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RBS takes a risk by banking on China

19th August 2005
By IB Staff Writer

After months of speculation, Royal Bank of Scotland has agreed to lead a GBP1.7 billion investment in Bank of China. As well as giving RBS a foothold in a market that could provide the growth potential UK and European markets are failing to offer, the move will please nervy investors as RBS's individual investment in China is smaller than was initially feared.

RBS's investment follows closely behind similar deals signed by Bank of America, which recently bought a 9% stake in China Construction Bank, and HSBC, which acquired a 19.9% stake in Bank of Communications last year.

Indeed, it is hardly surprising that the allure of China and its banking sector have once again proved irresistible to foreign investors. According to figures quoted by The Guardian, the Chinese economy grew by a staggering 9.5% last year, and it is estimated that personal deposits total GBP800 billion. At the same time, British banks are operating in a highly consolidated and competitive domestic market, while cross-border European deals targeting more fragmented markets, such as Italy, have been thwarted by national protectionism.

With this deal, RBS has established a relationship with a Chinese heavyweight. Bank of China is the second largest bank in China with an estimated 12% share of the loans market and a 14% share of the deposits market. It has over 11,000 branches, concentrated primarily in large cities, and caters to a large number of mass affluent customers.

RBS will be hoping to capitalize on Bank of China's distribution network to sell credit card, wealth management and general insurance products. In return, Bank of China will look to draw on RBS's corporate governance, risk management and financial management skills.

RBS's share price has risen following the announcement, ending a torrid few weeks for the bank. RBS's share price had fallen 4.4% amid fears that it was considering a far larger investment in Bank of China - fears that chief executive Sir Fred Goodwin did little to dismiss, and which ultimately overshadowed the bank's largely positive H1 results.

RBS's contribution to the deal is GBP900 million, giving it a 5% stake in Bank of China, which will be funded by the disposal of its 2.2% share in Santander Central Hispano. Santander bought RBS's UK rival Abbey last year, scuppering any hopes RBS may have had of forming a closer relationship with the Spanish giant.

Furthermore, the bank will also manage the stakes held by its two co-investors - telecoms tycoon Li Ka-Shing and Merrill Lynch. Together, RBS's fellow investors contributed GBP800 million, effectively upping the Scottish bank's stake to 10%.

While China is keen to buy in foreign skills, it does not want to see its banks in foreign hands. Indeed an individual foreign investor is only permitted to control a maximum 20% stake in any Chinese bank, and total foreign ownership of any one bank cannot exceed 25%. In light of this, RBS has announced that it has no intentions of increasing its stake in the future, thereby further placating jittery shareholders.

Considering the enormous potential that China holds, some may find it surprising that investors have been so nervous. However, the Chinese banking sector remains a risky place to invest. Chinese banks have always been somewhat overzealous in lending to state-owned companies, while consumer debt is starting to spiral. As a result, bad debts are already worryingly high and any future economic slowdown could leave foreign banks ruing their decision to invest in this market.

Nevertheless, while RBS is taking a punt on the Chinese market, considering the lack of alternative growth opportunities elsewhere and the enormous potential that China offers, Bank of China was clearly too good an opportunity to pass up.

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