Guanxi can be loosely defined as a mixture of “connections” and “relationships”. Some say that building a private banking initiative in China is impossible without it.

When it comes to doing business in China, it is all about Guanxi.

Although there is no direct translation into English, Guanxi can be loosely defined as a mixture of “connections” and “relationships”. Some say that building a private banking initiative in China is impossible without it.

Not that this has stopped a flurry of global private banks pushing into the region, in a bid to tap the nation’s rapidly-growing pool of wealthy entrepreneurs. The likes of UBS, HSBC, Credit Suisse, Goldman Sachs and Deutsche Bank are all vying to grow market share and many have had a presence in mainland China for over a decade. Some have established a number of regional hubs, others,  joint ventures, and some have an individual “rain maker” private banker.

No wonder China, with the fourth largest and fastest-growing population of high net worth individuals in the world is attracting banks like bees to the honey pot. According to a study published last month by Switzerland's Julius Baer and broker CLSA Asia-Pacific Markets, China’s population of millionaires will hit 1.4 million by 2015, with wallets worth nearly $9 trillion. 

Slow Progress

But progress is painfully slow. According to the latest biennial PricewaterhouseCoopers survey, Foreign Banks in China, less than 5 per cent of Chinese assets are in the hands of foreign banks. Industry sources say that global banks are finding it challenging to squeeze fees out of Chinese clients.

An estimated 80 per cent of Chinese high net worth individuals (those with over $1 million in liquid assets) are first generation business owners and entrepreneurs. These individuals are used to making their own investment decisions. Many cannot see the draw of paying a discretionary manager to run their portfolio their behalf – when their own investment nous has already proved successful, say sources.   

"The standalone private banking offering doesn't hold much weight in China. The Chinese don't want their money managed, they want investment opportunities. Many of them have their assets tied up in their business, where they could be making a 30- 35 per cent annual return. They cannot understand why they would swap that for a 10-15 per cent return on their investment, from a private bank,” said Jonathan Hollands, managing director at Asia-based executive search firm Carraway Group. 

A case in point is Li Ka-Shing, one of China’s wealthiest men. Rumour has it that Li conducts his wealth management through a family friend he has known for decades from his home village, turning away Harvard-educated private banking veterans promising low risk high returns discretionary portfolio management.

The Case for Diversification

Of course anyone can argue the case for asset allocation and portfolio diversification. One only needs to look back at the great losses incurred during the various historical financial crises, to see that it does not make sense to put all your eggs in one basket, even if that basket is your business. But the key is trust, which takes a long time to build and even longer in China. 

The global financial crisis had a negative impact on the reputation of international banks and wealthy Chinese clients lost trust in foreign players. According to this year’s China Private Wealth Study by Bain & Company and China Merchants Bank, 85 per cent of high net worth respondents who use financial institutions for wealth management now select domestic banks above foreign institutions.  The 2011 survey, of 2,600 Chinese HNW individuals, classed HNW as those with RMB 10m ($1.5 million) and above in liquid assets.

This is partly why global players are finding their margins in the region growing thinner and thinner. According to Sebastian Dovey at consultant Scorpio Partnership, private bank cost-income ratios rose last year to a record of nearly 80 per cent. But in Asia they are often much higher. 

Dovey said: “In Asia, where there is very heavy investment in developing the distribution capabilities (aka relationship managers) the costs are very substantial right now. Those with a higher weight of business in transactional or advisory are showing slightly improved cost-income ratios because the revenues in volatile trading markets can be good. But all recognise this is a risky revenue bet to play. While most financial institution are not yet officially reporting regional cost-income data for wealth management our fieldwork suggests some well known institutions are operating with much worse cost-income ratios in Asia, but are validating this on the basis they are investing now for future growth. They have been doing this for some time. ”

What is more, the domestic banks are learning new tricks from their Western peers. Afzal Tarar, a partner at accountant PricewaterhouseCoopers in Shanghai, believes Chinese banks have evolved “significantly” since the country’s economic transformation began three decades ago. Local players have strengthened their focus on individual clients and have aggressively pursued the emerging mass affluent client base with new products and services, including separate outlets and service counters and preferential membership cards.

Learning from the West

To attract the new wave of emerging affluent, Chinese banks have begun to incorporate the western private banking concepts and practices into their business models and operations. Since 2007, all major Chinese banks have begun private banking operations while others are planning to join this new area of business, said Tarar.

Many, for example, are adopting the integrated services model, which provides all forms of financial services under one roof. Among other services, banks provide corporate banking and lending, investment banking, corporate jet lease, extensive in-house investment advice and investment management services, and give their clients life and health insurance and advice on succession planning, trusts and philanthropy foundations. 

"There is a growing trend and growing revenue streams for banks that offer 'Corporate Advisory' services to their clients in addition to more mainstream personal investment opportunities, which address business needs not just personal ones. The monetary size of these entrepreneurial needs often fall below the interest level of the main investment banks, but can provide lucrative fees if addressed correctly from within the private banks," said Hollands. 

The better private banks also supply third party connections, for example to Simu Jijin (exclusive private investment funds set up by individuals), private equity funds, off-shore investments and art collection advice.

And the model is evolving. “It seems that many of these banks are principally driving their business through transaction fees and investment management fees and offer many other services as “value-add”, mostly for free. We believe the model will evolve over time and clients will be willing to pay for these services and banks will have increase service fee revenue,” added Tarar. He added that Chinese clients put heavy emphasis on the relationship with private bankers who serve them, which gives Chinese private banks an advantage as they have a more localized understanding of what matters to domestic Chinese clients – coming back to the ubiquitous problem of Guanxi.

Successes

The Bain & Co survey said among the most successful domestic players are China Merchants Bank (which sponsored the research),  Industrial and Commercial Bank, and Bank of China. Others point to  China Mingsheng Banking Corporation and Agricultural Bank of China.

Although annual results are rarely broken down into wealth management, at CMB for example in 2010, net profit at the private banking unit rose RMB400 million ($62 million). The assets and customer base of the private banking division are forecast to grow more than 35 per cent year-on-year in 2011, according to a newswire interview with CMB vice president Ding Wei earlier this year.

But China's HNW individuals could be on the verge of turning from their domestics. In the first half of this year, China's mutual fund industry made a combined loss of RMB125.4 billion (around $19.6 billion) battered by weakness in the country's stock market, according to official financial newspapers last month. This compared with an even greater loss of RMB439.75 billion in the first half of 2010.

All of the country's 61 fund management companies, which manage 763 mutual funds, posted losses in the first six months of this year, the official Shanghai Securities News said.

Surely there comes a time when Guanxi can no longer be justified over high returns and stable investments.  Or at least, that is what foreign private bankers are be hoping.

Offshore banking

And there are other ways in which the global banks can, and do, differentiate, even without Guanxi. Offshore banking is one of them. Spooked by the nation’s volatile financial markets, increasing numbers of mainlanders are seeking investment opportunities and wealth havens outside of China. But legal restrictions dictate that Chinese mainlanders may move no more than the equivalent of about $50,000 out of the country annually.

But there are ways of moving money around, and global banks with distribution channels in Hong Kong can advise Chinese clients on international investment. Nevertheless, even here Chinese banks are catching up. Some of them are setting up private banking outlets overseas, to go after the domestic Chinese clients’ offshore funds, said Tarar.

What the global banks also have on their side is experience, and branding. The can provide sophisticated offshore services, products and research. They can also give more flexibility on intra-departments collaboration. Foreign banks also tend to be more focused on long term investment products with more of stable return profile, which might not be the preferred choice for the Chinese due to their demand for higher returns.  

“Compared to Europe and the US, the private banking business and corresponding business model are at an early stage of development among Chinese banks. Different Chinese banks treat their private banking business differently – for most banks the private banking is a new customer segment within the retail banking division while for some it is a separate business unit,” said Tarar.

He added that China Minsheng Banking Corporation (CMBC) seems to be the only bank in China so far that lists private banking division as a separate business unit. The rest of the banks have kept the private banking business as a “tier one“ department, at the same level as the retail banking department (e.g. ICBC), or as a “tier two” department under the retail banking department (e.g. China Merchant Bank and ABC).

But not everyone agrees that Guanxi is at the heart of the problem. “Lack of Guanxi is the excuse that people use when they are unsuccessful in China,” says a former investment banker at a French lender, who was previously based in Hong Kong. “The Chinese are very financially-savvy and open-minded to new products and initiatives. If you give them a better offer on their current situation, they will take it. The problem is, few Western banks can do that.”