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China banking: Rolling with the times

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Points of Essence:

  • As China experiences a tremendous growth and immense potential of their banking industry, it has also set to join the fray in the booming Islamic finance to tap on the wealth sources from the Middle East.
  • The rapid expansion of the domestic industry and a significant Muslim population in China provided a ready platform for China to aggressively pursue Islamic finance to meet the requirements of the industry and the people.

By KFH Research Ltd

China’s banking industry has witnessed rapid growth over the years, riding on the coat-tails of the country’s economic boom. In 2007, the industry grew by 19.7% vs 17.3% in 2006, underpinned by the country’s strong economic performance and continued liberalisation of the industry.

For the first time, the weighted average capital adequacy ratio of the banking sector exceeded the minimum regulatory level of 8%, while the non-performing loans (NPL) ratio of commercial banks was reduced to a historically low level of 6.2%. We expect China’s banking industry to continue to post commendable growth over the medium term, underpinned by the country’s healthy economic growth, huge population and growing middle class.

Nevertheless, China’s banking sector is still subject to risks, given the declining stock market, tighter monetary policy, impact of the subprime crisis, as well as slower global growth, which may affect loans growth and hence impact banks’ earnings.

Overall, we expect the sector to remain stable as industry regulators and banks continue to step up joint efforts to reduce the sector’s NPL.

Drivers for China’s banking sector include:
• Strong GDP growth. Strong economic growth since 2003 has boosted China’s per capita and disposable incomes, resulting in an increase in consumer spending. This in turn has supported demand for retail banking. There are also a growing number of small- and medium-sized enterprises needing banking services to fund their expansion plans.
• Rising population. China’s population is expected to grow by 0.6% to 1.3 billion this year, with a median age of 33.2 years. In 2007, the proportion of people aged between 15-64 years represented 71.7% of the country’s total. This segment will drive demand for banking products and services.
• Reformation in the financial sectors. The reformation in the banking sector will help Chinese banks shift from traditional commercial banking to focus more on developing the retail segment. The reformation has improved the asset quality of Chinese banks and strengthened their risk management systems.

China has also set its sights on Islamic banking and finance in order to tap the Middle Eastern market and attract investors looking to capitalise on the country’s rapid economic growth. The growth potential for the industry in China is huge, particularly given the country’s robust economic growth, huge population and favourable demographics.

Opportunities for the advancement of an Islamic capital market in China are also huge, given the country’s vast infrastructure investment needs and growing liquidity.

While Islamic banking is generally the most developed part of the Islamic financial system, there is great potential for an Islamic capital market to develop in China as the industry matures and holdings of financial assets gradually transfer from the Islamic banking sector to the Islamic capital market.

For example, the pressing need to address liquidity management for Islamic banks and takaful operators have prompted countries like Malaysia, Bahrain, Kuwait, Sudan and Iran to introduce sukuk to facilitate the management of assets by Islamic financial institutions.

In terms of banking products, China’s domestic market is promising given that the country has a Muslim population of approximately 20 million, equivalent to 1.5% of its total population. In comparison, Britain has about two million Muslims, or 3.3% of its 60 million population, yet the country has developed a thriving Islamic financial market.

The highest concentration of Muslims in China can be found in the northwestern provinces of Xinjiang, Gansu, and Ningxia, as well as significant numbers in Yunnan province in southwest China and Henan Province in central China. China’s addressable market becomes a lot larger if the potential interest from the non-Muslim segment of the population is factored into the equation.

Pockets of opportunity in residential mortgages
The residential mortgage market offers a wealth of opportunity for Islamic banking in China. Between 2004 and 2006, housing loans granted by the banking sector grew by a compounded annual rate of 19.86%. As of October 2007, outstanding housing loans of major financial institutions increased by 35.6% year-on-year (y-o-y) to reach 2.6 trillion yuan (RM1.3 trillion), accounting for around 10% of total outstanding loans.

China’s mortgage loans are mainly offered on a floating rate basis. However, banks have also started to offer flexible rates such as monthly straight-line payment, fortnightly straight-line payment, monthly reducing balance payment, deferred principal and step-up repayment.

Most of China’s mortgage loans originate from domestic banks, given the number of branches available and their better understanding of depositors’ histories. Chinese mortgage loans have yet to experience a significant number of defaults. Conversely, some lenders have experienced very fast re-payment speeds which reduce the expected returns on the loans.

As such, the Murabahah (deferred sale finance) mortgage structure seems most suited for the China market. This is an option for individuals who have capital to spare, given that the structure of the mortgage requires the home buyer to pay about 20% of the home’s value on the day of purchase. From that day, the house will be registered as their own. The homeowner can pay off any debt that is outstanding on the property at any point.

Insurance sector beckons
Opportunities also exist for robust growth of Islamic-based insurance products or Takaful in China, which has the fastest growing insurance market in the Asia-Pacific. The potential for life insurance services in China is high compared with other markets in the region, given the country’s strong economic growth, increase in per capita income and the rapidly growing Chinese middle-class segment.

Total premium for China’s insurance industry grew at a CAGR of 17% per year as compared to India’s 26% per year. Between 2002 and 2007, the life segment increased from 227.5 billion yuan to 494.9 billion yuan, and is expected to increase to approximately 750 billion yuan by 2011. Meanwhile, the non-life segment grew from 77.8 billion yuan to 208.7 billion yuan during the same period, and is expected to reach 450 billion yuan by 2011.

China’s insurance sector’s rapid expansion began in 2004, resulting in the establishment of 105 insurance companies by December 2007. The top three companies command just over 70% of market share by premium, although this is expected to diminish as newer participants become more established. Growth thus far has been concentrated in the coastal regions and wealthier areas.

However, this is changing fast as newer companies are setting up offices outside the coastal regions, enabling them to capture a greater share of the market in those areas. The outlook for the industry remains positive, underpinned by a relatively low insurance penetration level, a rapidly emerging middle class, improving operational fundamentals and the development of a more proactive regulatory framework.

China’s growing wealth club
On the wealth management side, China stands out in the Asia-Pacific region for having among the highest concentration of high net-worth individual (HNWI) wealth.

Asia-Pacific is home to 27.1% of the world’s high net-worth population. A further breakdown shows that Japan and China, accounted for 43.7% and 20.6%, respectively, of the region’s total wealth.

In 2006, Asia’s HNWI increased by 8.6% to 2.6 million individuals (2005: 9.1%) while HNWI total assets rose by 10.5% to US$8.4 trillion (2005: 7%).

These were driven by significant HNWIs and HWNI wealth growth witnessed in Singapore, Indonesia, Taiwan, India and China on the back of robust GDP growth, positive economic sentiments and strong equity markets performance.

These strong fundamentals, combined with continuous economic reforms and market liberalisation in these emerging markets, will translate into strong Asian demand for investment products and fund management services in the future.

The growing number of high net-worth individuals in China will increasingly demand better customer service and higher returns on their investments. Concurrently, domestic banks are increasingly offering innovative products to meet customers’ needs and requirements, of which Islamic wealth management products and services may be a viable option.

Like other conventional markets, China has realised the importance of incorporating Islamic finance into its banking system to position itself as a complete financial centre. Hong Kong and Shenyang have already announced plans to establish Islamic finance centres in the region.

Shenyang provides a ready market for Islamic banking and finance products, given its population of 7.2 million and relatively high income per capita. If the plan materialises, this would complement Shenyang Finance Development Target 2010 which includes the development of a regional finance centre that houses financial institutions, financial markets, advanced financial facilities and efficient financial services.

Shenyang is currently the base for the equipment and manufacturing sector, housing industries such as mechanical processing, metallurgy, chemicals, medicine, light textiles, electron, automotive and construction materials.

Currently, Shenyang has 59 financial institutions including 25 banks, 25 insurance firms, seven securities branch agencies, and two futures agencies. The introduction of Islamic banking and finance products will benefit Shenyang’s industrial players and complement the conventional banking and financial products in the city.



Written by Suapi Shaffaii

August 20, 2008 at 8:01 am

Posted in Articles

Tagged with ,

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