SHANGHAI — In the first 10 months of 2006, Chinese regulators uncovered 776 banking crimes, including 205 cases involving more than 1 million yuan ($125,000 U.S.). Fraud and other irregularities at Chinese banks added up to $95.9 billion in 2005, an increase of 31% from 2004, according to the China Banking Regulatory Commission.
In one widely publicized case last summer, a government audit uncovered financial crimes and bookkeeping irregularities totaling 52 billion yuan ($6.45 billion) at the state-owned Agricultural Bank of China, the country’s second-largest bank in terms of assets.
With losses that big, it’s no wonder Chinese banks are investing heavily in risk management technology. For example, Agricultural Bank of China last year rolled out a new real-time monitoring system to reduce fraud.
But adopting technology for risk management and fraud control is only part of the Chinese banking industry’s agenda. Banks are centralizing operations, improving financial reporting, automating manual processes, improving customer service and developing new products to compete in an expanding marketplace.
And like their counterparts in the U.S., many are feeling the pinch of new regulations. IT is at the heart of all this activity, and the scale and speed at which the Chinese banking industry is ramping up may be unprecedented.
“The scale is tremendous,” says Elias Baltassis, director at the Paris office of New York-based consulting firm Opera Solutions LLC. Moreover, Chinese banks have to upgrade all their systems at once because they are behind in every area. “This is a problem U.S. banks never had,” Baltassis says.
Chinese banks are buying new IT systems “across the board,” for areas such as core banking platforms and risk management operations, as well as physical infrastructure systems such as ATMs, says McKinsey & Co. partner Chris Ip, who heads the New York-based management consultancy’s greater China IT practice.
Until now, Chinese banks have operated in a fundamentally different way from banks in the U.S. In many Chinese banks, each branch borrows and lends money almost as if it were a stand-alone business, says Colin Lawrence, risk enterprise and transformation leader for greater China and the Asia-Pacific region at IBM Global Business Services. For example, if a branch needs money to issue a loan, it will turn to the interbank market — where Chinese banks lend money to one another — and pay for the privilege.
“If each branch sets its own prices and lends its own money, it’s obviously inefficient,” Lawrence says. “By having a common system, you can combine all the deposits and all the loans from the entire bank, reducing the need to go to the interbank market.”
One organization that appears to have gotten ahead of the wave is Bank of Communications Co., the fifth-largest bank in China. In August, it completed a project to centralize data for its retail operations, with the help of Sterling Commerce Inc., a Dublin, Ohio-based IT consultancy.
Working with a Western partner is a common practice among Chinese banks. Bank of Shanghai, for example, hired Hewlett-Packard Co. two years ago to build a standards-based service center that reduced the costs and processing time of online transactions. HP in turn worked with Temenos Group AG, a provider of banking systems in Geneva.
Bank of Shanghai is considering working with Temenos again, says Chen Chen, an IT manager at the bank. But Chen says foreign vendors must work to localize their systems for Chinese needs — beyond just adding Chinese character support. “Business requirements are different from abroad,” he explains.
For example, Chinese banks still need to improve nonperforming-loan ratios and transparency, says Michael Araneta an IDC Financial Insights analyst based in Singapore. Converting paper processes to electronic systems is also critical, but so is organizational restructuring, he says. “The benefits of having straight-through electronic processes — such as increased productivity of staff, improved turnaround times for products, elimination of errors and better management of operations costs — will be limited if Chinese banks continue to have systems that are not integrated and if branches continue to operate as islands by themselves,” Araneta says.
But with data centralization comes the challenge of keeping all this newly accessible data safe. Here again, Chinese banks are working with international vendors to take advantage of their experience and best practices.
And those are sorely needed. A Sterling Commerce study showed that many Chinese banks transfer files using free software that they’ve downloaded from the Internet.
“Freeware has a lot of security loopholes,” says Albert Visscher, Sterling Commerce’s marketing director for the Asia-Pacific region. It increases the risk of data breaches and can cause operational problems, he says.
Badly managed credit risk is another big problem. Chinese banks are notorious for bad loan portfolios and government bailouts. “In practice, many [Chinese] banks are not able to discriminate between high- and low-risk borrowers and price accordingly,” says Mark Lawrence, a principal at McKinsey. Credit risk management systems can improve banks’ bottom lines and create opportunities for new revenue by making it possible to charge higher-risk borrowers higher rates.
“The theory is known. The main challenges now are practical implementation challenges,” he says.
New international competition is raising the stakes. In December, the Chinese government opened the country’s banking sector to foreign firms, and at least 10 banks have already applied for licenses to incorporate in China. Incorporation will allow them to issue credit cards and offer yuan-denominated bank accounts to Chinese customers.
And those customers might be interested in the new arrivals, because the quality of service offered by Chinese banks has been a sore spot. For example, at the country’s largest bank, Industrial and Commercial Bank of China, wire transfers can take three days. In contrast, they’re virtually instantaneous in many other parts of the world. And a Chinese bank customer who loses an ATM card may find that it’s less onerous to open a new account than to get the card replaced.
Advanced IT enables foreign banks to offer better service, which can be particularly attractive to affluent customers, says Christopher Formant, executive vice president for global financial services at BearingPoint Inc., a McLean, Va.-based IT outsourcer with a strong presence in China.
To meet that challenge, Chinese banks are ramping up quickly. “I know of a bank rolling out a new core banking platform in less than one year,” says Ip. In the West, such a project could take years, he adds.
Chinese banks are able to move so quickly in part because they’re deploying new technology so late in the game. The problems they’re addressing have already been solved by other banks. “The solutions exist,” Opera Solutions’ Baltassis says.
But it’s not quite as simple as it sounds because the software has to be customized. “Off-the-shelf [software] will cover 90% of the distance,” he says. “The competition takes place in the last 10%.”
Many banks in China underestimate the complexity of implementation, Ip says, citing the frequent need to build Chinese-language interfaces. But some say that Chinese banks primarily lack the skills and experience needed to use this technology.
“It is time for the big banks to focus on the people and process side,” says Charles Richard, co-founder of Quantitative Risk Management Inc., a risk management consulting firm in Chicago.
Chen echoes this view. “I don’t think the weakness lies on the IT side,” he says. “It’s on the business side.”
To keep their best customers and compete with foreign banks, Chinese banks are also investing in technology to support new lines of business. Last year, for example, Agricultural Bank of China went live with software from London-based Misys PLC to handle trading and risk management of treasury market derivatives and structured products. It uses a straight-through processing system that covers transactions all the way from the front office to the back office.
The move was also driven by the China Banking Regulatory Commission’s requirement that banks implement technology before engaging in certain types of business.
“We did it to meet CBRC’s regulatory requirement,” says an IT manager at China Merchants Bank, another early adopter. “If we want to trade derivatives, we must have this kind of system.”
And if China needs it, China will have it. “The pace of change and the growth is extraordinary,” Formant says. He predicts that over the next decade, Chinese banks will take their place among the world’s leading financial services companies.
Richard agrees. “I see the evolution not taking 10 years or five years,” he says. “I see these modern methods coming together very quickly.”
Wendy Yu and Patrick Martino contributed to this report.