the company’s risk appetite,management’s trust of budget holders, and thesize of the organization.

3) Management Reporting. Conventionalmanagement reporting processes often focus toonarrowly on business and financial governance,overlooking cost control issues. Cost controlshould be closely integrated into the managementreporting process to track key value drivers, thusproviding early indicators to cost issues andaiding in decision-making.

4) Monitoring. Monitoring consists of performancemeasurement and internal auditing. Performancemeasurement requires alignment of metrics withstrategic requirements, the setting of appropriatetargets, and a closely linked incentives system.Regular internal auditing is also imperative to

minimize operational risks. The goal is to ensurebudget compliance.

The benefits of a comprehensive cost management andbudget control framework are not limited to budgetcompliance and avoidance of operational risk. Such aframework also helps uncover structural costmisalignments, highlights opportunities for sharedservices and scale-related savings, and identifies internalcost cutting opportunities through internal or externalbenchmarking.

Aligning IT initiatives with business priorities

Both the Chinese government and the banking industryplace strong emphasis on improving the country’stechnology infrastructure, as demonstrated by the GoldenCard project and significant IT investments by Chinesebanks. Recent initiatives to replace legacy systems, tocentralize data systems, and to acquire risk management,customer relationship and e-banking systems continuethis trend.

Several studies by BCG reveal that IT issues such asproject failures, cost blow-outs, and time overruns stem

Exhibit 3.4.1Four Key Components Of Cost Control and Management (CCM) Systems

Budget Planning Business Request ExpenseAuthorization Purchasing Management Reporting Monitoring

Annualplanningprocess

Departmentbudget

Paymentrequest

Business need

Authorization

Authoritylimits

Budgetholder

Purchase

Supplier

Monthlyreport

Profitabilityreport

Actualvs

budget

P&L+

B/S

Monitoring

Performanceassessment ofbudget holders

Internal audit

Key CCM system components

Direct CCM system modulesNote: Business Request and Purchasing belong more to the purchasing system rather than cost control system


from management rather than technical shortcomings.Therefore, attempts to address these complicationsthrough additional IT resources are doomed to fail. Thekey to IT success rests with proper management, notwith increasing expenditure. BCG has identified six majordisciplines to make sure IT investments providesustainable and tangible business value:

Business and IT Strategy Alignment. IT begins withbusiness objectives, not systems, and the bestsolutions emerge only when business needs drivetechnology decisions. Thus, it is critical thatcompanies should first ask “What is IT for and howcan we use IT to create business value?” rather than“How much IT do we need?” Moreover, successfulcompanies systematically focus their IT resourceson helping the business create advantage (forexample, in supporting customer service excellenceor low-cost processing).

IT Architecture. Successful companies gaincompetitive advantage through transforminginformation into insight, not by blindly acquiringtechnology’s newest bells and whistles. Theyselectively choose new technologies and

aggressively simplify and standardize theirarchitectures. Chinese banks should create ablueprint and standard for their IT systems andenforce them in order to break away fromincompatible, decentralized and fragmented legacysystems. In the long term, this will bring themsigni f icant cos t sav ings combined wi thunprecedented flexibility.

IT Investment and Renewal. Not only do successfulbanks know how much they are spending on eachand every IT project – and why – but they alsoemploy a disciplined process for setting projectpriorities and spending targets. Banks shouldconsider IT projects as financial investments withclear, achievable return goals. Therefore, everyproject must have a strong business case, wherecosts, benefits and risks are clearly articulated,discussed and approved by senior executives.

IT Skills and Sourcing. Success in any area dependsas much on what a company chooses not to do as onwhat it actually does. This fact has proved especiallytrue in IT because new technologies are continuallyemerging and demanding new, initially scarce, and

3 6

Exhibit 3.4.2Six Disciplines Of Managing IT For Business Value

Business and ITStrategy Alignment

IT Architecture

IT Investmentand Renewal

IT Skills andSourcing

ITDevelopment,Delivery, and

Support

IT Leadershipand

Governance

Identify IT-enabled businessopportunities and key value drivers

Choose technologies;simplify and standardize

aggressively

Develop options andtradeoffs, set priorities

based on business value,and commit resources

Define what you must haveinternally and what you will

buy from others

Build effective businesssystems through smaller,

shorter projects; make toughgo-no-go decisions

Set the direction and make itstick across the IT

organization and line units


often expensive skills and experience. Many Chinesebanks have also tried to “economize” by developingcomplete applications themselves, when they wouldhave been better off leveraging off-the-shelfproducts, which are more stable, mature, and morequickly deployable. Successful companies rigorouslydefine which IT functions their employees shouldperform and which should be performed externally.They also recognize that outsourcing does notnecessarily eliminate a problem, but rather exchangesone set of issues for another.

IT Development, Delivery, and Support. IT failurerates rise sharply with project size. Often, the cost ofa failed project goes beyond just lost dollars toinclude lost time and missed opportunities – hugepenalties in today’s marketplace. Smart companiesthink big but start small. They avoid mega-projectsand costly system failures by planning and executingin short, intense phases. Three-month cycles fordelivering project results with business value arerapidly becoming common practice.

IT Leadership and Governance. Winning companiessucceed only when they translate their vision into

results on an ongoing basis. To accomplish thisgoal, they foster deep collaboration and joint decisionmaking among business and IT managers. Broad,strategic IT steering committees and lean projectreview groups are efficient means, among others, toensure effective decision making and accountablesolution delivery. BCG often assists clients indeveloping powerful governance mechanisms andmanagement processes to turn governance and ITleadership concepts into practice.

Optimize branch network efficiency

Branch offices are expensive. Branch rationalization offersan effective means of reducing costs and improvingoperating efficiency. Following PBOC’s directives,between 10% and 30% of state bank branches have beenclosed down since 1997. However, there is still substantialroom to improve both branch efficiency and customerservice.

The considerations for closing or merging branches havefocused mainly on standalone branch efficiency and assetbase. But in fact, effective branch rationalization involvesmultiple considerations:

3 7

Exhibit 3.4.3Benefits of IT Projects Must be Evaluated and Prioritized

200

150

100

50

00 25 50 75 100

System C

System A

System B

Profilemonitoring

Positionmanagement

Project X

Project Z

Price changes

UpgradeRisk mgmt.

‘Should do’ andrecommended

Mainframereplacement

‘Nice to have’ If budgetand schedule allow

Rescope or avoidif possible

Present Value OfBenefits(Index)

Present Value OfCost(Index)

Illustrative

Risk

High

Medium

Low


Teller efficiency: By re-allocating staff throughoutdifferent locations, a client achieved a 10%-50%reduction of headcount.

Network optimization: Banks need to decide on howbranch network and format design can strike anoptimal balance between coverage and cost.

Multi-channel management: Segmentation, deliverypreferences, channel cost and usage, and newchannel formats need to be carefully considered tohelp channels deliver the most efficiency.

The goal is to optimize both branch efficiency andcustomer experience of the overall network.

Reengineer people and processes

In the early 1990s, process reengineering was implementedextensively in the United States. To remain competitive,many methodologies were developed to cut costs andenhance efficiency through redesigning and restructuringprocesses. As a result, many U.S. institutions have highlyefficient operations. In order to close gaps in operationalefficiency with foreign banks, Chinese banks will also

need to take a closer look at their people and processpractices.

A variety of tools can be used to identify, measure andevaluate potential areas for efficiency enhancement. Theapproach should be systematic: first, map the key businessprocess/decision flows, including all people, informationand document activities. Second, analyze the breakdownsof business processes against indicative criteria such asunit cost and turnaround time. Third, identify potentialimprovement opportunities (e.g. bottleneck, duplication,unnecessary procedures) through benchmarking or gapanalysis. Finally, redesign processes and implementchanges

Exhibit 3.4.4 illustrates a BCG client sample unit-costanalysis. By comparing against industry benchmarks (e.g.in absolute dollar terms or percentage composition), areasof potential cost savings and service quality improvementcan be identified.

Another useful tool is process flow analysis. As seenfrom Exhibit 3.4.5, the average length of time taken fromthe start to finish along each major process is tracked.Each “white-space” represents process wait time along

3 8

Exhibit 3.4.4Unit Cost Analysis and Benchmarked Savings

Illustrative

ActualUnit Cost

Unit Costfrom

Bench-marking

Screening andapplying

Pre-evaluation Credit analysis Credit approval Offer Offer tocustomer

acceptance

Documentation Disbursement Total

Bench-marked

Cost

PotentialBenefits fromBenchmarking

ActualCost

Key

Source: BCG case example

Case Example:Credit Origination-To-Disbursement Unit Cost Benchmarking


the process. Excessive “white-space” suggests potentialinefficiency that could be eliminated throughreengineering.

Reduce cost through strategic sourcing

Strategic sourcing has recently been a popular cost-saving initiative. New technology platforms have evenbeen created to support these efforts. However, this topicis largely overlooked in the Chinese banking sector for acouple of reasons:

Except for technology platforms, purchasing costsare believed to be relatively low due to cheapmaterials and servicing costs. Chinese banks arealso thought to incur fewer purchasing expensesrelative to those in advanced markets (e.g. fewerdirect-marketing mailings, less general businessoutsourcing).

Potential conflicts of interests and various formsof “buyer kick-back” practices to stakeholders arestill pervasive in China. This reduces the incentiveand makes it more difficult for stakeholders to raisesensitive procurement opportunities and explorecompetitive supplier pricing.

Even though purchasing costs in China may not be huge,the cost savings may still be substantial relative to netincome since they directly impact the bottom line. In fact,using estimates from typical BCG client procurementprojects where average savings of 20% of addressablebaselines are possible, strategic sourcing can result inapproximately 10% to 15% increases in profit margins forstate and listed Chinese banks.

Significant savings can be achieved by:

Leveraging volume discount: Consolidate buyingpower across business units or regions, rationalizecentralized vs. decentralized procurement

Negotiating better terms: Screen for preferredvendors, renegotiate contracts to demand bestpricing available, review branch leasing andmaintenance programs

Challenging specifications: Understand cost/performance tradeoffs and avoid unnecessaryover-specifications. Managing demand can beone of the biggest levers of savings.

Enhancing purchasing management: Control

Exhibit 3.4.5Process Flow Analysis Can Highlight Process Inefficiency

Customerprovides

documents

Screening and application Pre-evaluation Credit Analysis Approval Offer

Customerreceives offer

letter

Averagetime

worked

Averageworking days

elapsed

Average Turnaround Time

8 days

22 Working daysor

31 Calendar Days0 5 11 15 19 22

Duplication and handoffs Handoffs

Working time Waiting time

Source: BCG case example

Case Example: The Application-to-Offer Process for Relationship Banking

3 9


maverick spending, promote system rationalizationand standardization, encourage buyers tochallenge specifications and costs, and avoidconflicts of interests

Improving cost control and budgeting: Monitorsavings and benchmark market pricing, incentivisecost-saving behavior, and create a cost-consciousculture

* * *

3.5 Priority #5:Use partnerships forcompetitive advantage

BCG Insight: Chinese banks should leverage alliancecapabilities to benefit from the competitive advantagesof their partners. Whatever the situation of the bank,partners can usually bring something valuable to thetable, as long as the partnership is selectedappropriately and the process defined properly.

As China’s growing economy leads to diverging customerneeds, many banks will seek to expand their product andservice capabilities through allying with other firms.While current partnerships mainly focus on distribution,the scope of alliance cooperation will likely beincreasingly complex. Banks are urged to start buildingup partnership capabilities as follows:

Leverage alliance capabilities to expand services andrevenueSelect and manage alliance relationships carefullyDesign an appropriate variety of alliances

Leverage alliance capabilitiesto expand services and revenue

The most common form of alliance relationship in theChinese banking industry today is the distribution alliance.Partners include insurance companies, securitiesbrokerages, fund management firms, mobile operators,and other banks. The scope of cooperation ranges widely,and includes product development, sales and distribution,and services. Examples include:

Expanding product capabilitiesInstead of trying to develop new products in-house,which may not be feasible due to internal or externallimitations, banks can turn to their partners for helpwith developing new products or services, allowingfor a shorter time to market.

Capturing revenues through sales and distributionof third-party productsWith their extensive reach and established customerbase, Chinese banks can capitalize on relationshipswith customers by serving as distribution channelsfor third-party products and services.

Offering new intermediary servicesChinese banks are expanding their revenue base byoffering new intermediary services to their alliancepartners.

Foreign banks are not always competitors. Indeed, Chinesebanks can benefit from allying with them in poolingsyndicated loans. They can also offer RMB interbank loansto foreign banks, which exceeded RMB 21 billion at theend of 2001. If these cooperative relationships continue,Chinese banks might extend their services overseasthrough their foreign partners, or be considered as mergercandidates when regulations relax.

Select and managealliance relationships carefully

Be very focused in sourcing partnershipsAllying with the right partner is critical to success.Banks need to carefully examine their own capabilityand resource gaps against their strategic goals, andidentify partnership candidates that complementthem. Expectation and cultural fit are other importantconsiderations. Banks that are new to formingalliance relationships are advised to start with simpleand common arrangements, and to learn the skills todevelop successful partnerships over time.

Manage partnerships against commitments andmetrics that are clearly defined at the outsetClear initial structuring of alliance relationships interms of time, skills, resource commitments andmanagement metrics is necessary to avoid unpleasant

4 0


surprises down the road. This is even more crucialwhen foreign partners are involved, since culturalmisunderstanding and expectation differences canarise. Partnership management is an on-going anddynamic process. Banks need to monitor themanagement metrics and refine them if necessary.Open communication is vital.

Design an appropriate variety of alliances

The alliance mechanism selected has to reflect the long-term interests of both parties. In particular, many accordswith foreign parties are set up with little thought regardinghow the alliance will evolve as:

the Chinese partner acquires technical expertisethe foreign partner acquires knowledge of theChinese market

Successful alliances are built on a long-term symbiosisbetween complementary businesses.

Chinese banks can get world-class know-how fromconsultants and from third-party advisors who have:

knowledge bases from many institutionsskills at introducing different practices into bankspractical experience in China

Alternatively Chinese banks can acquire technicalknow- how through allying with foreign parties. However,for existing shareholders, selling an equity stake may proveto be a very expensive method for acquiring intellectualcapital even though no immediate cash outlay is required.Strategic alliances should be built on a sounder, mutuallybeneficial advantage.

* * *

4 1


4. How Should Banks BeginTo Create Winning Game Plans?

4.1 The importance ofstrategic planning

The five key strategies set out in Chapter 3 can greatlyenhance the capabilities of any bank, if properly designedand executed. Banks need to work out in a strategic planhow to prioritize their capability-building initiatives, howto integrate the inevitable dependencies, and mostimportantly, how to develop capabilities to support theoverall set of business objectives.

Such a strategic plan gives clear direction on whatobjectives the organization is working toward and whattargets it is trying to meet over specific time frames. Itrepresents the bank’s vision for the kinds of customers it

will serve, the types of products it will offer, and how itwill deliver them. Clearly, all this needs to be developedin the context of a dynamic market, an evolving competitivesituation, and a realistic perspective on internalcapabilities.

Without such a plan, banks can expend significantresources without accomplishing anything. This isbecause every initiative is uncoordinated, purely tacticalprojects emerge just to plug gaps, and any strategic impactthat might have been achieved is lost. The small windowof opportunity to close competitive gaps before foreignbanks enter in force can be squandered.

A typical strategic planning process is set out below.

4 2

Exhibit 4.1.1Strategic Planning Process

Phase . Understand Current Position . Develop Strategic Direction . Define Corporate Plan

Where are we today and how will themarket evolve?

Where do we want to go?How do we get there?

What outcome do we expect?What initiatives/actions do weneed?

Market profiling (size, segmenta-tion etc.,)

Competitive analysis againstlocal and foreign players

Review of financial performance

Define and decidestrategic direction

Target segmentationEnablersInfrastructurerefinement

Evaluate merger/allianceopportunities

5-year financialprojections

Development ofthe 5-yearCorporate Plan

Quick win initiatives

Rec

omm

enda

tion

and

Prio

ritis

atio

n

New

Lon

g-te

rm S

trate

gic

Plan

6

7

1

2

3

4

5


The process needs to be tailored to a bank’s specificsituation.

The next section discusses some of the key challenges ofstrategic planning in China.

* * *

4.2 Key strategic planningchallenges in China

Three challenges faced by both Chinese and foreign banks

Banks face a unique set of circumstances that are peculiar toChina. The strategic planning process has to take these intoaccount.

Uncertain Market LandscapeIt is unclear what further steps the regulatoryauthorities will take to catalyze reform. This, in turn,makes it difficult to chart the reform process withany degree of accuracy or certainty. Under theseconditions, it is important to craft flexible strategies.

Banks should anticipate the unfolding of differentscenarios and develop the ability to bend with eachone. For instance, changes in regulations have andwill create new markets overnight. Banks shouldprepare to capitalize on new opportunities andrespond to challenges as they arise.

Heavy Market FragmentationBanks operating in China should bear in mind that itis a vast country, and that its regions have developeddifferently. This geographical and economicfragmentation has given rise to a series of differentfinancial sub-systems that have dissimilar economiccharacteristics. Strategies should be adapted forregional differences and for their specific businesspractices.

Further, China’s recent transition from a centrallyplanned to a market-oriented economy has created aplethora of different corporations and consumers,each with their own distinct financial needs. Thisbroad cross-section of customers necessitates astrategy that incorporates each segment’srequirements.

4 3

Exhibit 4.1.2Tailored Strategic Planning Approach

Bank X’s characteristicsDesign for Strategic Planning dominated by

business line relatedness, turbulent environ-ment and poor financial track record

Illustrative

Highly related

Corporatecenter

Turbulent

Commandand control

Poorperformer

Unitary

Ownership

Financial track record

CEO style

External environment

Location of strategic capabilities

Relatedness of business lines

Unrelated

Business lines

Stable

BU autonomy andownership

Top performer

Diverse

Bank X’s approach to strategic planning needs to balanceBuilding coherent joint strategy in turbulent environmentDevelopment of effective monitoring mechanisms

Implication for Strategic Planning processNeed joint strategy team with strong representation from eachbusinessQuarterly targets need to be agreed for key performanceindicatorsResources need to be focused on initiatives to strengthen the corebusiness

....

Dominant dimensions:Highly related business lines need coherent joint strategyHowever, strategic capabilities are in the business lines not thecenterTurbulent environment needs close monitoring despite CEO’srelatively hands-off stylePast financial performance limits degrees of freedom


Poor Data AvailabilityIt is often difficult to obtain accurate and timelyprimary data. Changes in methodology andenvironment have also created discontinuous datasets. Besides, definitions are not always accurateand must be carefully analyzed for consistency andreliability. Other data, apart from official sources, alsoexist, and a certain degree of local knowledge isrequired to obtain these data.

It is thus important to know where to find reliabledata and to understand how they should beinterpreted for them to be useful. A similar, even morefundamental data challenge is the shortness ofrelevant time series, given the many structural, stepchanges in the recent past.

Three specific challenges faced byChinese banks

The management of China’s domestic banks, especiallystate banks, has had little experience in commercialmarkets. As China moves towards market deregulation,management in domestic banks face severe strategicplanning challenges in preparing their institutions forcompetition.

No call to action: unclear objectives, ineffectivegovernanceThe legacy of protected, strictly regulated marketshas created a management infrastructure that isill-prepared for the competition ahead. There havebeen no requirements for institutions to maximizereturn to shareholders, and little urgency formanagement to shift the institutions, particularly statebanks, to higher levels of efficiency or profitability.At lower levels, incentives have not been in place tomotivate employees to be more productive orprofitable. This has ultimately created an indifferentand risk-averse corporate culture.

These norms will have to change if China’s banksare to succeed in the coming years. Managementand employees alike need to be hungrier. Incentivestructures need to be re-aligned.

No history of commercial planningChinese banks have little experience in commercialplanning because the central government hastraditionally taken care of it. This means thatmanagement today often has no real concept of whatis practically achievable. Objectives can often beunrealistic and unattainable. Further, the industryas a whole has exhibited few long-term trends, makingit difficult to leverage past experience into realisticforecasts. This has made the work of the corporatestrategist tricky.

Strong financial performance is often underpinnedby good strategic planning. China’s banks need torealize this in order to deliver successfully in thefuture.

Weak executionThis lack of both planning and achieving corporateobjectives has engendered a weak operational culture.Often, even if plans have been well thought out andconstructed, they have not been effectivelyimplemented at lower levels of the organization.Planners need to take this into account andcommunicate with line managers so that targets canbe realistic and achievable. This often means scalingdown the complexity of the plans to deliver simpleand succinct objectives that can be easily controlledand monitored.

Decentralization at provincial levels and below oftencomplicates execution. Planners must realize thatsub-offices and branches often have their ownprocedures and systems.

Plans should also not be too ambitious in the short-term.As the internal infrastructure evolves, so will itsability to reach more complex objectives. But thiswill take time.

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5. What Are The Key ImplicationsFor Management?

“Recognize the urgency, impart aculture of change, plan, and takeaction”

Just as the strategic plan is the crucial first step to setfuture direction for the bank, strategy implementation isthe actual journey that takes the bank to its destination.Efforts to navigate a path ahead are futile if theorganization is not motivated to get started, not preparedto overcome the obstacles along the way, exhausts itsenergy to continue, or just gets lost.

Chinese banks face some unique strategy implementationissues. These include:

Strong resistance and limited motivation to change.A highly risk-averse culture and a lack of performanceincentives to encourage improvements andinnovation are among the biggest roadblocks. Topmanagement often discourages change, andmanagers below fear attempting innovation andfailing. In addition, the geographic scale and diversityof branch networks compounds the inability to forcethrough change.

Complex stakeholder objectives. For example,meeting conflicting social and economic developmentobjectives as well as profit objectives.

Distraction of near- to medium-term public listings.With many banks seeking public listings,management focus can turn toward packaging theinstitution for investors rather than making seriouschange. Since implementation of major initiativesoften incurs disruptions and risks, it can be difficultto drive change.

Gaps in key skills to manage change. Competition,increasingly sophisticated customer needs, andchange management demand new skills beyond thoserequired for core banking operations. Most banksdo not have these skills in-house and can besignificantly challenged in managing throughevolutionary stages.

Incomplete control over all the levers of competition.For example, regulators still limit the flexibility overareas such as product development and pricing.Established internal procedures such as humanresource policies, particularly when they need to becoordinated with government input, may also impedethe speed and scope of changes.

However, Chinese banks can take several practical stepsto begin the journey forward successfully:

1. Make sure the entire senior management team

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realizes the imminent challenges ahead, and feelsthe urgency to acquire the capabilities needed todeal with themThis step is critical. The management team needs tohave a shared understanding of the tasks ahead andthe need for change. Executives also must have arealistic view of the capability gaps, and askthemselves: ”How much better do we need to be,and in what areas?”

In order to be useful, these views need to be basedon facts and analysis, not just on opinions. Theyalso need to be shared by the whole managementteam, not just by a few individuals. Otherwise, theorganization will be unable to make the necessarychanges to meet new objectives. Most importantly,the gaps need to be prioritized. An organizationcannot expect to improve in all areas all at once.

2. Develop a realistic plan to move beyond thecrossroadsThe road ahead is a long one and fraught withuncertainties. A bank cannot expect to navigatethrough the complexities without a well-crafted plan.

Starting with the priorities established in the firststep, this second step addresses how to achievethose priorities: what needs to be done by whom, inwhat sequence. The plan needs to balance carefullybetween what can be done versus what must be done.It must involve evaluating various competitivescenarios, and determining the best course of actionin each one. It also involves setting tough prioritiesabout what is most important to success, and whatis less so. Consequently, third party experts aresometimes involved to bring in state-of-the-artcompetitive planning techniques.

3. Pursue implementation of the plan with appropriatevigor and flexibilityThis step is clearly the most difficult, and requirescommitment over a long period of time. In a complexorganization, it also requires a willingness to tacklemany obstacles and to lead the process of changeon a large scale. Implementing company-widestrategic changes requires the involvement of many

people across the company, and requires them to domany new and unfamiliar tasks.

It is essential to distill such a complicated implementationinto several basic success factors, and be sure to focusadequately on each of these. When each success factorreceives the right amount of attention, implementationon any scale can succeed. If these factors are not properlyaddressed and balanced, however, implementation willcertainly fail.

The six key success factors for successful implementationin a Chinese company are:

A. Develop a compelling vision for actionFormulate a compelling case for change, whichincludes a clear and detailed vision of the desiredlevel of future performance. This is especiallyimportant when there is little recognition of the needfor change, and where there is a strong belief inpreserving the status quo. These conditions oftenexist in state-owned enterprises that have not beenexposed to significant competition in the past.

B. Have visible, committed leadership willing to tackletough issuesEnsure that there are visible and united senior leaderswho are committed to leading the organizationthrough the difficult changes, and that these leadersclearly expect all managers to support change. Thisis especially important when the organization haslittle experience at major change projects, and whenpeople are not sure whether the senior team is fullycommitted. In state-owned enterprises, middlemanagement is reluctant to act without clearendorsement from the top.

C. Use rigorous project management techniquesUtilize structured project management methodologiesand clear accountabilities to ensure full delivery ofproject benefits on time. This is especially criticalwhen the complexity of change is high, when there isa previous lack of discipline, or when the companyhas weak project management skills. In a state-owned enterprise, some managers may be verycomfortable with the techniques, but other managers

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may have no experience at all.

D. Actively obtain the support of key stakeholdersUnderstand and address the issues of the differentstakeholder groups/individuals to build support andfacilitate smooth implementation. This especiallymatters when stakeholders have conflicting agendasor priorities, when there is low acceptance ofproposed change, when the impact on the workforceis likely to be high, or when the change will impact abroad range of stakeholders. In a state-ownedenterprise, there is typically a very complicated setof stakeholders, and each of them can be critical tosuccessful change.

E. Fill gaps in capabilities and cultureSystematically assess and develop the humanresources and organizational behaviors needed todeliver the proposed changes. Remember that rolesand responsibilities for a significant proportion ofworkforce may change. Many new employeecapabilities may be needed, and cultural andbehavioral change is essential to success. When astate-owned enterprise prepares for toughercompetition, it is inevitable that there will be importantgaps in capabilities that need to be addressed.

F. Put in place the right support infrastructureEnsure that the key elements of corporateinfrastructure are adjusted to support the newperformance requirements. For example, budgetprocesses and performance metrics, HR policies andprocesses, and IT architecture and systems all mayneed to be revised in order for change to besuccessful. In a state-owned enterprise, theseinfrastructure issues are often critical elements ofsuccessful change.

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6. Conclusions

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The Chinese banking industry is at a crossroads today. Rapid transformation is taking place in theexternal environment: this includes market-oriented reforms, increasingly demanding customerneeds, and intensifying competition from foreign entrants. Meanwhile, critical internal issues arecompounding the pressure for change: high non-performing loans, the imperative for strengtheningrisk management, and desperately needed infrastructure upgrades. Chinese banks cannot affordto stand still.

However, this is also not the time for banks to go in all directions, lest they flounder and end upgoing nowhere. Banking executives need to make carefully considered decisions about the futureof their institutions. As seen in Chapter 1, the challenges facing each bank are very different, andeach player has to decide on which direction to take and how to shape its own strategic path.Many uncertainties exist and the competitive scenarios set out in Chapter 2 have yet to be playedout. But competition does not stop banks can still choose which role they want to play in thisunfolding landscape.

The priorities set out in Chapter 3 can equip Chinese banks with strengthened capabilities to winin any new landscape regardless of what shape it takes. Indeed, strategically building theseinternal capabilities is not just an option, but a prerequisite for success in any competitive market.These capabilities need to be built with a common purpose in mind. In Chapter 4, the importanceof developing a strategic plan to give clear direction and priorities to the organization is highlighted.However, strategic planning is difficult in China, because of both the nature of the market and theinherent characteristics of Chinese banks.

Fortunately, as set out in Chapter 5, there are some practical steps that senior management can taketo begin moving ahead successfully, and there are six key success factors that are extremely usefulfor superior implementation in Chinese companies.

The market is changing. Competition is imminent. But there is a path that leads through theuncertainties. Now is the time to make the tough decisions and take the next step forward.

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Hong KongThe Boston Consulting Group International, GmbH34th Floor, Shell TowerTimes Square, Causeway BayHong Kong CHINATelephone: 852-2506-2111Facsimile: 852-2506-9084E - m a i l : [email protected]

ShanghaiBoston Consulting (Shanghai) Company Ltd.21st Floor, Central Plaza227, Huangpi Bei LuShanghai, 200003 CHINATelephone: 86-21-6375-8618Facsimile: 86-21-6375-8628E - m a i l : [email protected]

BeijingThe Boston Consulting Group (Beijing)3rd Floor, North Tower, Beijing Kerry CentreNo.1, Guang Hua Road Chaoyang DistrictBeijing, 100020 CHINATelephone: 86-10-8529-8877Facsimile: 86-10-8529-8878E - m a i l : [email protected]

The Boston Consulting Group is a generalmanagement consulting firm that is a globalleader in business strategy. BCG has helpedcompanies in every major industry and marketachieve a competitive advantage by developingand implementing unique strategies. Foundedin 1963, the firm now operates 54 offices in 34countries.

Copyright 2002 by The Boston Consulting Group, Inc.All rights reserved. Published in September 2002.Report designed by BCG Greater China marketing team.

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china crossroads: competitive priorities for chinese banks · china crossroads: competitive...

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