Euphoria, mad rush, and ............. crisis ?

The biggest-ever initial public offering completed recently by ICBC, China's largest bank, has brought into focus the problems facing the Chinese banking system, as the euphoria evaporates. According to analysts, reforms in the banking system are a long way from completion and Chinese lenders may be headed towards a crisis if a culture of risk management is not ingrained into the lending practices. A Bloomberg story titled "China's IPO Revolution May Be Long March to Doom" highlights the problems of large bad debts and compares the mad rush for Chinese banks' IPOs with the dotcom era. Here are some excerpts from the story:

Nothing underscores China's financial rise in this century more than this month's share sale by Industrial & Commercial Bank of China Ltd. Those who got a piece of the deal may fancy themselves as winners. They now have a pivotal stake in the China-growth story. Looking under the surface, though, it's hard not to wonder what some of these buyers are thinking. Just as investors who had rushed indiscriminately into dot-com shares in the 1990s regretted it, so may those betting on Chinese banks.

Much of the euphoria surrounds China's efforts to clean up banks saddled with bad debt. The Beijing-based bank, China's largest, faces the challenge of balancing rapid growth against proper risk-screening after a $141 billion government bailout of bad loans. Chinese bank lending jumped almost 50 percent in the first half in a nation that is likely to expand more than 10 percent this year.

Loan growth is impressive, but those new loans are not seasoned yet. Nobody can tell whether there will be another massive bad-loan problem in the future. The question isn't whether China is reducing the bad loans of the past; it's whether sufficient steps are being taken to keep loans made today, tomorrow or next year from going bad.

Why are Chinese banks hot?

The huge interest shown by overseas investors in the initial public offering of the Industrial and Commercial Bank of China (ICBC) highlights the scramble to gain a foothold into the Chinese banking system. ICBC is the largest bank of China and its IPO is all set to become the world's biggest IPO. ICBC plans to debut in Hong Kong and Shanghai on Oct. 27 - the first IPO to be simultaneously listed on both stock exchanges.

The degree of interest in ICBC stock can be gauged from the fact that the entire order book meant for institutional investors had been filled within an hour of the formal solicitation of bids. By the end of the first day investors had placed bids for three times the number of shares on offer and it was nine times subscribed by the close of the next day.

If priced near the top of the range (which is almost certain), the issue will garner US$22 billion, beating the record of $18.4 billion set in 1998 by a Japanese mobile-telecoms operator. The sale will also place ICBC among the ten most highly valued banks in the world, with a market capitalisation close to $130 billion.

ICBC is the latest in a series of massive IPOs launched by Chinese banks during the past year. Bank of China, the country’s second largest lender, raised US$11.2 billion with an IPO that was the fourth-largest on record. China Construction Bank, the mainland's no. 3 bank, raised US$8 billion in October 2005. It’s the strong growth recorded by these banks in the sizzling Chinese economy that is luring the institutional investors. There is a scramble among the financial powerhouses of the world like Goldman Sachs, Morgan Stanley and Citigroup to gain a foothold into the Chinese banking system.

For the investors, these banks are a sort of a proxy for China itself: vast, diverse, growing fast, and with extraordinary scope for internal restructuring. Economist terms the ICBC IPO as a single transaction that could sum up the knowns and unknowns surrounding China's red-hot economy. According to an Economist article, “…ICBC, however valuable, also reflects the murkier side of life in the Chinese economy. Political considerations often come first, information is unreliable, and openness in the banking system is questionable, despite conditions tied to China's entry into the World Trade Organisation.”