Foreign strategic investment and banking efficiency in China

Abstract

Ying Xu1 INTRODUCTION China�s banking sector has traditionally been under heavy government regulation and control and foreign participation in the banking sector has been restricted. However, since its accession to the World Trade Organization (WTO) in 2001, China has gradually lifted these restrictions and substantially opened up the banking sector to foreign investors. In recent years, attracted by China�s huge market potential, foreign bank participation has increased significantly. Moreover, encouraged by the government, the majority of foreign investors have adopted a unique form of foreign entry: foreign strategic investment. Foreign strategic investment (FSI) is �medium-to-long-term� foreign investment based on minority equity participation and agreements on the transfer of know-how (CBRC, 2003). Compared to traditional forms of foreign entry, FSI has two important features. First, FSI is minority equity participation, currently under the ceilings ensured by the authorities of 20 percent ownership by a single foreign investor and 25 percent by the combined share of all foreign investors in one bank (CBRC, 2003). Through this form of participation foreign investors can therefore only own up to 20 or 25 percent of any local bank. This contrasts with foreign direct investment (FDI), which is characterized by foreign investors holding controlling ownership stakes of a domestic bank (OECD, 1996).2 Second, FSI also differs from international portfolio investment. The latter involves only equity participation, whereas FSI entails long-term business cooperation, managerial involvement and technology transfer. In almost all cases of FSI, foreign investor equity purchase is accompanied by agreements on transfer of information...