City banks' IPO push puts investors, SMEs at risk

Soon after the China Securities Regulatory Commission issued a draft outlining listing criteria for small and midium-sized banks earlier this year, a wave of city commercial banks came forward with plans to launch initial public offerings (IPOs) in the stock markets. Currently, as many as 16 city commercial banks are working toward getting listed, and nine have already passed the first round of the IPO approval process.

China's city commercial banks emerged from urban credit cooperatives in 1995, and were established to meet the financing needs of local governments. Over the years though, city commercial banks have been growing rapidly and now play a major roll in providing financing to the nation's cash-strapped small and medium-sized enterprises (SMEs). Experts and officials believe that allowing city commercial banks to go public will enlarge their capital and place them in a better position to serve China's SMEs, a large number of which have taken a financial beating in recent months as the economy slows and credit remains tight.

I would argue though that investors may be put in danger if regulators open the IPO door to city commercial banks, many of which are in a state of overexpansion and suffering under a mounting burden of risky debt. Also, with money raised from the market, these banks may seek further expansion, which could make them less willing to meet the needs of SMEs.

Over the past two years, city commercial banks have witnessed an alarming rate of growth. By the end of 2011, their total assets reached 9.98 trillion yuan ($1.58 trillion), up 27.1 percent compared to the previous year. In comparison, the assets of the banking industry as a whole grew by 18.3 percent year-on-year during the same period.

This breakneck growth rate has greatly increased risk levels at city commercial banks. To gain capital, these banks issued a large amount of subordinated debt, which drove up their capital costs. Also, city commercial banks may soon be facing a payment crisis, after racking up 1.2 trillion yuan in non-performing loans issued to local governments, according to experts. It would be unfair for investors if regulators allow city commercial banks to go public when they are saddled with so many bad debts.

Moreover, city commercial banks may be inclined to use the money they raise in the market to open more branches outside of their area and court bigger clients as a way to push up their stock prices.

This would likely divert the attention of these banks away from SMEs and their local economies.

Actually, such a scenario is already being played out with a few of China's larger city commercial banks. Bank of Nanjing, for example, has opened eight locations outside of Nanjing, which accounts for just 37.2 percent of its total assets. Also, loans made to SMEs by Bank of Chongqing, on of the local lenders with its sights on the IPO pipeline, only account for 14 percent of total assets.