The Rise Of Asia's Banking Cartels

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Includes: ACGBY, BACHY, CICHY, IDCBY
by: One Road Research Company
Summary

In the past, central banks were tools for Asian governments to control their economies and engineer political agendas. Some has even fixed currencies to the gold standard.

Central banks in Western countries became independent after the Bretton Woods system collapsed, which brought them much success. Asian economies saw different outcomes after following Western footsteps.

Not every Asian central banks are free of government control. Central banks that are not independent can adjust to economic shifts more quickly, reducing financial damages from economic busts.

Central banks, and the government, can change commercial banks’ reserve requirements to adjust the amount of money supply of a country. Reserve requirements and money supply are negatively correlated.

Changes in central bank balance sheets canultimately change the balance sheets of commercial banks, which can becomegreat investment opportunities if implemented correctly.

In today’s world, global finance is fiercely competitive. Large banks hold strings of power, delicately balancing influence across many countries. But, don’t be fooled. State’s central banks and global banks, like the International Monetary Fund (NYSE:IMF) and the World Bank, are the main puppet masters.

These entities use the tools they gained from laws passed during the ‘Washington Consensus’ to influence developing Asian countries. But let’s not get ahead of ourselves. We’ll save those juicy details, about the West’s guide to economic development in Asia, for later.

But if this topic tickles your fancy, please look out for a future series called ‘One Belt One Road’. This will be a special report on China’s ‘Beijing Consensus’ and the rivalry power struggle over global trade it created.

In the meantime, this article will explain the historical entrance of these big bank players into the economic game. Take special note on how they set the rules and tend to walk away as winners.

The role of central banks evolves

Consumer banking and fractional reserve banking concepts were first introduced to Asia during the 19th century by European bankers.

While banking practices in Asia evolved, they didn’t revolutionize at first. Central banks were still used by governments to control the economy and engineer political agendas.

Vietnam’s Central Bank, located in Hanoi (Photo credit: Shutterstock)

A 1897 Coinage Law made Japan an Asian economic trail blazer. It became the first nation to adopt a gold standard. The law made Japan’s currency, called the Yen, fixed at 0.75 gram of pure gold. Banknotes were also printed that could be converted into gold. The Yen remained pegged to gold until WWII. But following the war, the Yen got fixed to the U.S. dollar instead. This caused it to lose most of its prewar worth.

The switch from gold backed currency to paper money caused a few issues. For the first time, central banks (at the will of their governments), could print money without many restrictions. During the 1970s to 1980s, after the collapse of the Bretton Woods system, Western governments became irresponsible with this new-found privilege. A ripple of price instability followed.

The aftermath lead to debates about separating politics and banking. The result: an independence of central banks. This practice had broad success in the West. Yet, Asia would find out the hard way that not all solutions work the same.

Central banking comes in many forms

Asia is home to a diverse range of economies. So, it’s easy to see why Asian banking policies differ so much. The major contrasts are found between centrally planned economies and free-market orientated ones.

But in general, the key is figuring out how much power a government has to influence monetary policy.

Prior to the Asian financial crisis, Japan’s Ministry of Finance had a heavy hand in the central bank’s policy creation and decision-making processes. But in an effort to reboot the legitimacy and transparency of the central bank, the Japanese government pushed for a separation. In 1997, The Bank of Japan became fully independent. It remains so to this day.

The separation from government control granted Japan’s central bank both independence over its monetary policy and freedom of Japanese political pressure.

While all of Asia’s democratic nations are said to have independent central banks, it’s a bit of a white lie. The official classification may be ‘independent’, but governments keep a pinky finger stuck in the economic pie.

They usually still impact central bank policy making. A strong example of this is found in South Korea. In 2014, the government indirectly intervened in central banking. Due to government pressure, the Bank of Korea slashed interest rates, boosting faltering growth.

Meanwhile, neither China nor Vietnam, have fully independent central banks. Instead, their central banks must appeal all their major activities to government officials for approval.

Compared to nations like South Korea and Thailand, who were hit hard by the Asian financial crisis, China and Vietnam only experienced small speed bumps. Government control over the economy is largely to thank. They had the ability to curb the influx of foreign capital and control interest rates. Both proved highly effective in minimizing the economic fall-out which plagued the region at the time.

Because of such tight control, it is considered a safe move to invest in banks that belong to countries that do not have independent central banks, since they are much less vulnerable to economic shifts.

As for other countries in Asia Pacific, we are reluctant of recommending their banks to investors. Since their governments do not have direct control over their central banks, they are more vulnerable to any economic fluctuation.

In the table below, you can see how Asian nations, and their central banks, are categorized by varying levels of independence.

Country

Central Bank

Level of Independence

Malaysia

Bank Negara Malaysia

Independent

Philippines

Bangko Sentral

Independent

Indonesia

Bank Indonesia

Independent

Singapore

Monetary Authority of Singapore

Independent

Japan

Bank of Japan

Independent

South Korea

Bank of Korea

Independent

Thailand

Bank of Thailand

TBA: Still under martial law

China

People’s Bank of China

Not independent

Hong Kong

HK Monetary Authority

Not independent

Vietnam

State Bank of Vietnam

Not independent

How do Central banks control money supply?

Banks in different Asian countries have to maintain a certain amount of customer’s deposits so they can make withdrawals at any time. This is generally referred to as reserve requirement, and the percentage of the deposits the banks have to keep is determined by governments and central banks.

If the reserve requirement decreases, banks can loan out more money, thus increases the amount of money in the financial system (and vice versa). If the reserve requirement changes by 1%, then the ability for commercial banks to lend, as well as the overall money supply, will change drastically.

Commercial banks may appear to be gaining from the fractional reserve system, but they simply gather society’s wealth together and boost their ability to multiply and shift money to the rich and powerful. This helps GDP grow, which is quite handy for emerging markets because demand for credit there is high and their GDPs grow at healthy rates. Countries that follow the Asian Capital Development (ACD) model benefit greatly when their financial systems and national debts are kept under control.

However, if reserve requirements and money supply are out of control, then the damage can be catastrophic. Take Indonesia’s Century Bank during the 2008 Global Financial Crisis as an example.

When people found out that this bank was about to go bankrupt, depositors panicked and withdrew their funds. This made matters worse because the bank was essentially on the verge of a liquidity crisis, where total amount that was withdrawn was more than the amount kept on as a reserve requirement. President Susilo Yudhoyono knew he had to bail out the Century Bank to avoid the spreading damage within the financial system and prevent other banks from undergoing ‘bank runs’. At first, the bailout to recapitalize the bank’s reserves was thought to be 1.3 trillion rupiah ($70.9 million USD). Yet it failed, and other bailouts had to be included which turned out to be 6.76 trillion rupiah ($677.4 million USD), four times the original amount.

Therefore, when investing in foreign banks, it is necessary for investors to always keep an eye out for the reserve requirements that these banks have to comply from their respective governments and central banks.

The graph below represents different reserve requirements in Asia-Pacific:

Both China and the Philippines have high reserve percentages in order to maintain more control over their financial systems’ liquidity level, that means their banks are more controlled and investments to banks there have lower risks. But as we mentioned before, the Filipino central bank is independent, so it inherits higher risk compared to China.

The chart below represents the changes with China’s reserve requirements over time:

Current central banking practices in Asia

Looking into the crucial period from 2004-2016 gives us a better understanding of Asian central banking methodology.

For individual finance, a balance sheet is a great tool for determining the worth of one’s personal assets. You can track values increasing (hopefully) or decreasing over time.

If you look at the graph below, you can see that we’ve done the same with a balance sheet for central banks. During the time period, the total assets for Asian banks rose significantly. For instance, China’s central bank has made six-fold increases. Japan has also tripled its original value.

Central bank assets have primarily increased for two reasons. Firstly, due to an accumulation of foreign reserves from trade surpluses. Secondly, because domestic government bonds were bought from commercial banks, bringing liquidity into the financial system.

As the amount of cash in a nation’s financial system increases, the size of the central bank’s balance sheet expands. This generates growth in available credit as well.

As an investor, follow the rainbow’s arch of central bank actions. This will lead you to valuable insights on how they influence domestic capital markets. The central bank’s balance sheets grow while influence spreads and accountability decreases. If you can track how these events will affect the economy over time, you might find yourself a pot of gold.

To bring this into the context of Asia, when investing in banks, we highly recommend these four: Industrial and Commercial Bank of China (OTC: OTCPK:IDCBY), Bank of China (OTC: OTCPK:BACHY), Agricultural Bank of China (OTC: OTCPK:ACGBY) and China Construction Bank (OTC: OTCPK:CICHY).

First off, they are all traded in the U.S., and their stock prices are currently low. Second, China’s government has great control over its central bank, and effectively the reserve requirement ratio, making them relatively risk-free. Third, because of government and central bank support, their balance sheets look the most promising, where their P/E ratios are at least 5.5%, and their average yield is roughly 5.1%.

Below is a graph representing both the P/E ratios and P/B ratios of these four banks:

Thank you very much for spending time and reading this article. We hope that our content has provided you with useful insight that can help you manage your portfolio more wisely.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.