Foreign direct investment has been a common conduit of technology transfer for the locally funded enterprises in the host country to adopt foreign technology. In addition, it could be a powerful agent in affecting technology adoption within a technologically backward host country. By contrast, foreign direct investment has not been a significant source of information technology transfer into the Chinese banking system. Neither has it been an effective agent in affecting technology adoption in this system.
The priority and concern of the Chinese government in protecting, and retaining control of, its domestic banks and financial market have kept foreign direct investment in the banking industry at a relatively modest level. The controlled industry, the long wait for full market competition, and the inadequate infrastructure and operating framework have inhibited the foreign banks from adopting highly sophisticated information technology for their restricted business operations and from being an effective conduit in technology transfer.
BACKGROUND The Chinese Economy The Chinese economy’s GDP (Gross Domestic Product) has been riding on a positive growth phenomenon, since the initiation of its economic reform program and its transition from a command to a market-based economy in 1979. The new direction undertaken by the Chinese government has definitely propelled the growth of the economy between the pre-reform and reform periods, as shown in Graph 1. The real GDP growth between 1979 and 2000 (in the reform period) was at an average annual rate of 9.
25%, superseding the average annual growth of 5. 3% experienced between 1960 and 1978 (in the pre-reform period). Although the growth had lost its vigor between 1992 and 1999, many economists and observers remained optimistic in the potential of this emerging market economy. Copyright © Idea Group Publishing. Copying without written permission of Idea Group Publishing is prohibited. 2 Fong Graph 1: China’s Real GDP Growth Rates: Pre-reform and Reform Periods and Annual 14 12 10 8 6 4 2000 1999 1998 1997 1996 1995
1994 1993 1960-1978 1979-1999 (pre-reform) (reform) 1992 0 1991 2 1990 Real GDP Growth Rates (in percentage) 16 Period/Year Source: The World Bank, 1980-1999; China Statistical Yearbook, 1989-1999; National Bureau of Statistics People’s Republic of China, 2001. The Chinese Banking System Prior to 1979, the financial flows in the Chinese socialist economy were largely governed by the predetermined central plan. Under this system, the state-owned banks were the most active and important financial agents in the economy.
They provided the amount of money required to produce the predetermined amount of output and supervised the utilization of funds in accordance with the requirements of the central plan. The banks virtually had no independent role in the creation of either money or credit from the funds deposited by the households and the state-owned enterprises. They merely acted as financial agents of the Ministry of Finance, and the inflow and outflow of money effectively belonged to the latter.
The banking system at that time was a monobank system in which a single bank, the People’s Bank of China (refer to Appendix 1 for a brief history of this bank), undertook the roles of central and commercial banking. As compared to the capitalist system, the financial intermediary activity level and role of the Chinese socialist banking system was very limited and noncompetitive, and deliberately simple and passive. In terms of information technology adoption, there was less demand and incentive for banking technology applications.
The decision made by the Eleventh Central Committee of the Chinese Communist Party in 1978 to transform the socialist country to a market economy has resulted in the implementation of the economic reform program. Since then, the economic reform program has been conducted on a gradual and experimental basis, with emphasis on opening economic sectors (at varying degrees) to market forces, trade and foreign investment. The Chinese government recognized that the support of a welldeveloped and active financial industry is one of the requisite conditions for the full operation of a market economy.
Hence, the financial sector became one of the initial sectors selected for reform and for eventual full foreign participation. The ultimate aim of the reform of this sector is to achieve a sound financial system that is capable of deploying scarce capital resources in the most efficient way that The Foreign Banks’ Influence In Information Technology Adoption 3 supports economic growth. The admission of foreign banks is regarded as a key attraction not only for foreign capital but also banking expertise to boost the growth of the fledgling market-based financial sector.
As a result, several changes in the financial industry were targeted during the reform period, propelling the financial industry to play an active and pivotal role in the development of the economy. Effectively, the banking sector has been the central focus of financial reform because of its relatively established standing as the active financial intermediary in the economy since the prereform period. The reform of the banking sector has resulted in the People’s Bank of China becoming the country’s official central bank and the abolishment of competition restriction among its state-owned banks.
Four Chinese state-owned banks dominated the banking sector during the pre-reform period and the reform period of the 1990s, and they are the Industrial and Commercial Bank of China, the Bank of China, the Agricultural Bank of China and the People’s Construction Bank of China (refer to Appendix 1 for a brief history of these banks). The high market share of these four state-owned banks is a legacy from the past monopoly position of each bank in the pre-reform period, being the exclusive banking unit to specific market segments.
These four banks executed the credit allocation plans of the economy during the pre-reform period and have continued to play a primary role in the provision of financial intermediary services during the reform period. The high market share is also due to the fact that these banks have been relatively effective direct channels for the government in managing, controlling and regulating the economy since 1979. However, it is expected that as the reform of the financial system develops, the market dominant position of these banks will be dissipated in the long run by the entry and active participation of other financial units.
Table 1 depicts a diminishing financial intermediary role played by the four state-owned banks over time. However, in the interim, the state-owned banks are expected to remain the core financial units at the transitional stage of the country’s movement towards a market economy.
In addition to the above-mentioned state-owned banks, there are three state policy banks1 (State Development Bank, Export and Import Bank of China and Agricultural Development Bank of China); three state-held banks (Communications Bank of China, China Everbright Bank and CITIC Industrial Bank); three public-held banks (China Merchants Bank, Huaxia Bank and China Minsheng Banking Corporation); and over 80 city commercial banks, 3,200 urban credit cooperatives and 41,500 rural credit cooperatives in the country.
Table 1: The Extent of the Financial Intermediary Role Played by the Four State-Owned Banks in China Year Loan Deposit 1985 93 % 93 % 1986 93 % 93 % 1987 90 % 86 % 1988 89 % 81 % 1989 89 % 77 % 1990 88 % 73 % 1991 87 % 88 % 1992 86 % 89 % 1993 79 % 69 % 1994 67 % 68 % 1995 63 % 63 % 1998 71% 62%
Source: Almanac of China’s Finance and Banking, 1991, 1994 – 1996; Mo, 1999 4 Fong The Foreign Banking Sector in China Below is a brief history on the foreign banking sector in China, in regard to the origination of foreign banking presence in the country prior to 1949; the demise of foreign banks during the Communist regime; and the return of the foreign banks to the newly emerged market economy in 1984, after the implementation of the open door policy. 1) Prior to 1949 Foreign financial institutions were first located at treaty ports and in Beijing in the 1840s after the opium war.
These foreign financial institutions constituted a powerful influence on the direction of the Chinese financial industry development prior to 1949. This was especially so during the reign of the Manchu government. For much of the period, the operation of the Chinese financial industry was in the control of the foreign financial institutions, which even had the power to overturn rules issued by the Chinese authorities (People’s Bank of China Education Editorial Committee, 1985).
This extensive foreign power largely stemmed from the fact that the weak Chinese government allowed the operation of foreign financial institutions to be governed by the laws of their respective home country rather than by those of the host country. The vulnerability of the government was also reflected in the operations of joint venture banks in which the government had a capital share, for example the Russo-Asiatic Bank, Banque Industrielle de Chine, Chinese American Bank of Commerce, etc.
The internal organization of these joint venture banks was completely in the hands of the foreign shareholder, irrespective of the shareholding configuration. The public accorded lesser confidence to these banks than to the independent and fully funded foreign banks in their financial activities (Lee, 1982). In effect, the fully funded foreign banking sector had a monopoly role in the economy’s trade with foreign countries. Prior to 1949, the foreign banks continued to remain powerful financial agents even despite the turbulent political events in the country.
For example, after the Sino-Japanese war in 1894 to 1895 when many of the foreign banks withdrew their businesses from the country, the remaining 14 foreign banks still constituted a powerful force in the country’s financial system. The power of the foreign financial banks remained strong even during the rule of the KMT government and amidst attempts to strengthen the local Chinese banking sector. This was evidenced by the shore of total assets held by foreign banks within the industry and their influence in the monetary condition of the economy.
In October 1947, the 13 foreign banks located in the active financial market in Shanghai had asset holdings at 26. 2% of the total overall assets in the Shanghai’s financial market, whereas the 147 local Chinese banks’ assets only accounted for 54. 2% of the total. In August 1948, when there were only 12 foreign banks left in Shanghai’s financial market; their assets were even higher than before, at 36% of the total assets.
In terms of the monetary situation, the foreign banks always heavily influenced official and black market foreign exchange rates, and were very important in currency issuance. At the end of April 1949, for example, the currency issued by a foreign bank was about 5. 8 billion yuan, which constituted two-thirds of the total currency issued for circulation for China (People’s Bank of China Education Editorial Committee, 1985). The foreign financial influence and power came to an end in the year 1949, when the government came under the control of the Chinese communists led by Mao Zedong.
It was also the beginning of the era when the foreign banks and financial institutions, except the Hong Kong and Shanghai Banking Corporation, the Standard and Chartered Bank, the Overseas Chinese Banking Cooperation, and the Bank of East Asia, were either nationalized or had their assets expropriated or frozen by the ruling Chinese Communist Party (Wang et al. , 1990). 2) 1949 to 1978 The revolutionary event in 1949 resulted in the withdrawal of many foreign banks from the scene or, in the case of the U. S. banks, they were penalized heavily (through property expropriation or the
The Foreign Banks’ Influence In Information Technology Adoption 5 freezing of assets) for their country’s role in the Korean war. However, not all the foreign banks were ousted from the Chinese banking system, as the Hong Kong and Shanghai Banking Corporation, the Standard and Chartered Bank, the Overseas Chinese Banking Cooperation and the Bank of East Asia were allowed to remain, largely for political rather than economic reasons. Since the heavy exodus of the foreign banks, the national banking system has undergone several deliberate changes to the role of those banks that remained, mostly in accordance with the political climate.
In spite of the continued involvement of the four banks noted above, the closed economy era of 1949-1979 cut off any active presence of foreign banks in the industry. Through the People’s Bank of China, the government took steps to revoke the privileges enjoyed by the foreign banks in China, and consolidated and transformed private financial institutions firstly into public-private jointventure banks and then eventually nationalized them (Yan, 1993). 3) 1979 to 1990s With the open door policy in 1979 and the rapid growth experienced by the Chinese economy, the Chinese government declared the financial market opened to a number of foreign financial institutions2 in 1984.
Despite this declaration, barriers to foreign entry have been high and heavily restricted in their business location and activities. Nevertheless, the number of operational establishments created by the foreign financial institutions in China has been on the increase since 1979, as shown in Table 2.
A majority of these operational establishments are in the banking and insurance sectors. SETTING THE STAGE Business Interest of the Foreign Banks One of the main purposes of the foreign banks in establishing an early presence in the huge potential Chinese market was to provide support to their clients from their home country. The flow of foreign direct investment (FDI) into China has been on the increase as more international corporations move into this country to take advantage of its newly but gradually liberalizing Chinese economic environment.
FDI in China has grown from US$636 million in 1983 to US$45. 6 billion in 1998, which saw a concurrent increase in the number of foreign banking establishments in the Chinese economy. Although FDI has dropped to US$40. 4 billion in 1999, the country remains one of the largest Table 2: Number of Operational Establishments Created by Foreign Financial Institutions in China Year Number of foreign financial institutions in China 1979 33 1987 181 1990 209 1992 304 1994 404 1995 603 1996 694 1997 702 1998 717 Source: Jinrongshibao,1987; 1992; 1995, and 1997; Dipchand et al.
, 1994; People’s Bank of China, 1996; China Economic Information, 1997. 6 Fong FDI recipients in the world. Another main purpose of the foreign banks in establishing an early presence in the Chinese market was to prepare for the opening up of the local currency (Chinese yuan or Renminbi) business to them. In the Chinese culture, the propensity to save is one of the traditional virtues that have been highly regarded and upheld by the Chinese populace. The Chinese domestic savings as a percentage of GDP averaged above 30% between 1978 and 1998.
In 1998, the domestic savings as a percentage of GDP stood at 32%. This Chinese penchant for savings, which has placed the country as the world leader in savings rates, spells substantial business market potential for well-established foreign banks. Although the local currency business opening has been gradual, it had been assessed by experts to be inevitable, in view of the external institutional pressure, for example China’s desire to qualify for WTO (World Trade Organization) membership, and also of the evolution of a financial system that supports the development of a market economy.
This assessment was in part realized in 1997, during which year nine foreign banks were permitted to deal in the local currency business in the Pudong region of Shanghai. By September 1999, 25 foreign banks located in Shanghai and Shenzhen were given approval by the central bank to conduct local currency business. However, the local currency business clientele of the approved banks is only limited to foreign corporations – foreign investors and Sinoforeign joint ventures. Foreign banks are not allowed to engage in transactions with local Chinese citizens and wholly Chinese institutions.
It is expected that the foreign banks will be permitted to offer local currency services to local Chinese companies in two years, and to individual Chinese citizens in five years, after China became a member of the WTO. China is keen and resolute about joining the WTO, as evidenced by its concessions in opening financial businesses to offshore groups and giving foreign banks greater access to local currency business. Concessions such as the easing of geographical limits on those 25 foreign banks’ activities and the lifting of earlier prohibitions on their lending consortia formation, related management fees, and inter-branch transfers.
However, concessions have been conducted on a gradual basis, which is considered necessary by the Chinese government because the Chinese banks are not ready for full market competition with the foreign banks. The Chinese government viewed that the fledgling stage of the financial sector does not warrant the response to the calls, from the foreign governments and financial operators, for immediate full access. Table 3 shows the types of foreign participation in China’s banking industry in 1980, 1994, 1998 and 1999. A representative office merely functions as a liaison office, and is prohibited from conducting business.
As a result, the staff strength is kept to a size of between three to five staff. Except for those operational branches that have license to conduct local currency business, the usual business scope is confined to foreign exchange deposits and loans, note discounts, remittances, warranties, import and export settlements and ratified foreign exchange investment. Both types of operational branches (with and without the license to conduct local currency business) are restricted to activities with foreigners and foreign-funded enterprises.
To qualify for establishing an operational branch in China, the foreign bank must have a representative office in the country for at least two years, its parent company must have total assets of over $20 billion, and its headquarters are located in a country where there are sound financial supervisory and administrative systems (Chen and Thomas, 1999).
On the other hand, to obtain a license to conduct local currency business, the foreign bank must have a threeTable 3: Types of Foreign Bank Participation Types of foreign bank participation Operational branches Representative Offices Number in 1980 50 225 Number in 1994 100 302 Source: MacCormac, 1993; KPMG, 1994; Asia Intelligence Wire, 1999. Number in 1998 173 253 Number in n 1999 175 248 The Foreign Banks’ Influence In Information Technology Adoption 7 year history of operation in China, show that it has a profitable position for the past two years and have assets of value of at least US$150 million (Chan and Reuters, 2000).
The Performance of Foreign Banks The market share of the foreign banks in China is estimated to be not more than 3%. The total value of assets of foreign-funded banks in China was US$11. 8 billion in December 1994, with deposit at US$2. 49 billion and loans US$7. 5 billion. These amounted to 2. 0%, 0. 7% and 1. 7% of the aggregate values for the four state-owned banks respectively. These values increased by December 1995 to US$19. 14 billion, US$3. 1 billion, US$12. 75 billion respectively, with the relevant percentage being 2. 1%, 0. 7% and 3. 0% respectively.
At the end of 1997, 1998 and 1999, the total value of assets of foreignfunded banks in China was US$38 billion, US$34. 2 and US$31. 4 respectively, which is less than 3% of the aggregate values for the four state-owned banks in each year. Thus the level of participation of these foreign banking institutions remains very low. Though a greater role for the foreign banks in the industry (in the areas of local currency denominated deposits and loan transaction) is intended, the scope of market opening will be on a gradual basis.
The 1996 announcement that the Pudong district in Shanghai will be the first test city open to foreign entry has caused concern among the domestic banks. Foreign banks were known to have performed well despite the restriction imposed on their business scope and activity. When the foreign banks were not authorized to engage in local currency banking business, 90% of their income was earned from trade bills discounting for importers and exporters and fees from document processing.
One of the major banks in Shanghai has expressed the view that foreign banks will pose a serious challenge to its foreign trade settlement business, and have the potential to cut its business by 50% if full market access is granted to the foreign banks. This view is representative of the attitude of Chinese banks on foreign bank entry. The Chinese banks felt threatened by the foreign participants, especially in the international business area, and regard them as competitors with much higher levels of competitive advantage in capital resources, skills, services and technology.
The strength of the foreign banks in this business area was illustrated by the case of Dalian, where state-owned banks started to provide foreign exchange deposit services in 1988. After about seven years in foreign exchange business, the total foreign exchange deposit achieved by the four dominant local players in Dalian’s financial market in 1995 totaled US$400 million. The six foreign banks, which were only allowed to deal in foreign exchange business about two years ago in Dalian, had achieved three-quarters of the state-owned banks’ foreign exchange business in 1995.
This has greatly alarmed the domestic banks. The Chinese authorities have grave concerns that foreign banks may become overtly dominant if full market access is granted and lead to the repetition of the pre-1949 situation where control of the financial system fell into the hands of the foreign banks. On the one hand, the government authorities accorded heavy protection to the Chinese commercial banks, so that the protection of the interests of the Chinese banks was a priority in any new changes to be made.
On the other hand, they found foreign banking participation indispensable in its emerging market economy, as China’s domestic commercial banks are experiencing severe capital and credit shortages in attempting to meet all the needs of growing business activity. The Chinese government preferred to maintain control over the finance industry, rather than take the opportunity of rapid financial development offered by the full participation of the foreign banks. Therefore, to avert the loss of control over the banking industry, foreign banks were initially only allowed to serve foreign business investors in the Chinese economy.
Paradoxically, the customer scope of these foreign banks–mainly limited to foreign business enterprises, Sino-foreign joint-ventures and cooperative enterprises–has precluded their involvement with the high-risk major default borrowers which are the state-owned enterprises. The relative credit standing of these enterprises may be drawn from a survey conducted by a major bank in Guangdong, in which 92% of loan default was committed by the state-owned enterprises while the remaining 8% 8 Fong was by Sino-foreign ownership enterprises.
The foreign funded banks have generally performed well in view of the restrictions and their constricted scope of operations. In 1996, their average return on assets was 0. 6%, and their after tax rate of return on investment was reported to have increased by 31% over 1995. In 1997, their average return on assets was 0. 7%. Some of the foreign banks became profitable after two years of operation in China and made profound profits. For example, 13 of the 25 foreign banks allowed to operate in Tianjin were reported to achieve a total profit of US$7.
4 million with an ROI (return on investment) of 3. 08 times at the end of May 1999. However, because of the many restrictions imposed on the foreign banks, their businesses are limited to small clientele base and short-term loans. As a result, their business became saturated very fast. CASE DESCRIPTION Information Technology Adoption in the Chinese Banking System Prior to 1978, the level of information technology adopted in the banking system was insignificant.
Since the opening of the Chinese economy to world trade and the abolishment of the monobank system in favor of a market-oriented banking system during the reform period, the adoption of information technology within the Chinese banking industry has been on the increase in line with these developments. However, the increase in information technology adoption occurred mainly in the four dominant state-owned banks, among which the Industrial and Commercial Bank of China has been the leading information technology adopter in the Chinese banking industry.
Table 4 shows that this leading bank has made a profound increase in the adoption of information technology between 1985 and 1999. The initial focus of computerization in the four state-owned banks was largely centred on the front-counter or front-desk in business and saving outlets. This is the most heavily computerized work system as compared to other work systems, some of which still rely on manual work process. As a result, 90% of these banks’ business outlets have computerized front-counter or front-desk support.
However, a considerable number of the small and medium banks still rely on manual mode of operation in this work system. When the overall Chinese banking system is taken into consideration, the aggregate status of information technology adoption reflects a shallow pattern of technology applications, which affects the quality of information systems. The initiation and progression of technology adoption by the domestic banks are very much attributed to government’s efforts, which have been transmitted through the reform agenda and the specific projects
targeted at establishing the CNFN (China National Financial Network3 ) infrastructure for the banking system. Competition pressure from the highly concentrated Chinese banking market lacks the type of verve displayed by a developed market-oriented economy and is not forceful enough to propel rapid and strategic adoption of information technology.
Strategic moves, such as using Table 4: Information Technology Adoption in the Industrial and Commercial Bank of China Forms of Information Technology Adopted Mainframe computer Minicomputer Microcomputer Mainframe centers Computerized business outlets Source: Shan, 1999, 2000. 1985 1999 7 units 10 units 100+ outlets 141 units 963 units 106,475 units 47 centres 41,216 outlets The Foreign Banks’ Influence In Information Technology Adoption 9 information technology to create competitive advantage and innovative positioning, do not characterize the business strategy of the Chinese banks. In addition, there are limited market opportunities for the strategic use of information technology in the industry.
The bank customers still perceive banking services in very traditional terms and have not been able to fully appreciate the benefits associated with information technology based products and services. For example, the number of bankcards on issue has been on a rapid increase since 1993, but the incidence of card usage at the Automatic Teller Machines and the Point-of-Sale Systems remains low. It has been assessed that the status of technology adoption in the Chinese banking system is equivalent to the 1980s standard of the developed countries (Liu, 1999). The pattern of technology applications still constitutes islands of automation.
This is evidenced by the existence of manual and dual processing modes, and the inability of the banks to configure a virtual network that is capable of comprehensive geographical coverage and extensive interbank linkage. The internal focus of the banks during applications development, has led to the construction of proprietary networks. In the mid-1990s, a panel of 38 experts examined the status of the adoption of information technology within the financial system, and pointed out that the absence of coherent strategy and policy among the banks has hindered the interoperability of the banks’ corporate networks.
Even though the headquarters set standards and requirements, these were not consistent across the different banks. In addition, the lack of a distinct national direction governing technology adoption strategy had led to the result of further incompatible technology applications. It was stressed by these experts that financial computerization should be listed as a national strategy, to realign adoption undertakings to ensure compatible technology applications.
In 1997, the banks located in 12 major cities began to work towards an interoperable system for a unified banking system (Shang, 2000). However, banks continue to face difficulty in areas where telecommunication infrastructure is inadequate. In areas where the telecommunication infrastructure is inadequate, banks experience a connection gap not only among their own inter-organization networks, but also connection gap with the CNFN (China National Financial Network). The non-interoperability problem has resulted in partially automated or manual work processes.
It is expected that the resolution of the system incompatibility and non-interoperability problem will involve a considerable amount of time and cost which in turn, impinges on the deteriorating profit and tight financial position of the Chinese banks. Another problem facing the Chinese banking system is the shortage of information staff. In addition to this problem, the available information staff has limited skill to cope with the complexity of advanced user applications systems and this difficulty has resulted in many different system applications.
There were IBM mainframe systems, open systems, traditional systems; fund, savings and credit card systems, which were developed individually and demanded all types of different application environments. Information technology staff, who were knowledgeable in both technology application and in business organization, remained scarce and difficult to recruit. A majority of the information technology staff has largely applications skill, rather than skill in debugging and resolving problems which arose in the applied systems.
An unstable information technology support force further aggravated the lack of strong skill in this area. With the new labor reform policy4 in force, these banks faced tough competition in the labor market in attracting, as well as in retaining, a stable pool of the required talent and expertise. The banks were extremely frustrated with losing their heavily sponsored employees to companies, which could afford higher wages and benefits.
Even in the Special Economic Zones, where staff resources were comparatively richer in quantity and quality than the other areas, and where the bank branches registered a higher computerization rate, the problem of shortage of higher skilled information technology personnel constituted a crucial problem. Information Technology Adoption: The Implications for Domestic Banks Information technology provides an opportunity for businesses to improve their efficiency and effectiveness, and even to gain competitive advantage (Benjamin et al. , 1984; Earl, 1989; Ives & 10 Fong Learmonth, 1984; Porter & Millar, 1985; Dierickx & Cool, 1989).
In the developed countries, banks are among the biggest investors of information technology and they apply leading technology to achieve unprecedented cost efficiency and competitive advantage. Some of the technology investments undertaken by these banks in the past have become necessary tools for operations and competition today, such as the Automated Teller Machine, which constitutes the minimum standard of convenience expected of banks in the developed countries. A leading information technology application that has been expected to create new standard in the banking industry is the electron