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China Is Banking on Private Investment

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China's recent market reforms have taken another step toward liberalization.

In a recent announcement, the China Banking Regulatory Commission has announced that the state would allow the creation of between three and five private banks by the close of the calendar year. This announcement, following on the heels of Premier Li Keiqiang's Third Plenum party meetings in November, indicates a huge shift in thinking regarding how Asia's biggest market will approach future investment opportunities.

A shift in thinking
With the lowest profit margins across three continents, Asian banking has rarely been called "investor friendly." The Wall Street Journal has often made claims that the wealthy Chinese "have been lousy clients for private banks."

This is starting to change as the affluent and less-affluent alike are seeking to pass on money to their next of kin. Since 2011, the profit margin in Asian private investment has grown significantly (by 6% between 2011 and 2012) and seems primed to continue to grow in the next several years.

Why the switch?
This long-held banking view may be changing in the wake of the wave of shadow banking currently entrenched in Chinese financial markets. Though shadow banking, utilized for its ability to mimic commercial banking options, is an acceptable bandage for private investment, liquidity issues and lack of regulatory control has driven the decision for a more stable private investment system.

With a central banking system that favors government companies and reform advocates, the creation of new banks would allow currently credit-deficient businesses access to new investment streams as they continue to create jobs and wealth in the country. This paradigm shift is not strictly due to current investment concerns, however.

Although initial banking practices tended to have investors maintaining multiple accounts across several institutions, it appears that the process is breaking down to investor exhaustion. Coupled with new sales pitch avenues and the new valuation of banks as market-savvy entities, this should indicate a prime market for the banks that will come onto the scene this year, right?

Hold on a moment
It isn't yet time to pop the cork for Chinese banking. The limited private banking roll-out is founded on substantial amounts of concern. Minsheng Bank, one of two current private banks in-country, has been operating since 1976 on the pretense of taking on excessive amounts of risk that hold potential liquidity issues if investments go poorly.

If banks need to take on such incredible levels of risk to turn a profit, is the market ready or even needing new private firms? While consumer demand is growing in the country, there may not yet be enough of it to necessitate the creation of new types of lending that are currently unneeded in China. 

Naturally, the flip-side of this discussion lies upon three things. One, the financial state of Minsheng Bank is a history generated in a less private banking-friendly environment. It could be possible that new banks may not be subject to the same pressures that Minsheng had been.

Two, despite poorer projections on Chinese growth in the short and medium terms, the economic plan given by Premier Keiqiang does give a very real possibility of continued growth. Given the current principles of the "Likonomic" system, the resultant growth would generate the demand for consumer-based banking. 

Three, the Chinese system would have to relinquish some of its current control on a largely monopolized system. As referenced, government companies and reform advocates are the greatest losers in an open banking system where cheaper credit is available to competition. President Xi Jinping's recent reforms against interest rates controls seem to indicate the government accepts this as a very real possibility.

China is not magically becoming an advanced market economy overnight. But if the reforms proposed by the Chinese leadership have any positive effect, an open Chinese economy may be possible and even likely in the near future.

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Kurt Avard

A January 2014 addition to the Motley Fool team, Kurt Avard prefers to focus on the "dark" side of business and how it interacts with politics. Rarely writing on the same thing twice, he feels that, if he manages to convince you that the two are inexorably linked, he has adequately done his job. Follow him on Twitter @kurtsavard

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