April 15, 2008 -- With China's mainland financial market gradually opening up, foreign banks are moving fast into second-tier cities, including coastal and hinterland locations in the central and western regions for expansion.

"CBRC encourages foreign banks to expand to second and third-tier cities by prioritizing the central and western areas of mainland China," Zhaoxin Wang, assistant to the CBRC president, told Emerging China. "This policy tendency will have an important impact on the distribution network of foreign banks."

Since the government liberalized the banking sector last year, more than 20 foreign banks have been allowed to operate on the Chinese mainland with corporate status, including Citibank, Deutsche Bank, Standard Chartered Bank and Mizuho Corporate Bank, according to state-owned Xinhua news agency.

"As the market saturation rises, in the future the issuance and audit of the operating license for the financial sector will be strictly controlled, which will increase the difficulty in opening new outlets," Lin Xun, market director with HSBC Bank (China) Co. Ltd., told Emerging China. This is why foreign banks like Citibank, HSBC, Bank of East Asia have started to actively expand into cities like Wuhan and Chengdu, he said.

Just last month, HSBC Bank announced that it had received approval on its plan to open a branch in Zhengzhou, capital of Henan province in central China. HSBC will become the first foreign bank to locate there.

Elsewhere in central China, HSBC has already set up outlets in Wuhan and Changsha, capital cities of Hubei and Hunan respectively.

Nanchang, capital of Jiangxi province, is another emerging location. Standard Chartered (China) has started preparations for a new branch in the city after receiving CBRC approval.

So far, HSBC has 62 branches covering 17 cities in mainland China. Standard Chartered Bank has branches in 15 Chinese cities, while Bank of East Asia has 40 branches.

Market demographics is an important factor to foreign banks' expansion, according to Zhimin Lin, vice president of Bank of East Asia (China), which received CBRC approval last January 15 to open a branch in Urumqi, capital of Xinjiang province in northwest China.

"Before deciding the branch location, we made a field investigation in Xinjiang. We noticed that many indicators such as population, GDP growth, import and export volume and consumption capability are satisfactory," Lin said. "We believe many of our potential target customers are there."

There have been good results in second-tier cities, according to Kam Hou Yin, Bank of East Asia's general manager in Xi'an, capital of Shaanxi province. "Up to now, our branches in the central and western regions have accounted for 15 percent of the bank's entire East Asian asset," Yin said. Last year, the Xi'an branch reported a net profit of US$11.4 million (80 million yuan), he said.

Local officials in second-tier cities are also keen on introducing foreign banks. "With the aim to build Zhengzhou as a regional financial center, we will endeavor to create an incentive mechanism through financial talents' training program, preferential taxation policies and sound communication and coordination between all relevant departments," Jianqin Zhain, deputy director of the Henan Bureau of Commerce, told Emerging China. He said the Zhengzhou municipal government has set up a 100 million-yuan special fund for these purposes.

Foreign banks' expansion to central and west China is an effective growth strategy given fierce competition in first-tier cities like Shanghai and Beijing, according to Shengxin Ran, finance professor from East Normal University in Shanghai. Given domestic banks' stronghold in second-tier cities, foreign banks will compete on the basis of product diversification, he said.

"Foreign-funded banks in second-tier cities can outperform their Chinese counterparts in the high-end financial market with diverse product and tailored financial solution to guide investment orientation," Ran told Emerging China.

For example, the Van Gogh Preferred Banking center of ABN AMRO, which entered the Chinese market in 2003 targeting high-end clients, is now famous for its diverse financial management solutions, according to Yaosheng Li, senior researcher of financial products with Southwest Finance University. The Van Gogh center offers investment options like ecological, IPO, currency, as well as agricultural products to cope with diverse financial demand. It has also launched a facility allowing investors to track related global stocks in the energy sector. All these products are designed to diversify investment portfolio and reach an average profit of 30 percent, Li said.

Major foreign players like Citigroup, Standard Chartered Bank and HSBC are also gearing up to tap the financial needs of small and medium enterprises. Standard Chartered was the first overseas lender to offer non-mortgage loans to SMEs. Qualified small companies can borrow between 100,000 yuan and 500,000 yuan from the bank's outlets in Shanghai and Shenzhen without any collateral. Loans to those small and medium firms are a key product in the consuming banking sector, according to Christine Ip, China head of Standard Chartered's consumer banking.

But according to Yanpin Huang, credit card director of China Construction Bank's Jiangsu branch, domestic banks still have an edge over foreign banks, especially in the consumer business.

"In the short-term domestic banks won't be seriously affected by the card issuing of foreign banks. But in the long run, foreign banks will be a strong competitor in the card business sector," he told Emerging China.

The credit card market is crucial for the development of foreign banks in China, it was pointed out at the 2008 Foreign Banks Summit held in February. Only when the issuance of credit cards reach more than three million can banks make profit, Ping Lian, top economist with Bank of Communications, said at the summit.

Foreign banks have to compete with the likes of China Merchants Bank, China's first corporate owned joint-stock commercial back that was set up in 1987, which has amassed credit card volume. As of December 2007, its credit card volume has reached 21 million, based on statistics from the bank.

"That is why domestic banks spare no effort in attracting card users. At present foreign banks cannot directly compete with China's domestic banks in the sector of credit card," Lian said. HSBC and Citigroup cooperate with the Bank of Communications and Shanghai Pudong

Development Bank, respectively, to co-issue credit cards, using the latters' own bank card business experience and high brand awareness to develop the market, he said.

"In the long-term, foreign banks have good prospects of development in both product models and financial solutions in China's market," he said.