The Growth of Transaction Banking in China and India
These are challenging times for the world economy including Asia, but India and China continue to see economic growth. India’s gross domestic product (GDP) is expected to grow at about 7% in 2012, and it has been in the 6.5% to 8.5% range since 2008. However, inflation continues to be a problem in India and interest rates are high. China’s projected GDP for 2012 is below 8% for the first time in two decades, but that doesn’t mean China faces any real threat of recession. After a prolonged period of rapid growth, the slower rate of development, together with more focus on domestic consumption, should be more sustainable.
While both nations have a strong economic prognosis, they certainly are not immune to the eurozone crisis. Furthermore, both nations have their own challenges in terms of tightly regulated markets, a fragmented clearing infrastructure, non-automated payment systems and corporate governance rules that make cash management and repatriation of cash, a rather complex proposition for many foreign corporates. So what is the transaction banking environment like in India and China, and what are the challenges and opportunities?
Three of the main features of transaction banking in China are:
There are some underlying reasons for the features and priorities of Chinese transaction banking. Local banks place importance on deposits because China’s banking authority, the China Banking Regulatory Commission (CBRC), monitors their loan/deposit ratios. Another factor is that the interest rate is regulated, so the margins are more or less guaranteed. This drives business for local Chinese banks more than the transaction banking fees.
The defining features of transaction banking in India are not that different when compared with China. The primary objectives for companies are automation, outsourcing and risk management, while consolidating their transaction banking relationships to derive maximum efficiency and liquidity. Companies in India are increasingly looking at treasury consolidation in order to have better visibility of their liquidity, as well as the ability to move their money faster and more efficiently. They want to manage risk, and particularly counterparty risk, so having a consolidated view helps them manage their exposures across the entity.
In the transaction banking space in India, there has been a huge growth in volumes and increased penetration by corporates, with multinational corporations (MNCs) increasingly expanding into the second and third tier cities1.
While there are opportunities in both India and China, there are also challenges. Deregulation is a slow process and there are still regulatory constraints in both countries. One of the common challenges is that the regional regulatory bodies often have differing interpretations of the law, complicating compliance for corporates.
China is pushing for an upgraded national payment system, with China’s National Advanced Payment System (CNAPS) soon to migrate to CNAPS 2. The enhanced system will have a wider functionality and also allow large amounts of yuan to be cleared across regional borders. However, China’s network of fragmented local clearing systems remains in place.
India has more than 1,000 clearing zones, as well as 78,000 local and foreign bank branches. This has been a challenge for companies hoping to achieve efficient cash management and consolidation of accounts. However, the emergence of electronic payments (e-payments) has made transaction banking more efficient. E-payments have become dominant, with 90% of payments by value now processed electronically and 45% of payments by volume electronically. The challenge is that 55% of payments are processed manually, and even though they are very small value payments, it is still a treasury nightmare.
Transactions in India are on a scale rarely seen outside the sub-continent: with vendors selling products in the smallest shops in remote villages at one end of the value chain whereas at the other end, many of the MNCs have to handle huge transaction volumes and managing these as efficiently as possible is a major part of their cash management cycle. However, global banks have developed solutions to mitigate these challenges for clients through the use of a local partner banking arrangement that has an extensive coverage which enable efficient cash management and consolidation of accounts.
Likewise, the regulators stipulate that certain local taxes are to be collected by local bank branches only. This often poses further difficulty for corporates wanting to maintain streamlined accounts. However, over the last few years, banks in India have developed solutions around the local infrastructure and regulations to enable clients to process such payments with its global banks. Despite the challenges, and often because of these, it translates into opportunities for banks and companies operating in these countries.
In China, for example, there are three broad areas of opportunity for transaction banking:
The Asian economies will have to look closer at the impact of the eurozone crisis as Europe is an important economic partner to the East. Both China and India are not spared.
As China’s largest trade partner, the eurozone’s slowdown of consumption is affecting China’s export momentum. In the first quarter of 2012, China’s exports slowed down as compared to 2011, mainly due to reduced demand from the EU. Year-on-year, export growth to the US was 14%, but to the EU it decreased by 3.1%.
Although the financial sector in China can feel the change in business volume as a result of the slowdown in exports and trading business with Europe, the local banks on the other hand, are not over-exposed to the sovereign debts in the eurozone. The crisis is impacting the pace at which Chinese banks are expanding their business in Europe as regulators in the eurozone have slowed the approval process for entry for foreign banks.
Similarly, India can no longer say it is completely unaffected by the eurozone crisis. India has a largely domestic-led economy and, unlike China, it does not depend heavily on exports to the West. India’s largest trading partners are China and the Middle East. India exports natural resources such as minerals and agricultural products like cotton to China and buys capital goods like machinery, power plant and telecommunications equipment from China. Nonetheless, India is seeing a drop in demand and companies with clients in Europe are affected by this. They are under pressure to reign in their liquidity and adjust their counterparty risk exposures.
Another indirect effect of the European crisis is that companies want working capital efficiency and better liquidity management. This is partly an effect of the European crisis, but it’s also a result of India’s high interest rates, which is hitting the mid-sized and smaller corporates. As a result of this, solutions such as supplier finance programmes are seeing more demand in India and the banks’ ability to offer customised technology-enabled financial supply chain management solutions is bringing significant value to the clients.
The internationalisation of the RMB is significant in China and globally. In Q411, the People’s Bank of China (PBOC) expanded the scope of RMB cross-border payments, so the currency can now be used for cross-border direct investment, either outbound or inbound, as well as for cross-border shareholder loans into China.
The CBRC is also preparing for the new capital regulations for banks in China as part of Basel III. Chinese banks are already raising capital and this will put them on an equal footing with European banks.
The Reserve Bank of India (RBI) is also working on Basel III, although some of the requirements could be a strain on local banks. This hasn’t affected the market yet, but when Basel III adoption begins next year, there could be further tightening of credit and liquidity.
Regulations in India prohibit cross-border cash pooling, leading to trapped cash for MNCs. Current account convertibility is possible, but capital account convertibility is not. Dividend payments by local subsidiaries to their parents are subject to withholding tax and often can become a challenge for MNCs. Import trade in India is regulated and requires underlying documentation to be submitted to the bank before making the foreign currency payments. Because of these challenges, clients are looking at outsourcing solutions for import documentation management and automated solutions for FX payments and rate booking. Only a banking provider with a sophisticated and advanced array of transaction banking product suite are able to meet these requirements of these clients comprehensively.
The rupee has seen 20% depreciation in the past five years and the RBI introduced guidelines to regulate this, mainly to prevent speculative hedging. However, regulation has also made genuine hedging contracts more complex.
Shanghai and Beijing have launched schemes for MNCs to establish regional treasury centres (RTCs) in China. They offer preferential policy treatment and streamlined approval processes. This has led to some MNCs looking to establish RTCs for Asia in these locations, for example Shanghai or Beijing.
Working capital management is very important for corporates in both China and India because they cannot afford to keep excess cash in some entities while paying for funding in other entities, due to the gap between the lending rate and the deposit rate.
Repatriation of cash accumulated in China has always been a challenge, but this was made easier with the introduction of cross-border entrustment loans subject to regulatory rules. However, direct inter-company lending is still not allowed and companies are looking forward to more policy developments to allow them to repatriate cash out of China. There are also still some regulatory constraints on foreign exchange (FX) payments. For instance, supporting documents are required for inward FX conversion and outward FX payment, as well as the adherence to additional State Administration of Foreign Exchange (SAFE) procedures if the payment is to be executed outside of the city where the company is located.
In India, one of the biggest challenges for corporates is cash pooling, which is highly regulated and not available for all corporate structures. Inter-company lending is similarly regulated and dependent on company structure. Companies need to understand how they can move their cash more efficiently, while addressing the country’s local requirements.
The economic changes in China mean that companies may have to adapt their business models. Exporters to Europe tend to export through distributors, so they have to deal with a limited number of counterparties. They are also protected by trade finance instruments like letters of credit (L/Cs).
Selling to the domestic market requires a domestic distribution network, which is a completely different business model and has different banking requirements. Despite the differences, changing their business model from export-only to selling into the domestic market is now an alternative option some exporters are considering. On the whole, MNCs are increasingly focusing on China as a market rather than a production base, and they are expanding their physical presence in smaller cities.
Many companies in India are also taking a closer look at their business model and their transaction banking services as they’re looking at consolidation. Companies need to ensure that their bank’s strategies and growth models are aligned with their own.
Technology has always been a driving force for transaction banking. Consumer uptake of new technology and communication in China and India is advanced, so continual investment is needed to stay ahead of developments in mobile technology, such as interfaces with tablet PCs or smartphones. These consumer-led developments are shaping the corporate world and these countries are already seeing corporate treasurers using their mobile devices to authorise cash management transactions.
Advances in technology are driving upgrades in the infrastructure of China’s clearing system. With the upgrade to CNAPS 2, it is also developing its connectivity to the SWIFT global payment system. Once implemented, cross-border RMB payments will become easier.
China is also seeing connectivity between the RMB clearing system and other capital markets systems, such as the stock exchange or the central clearing system for bonds. CNAPS is now being connected with the bond clearing system in Hong Kong. Customers can buy and sell bonds and then get the proceeds in RMB via an automated cross-border payment.
There is good potential for cashless collection in China, particularly in certain sectors like business-to-consumer (B2C). Third party payment platforms also provide an interesting payment solution for B2C and e-commerce businesses.
In India, the RBI has set up the National Payments Corporation of India (NPCI) as an independent entity to build state-of-the-art, consumer-friendly electronic retail payments systems that would be available around the clock. Some of the key initiatives taken by NPCI, such as mobile payments (m-payments) through the Interbank Mobile Payment Service (IMPS), would have a significant impact in terms of improved efficiencies for corporates in India for their domestic collections and payments.
Overall, the three main factors that are of concern to corporate treasurers in both India and China are efficiency, liquidity management and risk management. Technology, innovation and optimisation will all play a key role in how corporates grow and are supported by their transaction banks.
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1In India, the general classifications are: Tier 1 cities are large urban towns with good clearing infrastructure; Tier 2 cities are semi urban towns with average or inconsistent clearing infrastructure; and Tier 3 cities are rural towns with poor clearing infrastructure.