By Ichiro Suzuki
In the summer of 2007, a financial sector analyst from Shanghai proudly told me “Seven out of the ten largest banks on earth, in terms of equity market capitalization, are Chinese.” It was twelve months before the Beijing Olympics. The booming Chinese economy was notching torrid growth rates that were well over 10% year after year. China was about to replace Japan as the second largest economy and the largest in Asia. It was perfectly legitimate for that analyst to be excited about the rise of Chinese banks as well as the economy.
Nonetheless, I still had to warn her that these rankings change from time to time, sometimes rather dramatically, and that Japanese banks once held the same positions and looked as dominant as Chinese banks of 2007. Japanese banks totally fell from grace after a brief period of what it looked as dominance. In the early 1990s, the infamous Japan Bubble had burst, sending real estate and stock prices into a tailspin. Banks were especially hit hard, as real estate lending that drove up their profitability in boom years came crashing down. Amid a banking crisis in a series of recessions that followed the bubble’s burst, Japanese banks was totally humbled, with some of them losing 90% of their peak market value, or losing 100% through bankruptcy.
At the time of the Beijing Olympics in August 2008, a year after that meeting with the analyst, the global financial crisis (GFC) was already raging fiercely. Subprime lending in the U.S. to less creditworthy retail borrowers were rapidly becoming non-performing. Exotic financial products created out of subprime loans, collateral debt obligations (CDOs), were losing value even faster than the original subprime products. Five months before the Beijing Games, Bear Stearns, the fourth largest investment bank, had ceased to exist, and was rescued by J.P. Morgan. That summer, the financial market fiercely attacked Lehman Brothers, the third largest investment bank, and other banks were under intense pressure. The rout in the U.S. immediately spread to the rest of the world. China did not escape that unprecedented volatility event, though it was none of China’s fault.
The GFC gave a mega blow to the global banking sector. If they did not fail, some weak link banks suffered a precipitous fall in size as measured by equity market capitalization, upon reporting of huge losses with little scope for recovery. Their return on equity crashed on new regulations that called for greater shareholders’ equity base and reduced leverage. Lower ROEs had an immense impact on banks’ valuation.
The crisis hit European banks especially hard for a variety of reasons. To begin with, there were too many banks in Europe. In a region of slower growth than North America, Europe is crowded with institutions with lower profitability. Prior to the GFC, their profitability was often a product of leverage, and such profits had evaporated. The European banking industry came out of the GFC still with still too many banks with too little profits, due to insufficient consolidation. (Each country wants to have its own national champions.) Many large European banks tried to boost their business in North America, often through acquiring U.S. institutions, and found themselves badly burned, unable to manage expanded businesses and unable to compete against Wall Street giants.
In China, an outsized fiscal stimulus package that was announced a few months after the Beijing Olympics saved not only China but also the global economy. The package, however, brewed a small bubble and became a source of non-performing loans for banks, on top of the GFC-associated problem they were already grappling with. While Beijing’s move in late 2008 was heroic, it did some damages to its own banking system, and hence the economy. The GFC had exerted intense downward pressure on the Chinese economy, at a time when double digit growth rates were no longer sustainable. Banks were forced to deal with bad debts created by a real estate bubble’s burst in the aftermath of the fiscal stimulus.
Fourteen years after that meeting with an analyst, Chinese banks have receded in global rankings in a environment in which banks around the world struggled immensely under markedly tighter regulations. Chinese banks still occupy five places on the league table though J.P. Morgan holds the title of the world’s largest bank by far. Chinese banks are unlikely to reclaim the dominant positions they had in the preceding years of the Beijing Olympics, as the Chinese economy’s growth rates continue to decelerate in the coming years, and they lack a global clout of U.S. banks. Global clout is one unique attribute of U.S. banks that sets themselves apart, based on a combination of a very large domestic market and Wall Street’s innovative ability and and culture to embrace high level of diversity. Though the upper echelon of their management team tends to be dominated by white men, Wall Street banks still have a remarkable capacity to absorb talents with a variety of ethnicities and and their origins. European banks tried to emulate Wall Street banks by acquisition of some significant Wall Street players. As it turned out, European banks still lacks scale that is required to play a game in this tightly regulated environment, in part because of the fragility on their domestic, European soil.
Though Japanese banks dominated the rankings in the late 1980s, they were hardly global players. Their rise was totally attributed to a spectacular real estate bubble, and their international business was essentially focused on serving Japanese manufactures that expanded into overseas markets. Their board was dominated by Japanese men, many of whom spoke little or no English. This was hardly something global banks had to offer. The infamous bubble’s burst decimated Japanese banks. In a sense, they are still trying to recover from damages they suffered in the 1990s.
Chinese banks did not suffer the way Japanese banks did. The bubble’s burst at the outset of the last decade was nothing comparable to the ordeals of Japanese banks. At half the growth rates of what they once were, China still boasts of one of the fastest growth rates. Nonetheless, slowing growth rates weigh on profitability of banks and it affects their market capitalization, if they continue to be managed in the same fashion. Today, five Chinese banks are on the top 10 list, but only two in the top 5. Industrial & Commerce Bank of China occupies the distant third place after J.P. Morgan and Bank of America. There is no Chinese presence on the list of the second ten largest, perhaps as a proof of a lack of depth of the industry. Chinese banks’ size is essentially attributed to the size of the Chinese economy and the rise of Chinese corporations, as were the cases of Japanese banks in the old days. One day, they might become truly global institutions but it is not in the foreseeable future.
The World’s Largest Banks by Market Capitalization
1. J.P. Morgan 475
2. Bank of America 347
3. Industrial & Commerce Bank of China 261
4. China Merchant Bank 207
5. Morgan Stanley 190
6. China Construction Bank 185
7. Wells Fargo 182
8. Agricultural Bank of China 159
9. Bank of China 150
10. Royal Bank of Canada 146
(in billion USDs, as of Sept. 7, 2021)
About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.