ABC's Top Banker Trains an Elephant to Dance

(Shanghai) – It took Agricultural Bank of China executives three years to complete internal reforms, restructure the state-owned giant and launch an initial public offering.

ABC Chairman Xiang Junbo, for whom the arduous process climaxed in July with a dual listing in Hong Kong and Shanghai, notes that certain animal trainers need similar patience.

"Making elephants dance," Xiang said with a smile, "is really not easy."

Xiang's wit and Sichuan humor accented a nearly two-hour interview with Caixin about the rise of ABC and its historic IPO, the world's largest. He spoke on the evening of July 14 in a Shanghai hotel just hours before ringing the morning bell at the Shanghai Stock Exchange to begin the bank stock's first trading day.

The following day, Xiang did it again by ceremonially opening the Hong Kong Stock Exchange as ABC's H shares hit the trading floor.

ABC was China's last, major state-owned bank to go public. Its restructuring began in 2008, but the global financial crisis delayed IPO plans. Moreover, the bank has been embroiled in scandals over the years and once led the nation's banking giants in bad assets.

Xiang throttled a reform train. He typically spent Mondays through Thursdays at the bank's headquarters in Beijing, then traveled to far-flung bank outposts across the country for field inspections Friday through Sunday.

By April, the smoke finally had cleared and ABC started preparing for the Shanghai and Hong Kong markets.

Xiang spent three, grueling years on the ABC overhaul. "This is the hardest work I've ever done," he admitted during the interview.

But the payoff was huge: The dual listing raised about US$ 19.2 billion amid a general slump for global capital markets.

When Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB) and Bank of China (BOC) went public in years past, Xiang noted, domestic capital markets and economic situations were better. Yet each of these big banks needed a half-year to prepare for an IPO.

"ABC's IPO preparation period was shorter, only two or three months, which means ABC completed the world's biggest IPO during the most complicated economic conditions and most difficult market situation in the shortest amount of time," he said.

Long before his accomplishment, Xiang was warned about the dangers. "If you don't work off three layers of skin at ABC," he remembers a government official saying,  "you'll never make it."

But ABC's reform process worked, Xiang indeed made it, and now the elephant can dance. Excerpts from the interview follow:

Caixin: In light of dismal market conditions recently, what's the biggest difficulty you faced when deciding to go public?

Xiang: The hardest part was how to assess whether to go public. To me, market conditions are ideal when the A-share market is stable at around 2,500 points. But on June 29, when I was in Edinburgh during a (pre-IPO) roadshow, the Shanghai index fell 4.27 percent in one day. I really felt the pressure.

To go against the trend and list involves big risks, and they are not only ABC's risks. They concern the entire reform process for state-owned commercial banks. This isn't my personal problem; it concerns the confidence capital markets around the world have in China's government, and it concerns the effect of future economic development. And it affects judgments of ABC's fundamentals.

Once I calmed down and thought about it, I realized I couldn't put it off. I have the kind of personality that says if you start something that's right, you have to finish it. So I wrote a report to central government leaders and high-level authorities expressing my personal view. They gave me their full support and enthusiastic help.

Caixin: What is it like to be put under the microscope of international capital markets?

Xiang: When we first started the international roadshow, the pressure was intense. At that time, The Financial Times and The Washington Post wrote very harsh articles, saying the world's worst bank was launching the world's biggest IPO.

During the non-deal roadshow, we went to Los Angeles, Denver, Omaha and New York. Then when the official road show began, I brought the team to Hong Kong, the Middle East, London, Edinburgh, Frankfurt and Australia.

Most institutional investors had very positive reactions. After talking with international investors one-on-one, our order ratio surpassed 80 percent, which is quite high. Some relatively large long-term funds in the international capital market were very interested in ABC's investment story after the roadshow, and they all placed big orders. This was an acknowledgement of ABC's investment value, and an acknowledgement of ABC's management. I felt very comforted.

To raise US$ 10 billion or US$ 20 billion is really not easy. Why should people pull money out of their wallets? Their questions were very tough. Some didn't have good answers. For example, state-owned commercial banks have paid dividends over the past few years, and growth wasn't a problem. But they wanted me to explain how ABC, in the next three to 10 years, can maintain continuous growth.

Ninety-five percent of the people asked me about local government-backed financing platforms and real estate regulation. In the end, we used numbers to dispel their worries and help them recognize ABC's strengths. I would say we were very successful in selling ABC's shares to cornerstone investors and the long-term portfolios of large funds.

Caixin: What was the turning point? Did you feel success was assured?

Xiang: From a philosophical view, success is never assured. Some international investors had doubts, too. For example, I spoke with one international investor three times. After he heard the ABC investment story, he felt ABC's room for future development and growth was very big. He felt very confident. He told me not to worry, that price has no limit. His fund invested more than US$ 1 billion.

His investment had an infectious effect on other investors. Standard Chartered Bank and Rabobank have a strategic partnership agreement with us, and they invested US$ 500 million and US$ 250 million, respectively, as cornerstone investors. Having these strong international banks sign cornerstone and strategic business agreements shows their strong acknowledgement of us, and set an example for other investors.

Caixin: What is your assessment of ABC's pricing? Is the current price too high or too low?

Xiang: Our pricing is reasonable, fully taking into consideration ABC's internal value, future growth, other banks, supply and demand. We believe it's a win-win price for us and investors.

Caixin: You just mentioned investors would ask you how you'll maintain growth in the next three to 10 years. How would you describe your strategy for development?

Xiang: This is also a question international investors would ask a lot. The urbanization process is the biggest opportunity for China's development. Urbanization in Britain, Germany and other European countries essentially took 30 years. China still needs to struggle through 30 or 50 years before we reach Europe's level. New York didn't become what it is until 80 or 100 years ago. Major cities such as Beijing and Shanghai have only had their infrastructures in place for the past 10 years or so.

Historically, because of a division by specialization, ABC's target market and network arrangement have been different than those of its competitors. Outlets in large and medium-sized cities are relatively few, and the foundation of big clients is a bit weaker. Over the past few years, we have been pushing into large and medium-sized cities to catch up with our competitors, expand the scope of our network, and develop new client resources. And we've already become a mainstream commercial bank in large and medium-sized cities.

But at the same time, we've also noticed that in prefectural cities, especially in the countryside, we have a clear advantage. With this in mind, I pushed three years ago to take advantage of the opportunities in the countryside's economic development and urbanization, especially in small cities. In the next three to 10 years, ABC's development will largely rely on this economic area. This is our development positioning. When that happens, we'll have to see who will be China's and the world's most competitive bank.

Caixin: Because costs are high and profits low, ICBC, CCB and BOC have been withdrawing from the countryside while ABC's withdrawal has been forcibly halted. To some extent, you've been compelled to stay in the countryside. How can you turn this to your advantage?

Xiang: This question needs to be looked at from the perspective of development. As I just said, urbanization is China's biggest development opportunity, and this is focused in the countryside.

Currently, China has more than 2,000 county-level cities and 34,000 towns. As the urbanization process moves forward, a rural population of more or less 10 million a year will become an urban population, which brings employment to the countryside's youth and college students. These county-cities and towns need to attract this working population. This is the next focus of development. In these county-cities and towns, ABC is the primary major commercial bank. The urbanization process is going to create all types of financial demands. This is the embodiment of ABC's advantage.

Now, most of ABC's profits come from business in cities  concentrated in the Bohai Sea, Pearl River Delta and Yangtze River Delta regions. But over the next three to 10 years, profit contributions from counties, central China and western China will grow at a relatively fast rate. In fact, this trend has become apparent over the past two years. After several years of development, ABC has completed large-scale investments in counties, and central and western China. As the national economic development strategy changes, it can be said that it is now ABC's turn to reap benefits.

Caixin: Some have suggested you change your name to Bank of Urbanization. Is this the primary reason for going public in the face of a down market?

Xiang: The main factors are, first, the fundamentals of China's economic growth have not changed. Rapid growth such as China's will always attract global attention. Second, as I said, China's biggest, future economic bright spot is urbanization, and ABC's market positioning is closely in line with China's future economic development model, and will receive the most benefits from it.

One basis for the success of this IPO is the dispelling of the market's traditional impression that the "agricultural" part of our name means low growth, high costs and high risks. Investors have realized ABC's intrinsic value and prospects for growth, as well as its interconnectedness with China's future economic development.

Caixin: How do you handle basic risk control?

Xiang: On my second day on the job at ABC, I represented the bank before the China Banking Regulatory Commission during an investigation into the Handan, 50 million yuan theft case. Because ABC has a relatively large number of outlets, risk management is always a formidable task. So all you can do is try harder.

In recent years, we have been building a comprehensive risk management system. After coming in, my first task with regards to strengthening risk management was creating a specialized risk management department to centralize risk management for the entire bank and strengthen credit management. At provincial and lower-level branches, I also posted risk inspectors or managers. It can now be said that ABC's risk management situation has been fundamentally improved.

Caixin: As just one man, how did you push through changes in behavior among hundreds of thousands of ABC employees?

Xiang: Some investors raised this question during the roadshow. They said, "The chairman and other senior managers were brought in from the outside, but most of the management team and staff haven't changed. Supervisors and lenders are still the same people. How do I know if you're doing well?"

My answer was that within a country, a company or a system, the most important thing is not to use people to manage, but to use a good system to standardize management.

Take credit approvals as an example. Before, each bank's basic-level branches made loans, and the lender had the final say. Later, back-end and front-end systems were separated, and then authorized credit systems were put in place.

Now, we've established an independent approval system. ABC's credit approval system and process are now very strict and tight. Seventy percent of approval authorizations for corporate loans are held by province-level banks or the main bank. Retail lending is primarily concentrated at each city's branch, each of which has adopted a centralized, online approval method.

The process is very strict. ABC now checks each level of management for three targets: a profit target, a risk target and a sustainable development target. We look at the company's interests, management skills and managers' personal interests. And after three years, if they've had no bad accounts, they're entitled to a bonus. If they've had a bad account, then they take responsibility for that, including me. These are ABC's supervisory and incentive systems.

Therefore, although the people are the same – it's still these managers – the system has changed. The method of management has changed. There will be a fundamental change in the consciousness of risk. Risk can be brought under control.

Caixin: In 2008, after you'd been on the job for one year, you dismissed your entire Shanxi branch management team. This had rarely been seen in the history of Chinese finance. Why did you come down so hard?

Xiang: Although the Shanxi case wasn't big, the branch was heavily bureaucratic and management was porous. The main bank did a blanket audit and found a lot of problems. The actual situation was completely different from what the management team was saying. So, according to the supervisory department's requirements, we replaced the entire management team.

Another example is the Huludao case in Liaoning Province, which involved falsified loans. This attracted a lot of attention. ABC again basically replaced the entire management team. Not doing so would have sent an insufficient message to the rest of the bank about changing the atmosphere.

Caixin: I heard that ABC's efforts toward internal audits in recent years have been quite extensive (with) fly-in inspections, midnight raids on vaults, and so on. Has this instilled fear in the staff?

Xiang: ABC has a lot of outlets, and the chain of command is quite long. We face a lot of risk pressure, especially operational risk. Our efforts to instill a culture of conformity are quite heavy.

When I first came to ABC, in reaction to the problems that arose from the Handan robbery, we used some unusual methods to bring risk under control, and the results were very noticeable.

The first line of defense was establishing the aforementioned risk management department, which unified the entire bank's risk planning, policy drafting, supervision and evaluation efforts.

The second line of defense was audits. I worked in auditing for 22 years, rising from a regular official to a deputy governor. So I had the right to be heard in this respect. ABC set up 10 audit departments throughout the country and formed a team of more than 2,000 professional auditors that reported to the board of directors. They conducted unscheduled audits and risk monitoring assessments.

The third line of defense was the internal compliance department, which was responsible to management and oversaw daily operational compliance risk management and control.

The fourth line of defense was the risk management dispatch system. Risk managers were gradually sent from the main bank to provincial banks, from provincial banks to city banks, and from city banks to county sub-branches to independently monitor and evaluate risk.

The fifth line was a complete shift for the inspection system. Provincial banks temporarily set up a professional inspection team of 15 to 20 people who go into an outlet and conduct a mandatory takeover for seven days while inspecting potential risks.

The sixth line is the earmark inspection system. The main bank has a specialized task force for unexpected inspections, such as on vaults, for example. I once braved torrential rain to go on a vault inspection in Lankao County.

Finally, ABC has many outlets, and the management radius is rather unique. So of course the best way to manage operational risk is to rely on a complete IT system and on staff members to develop a consciousness for long-term compliance. But the last two lines of defense also generate a good demonstration effect (by) educating and guiding staff members to do their work by the rules. Also, we bring in third parties to conduct independent evaluations of our outlets to improve the quality of our service.

Caixin: After you came to ABC, there was controversy over a regulator plan to split ABC to truly serve agriculture, rural development and farmers. Why did ABC not follow through on this plan? Weren't there good reasons to split?

Xiang: The National Financial Work Conference approved guiding principles for ABC's reform: serve agriculture, rural development and farmers, completely restructure, operate commercially, and go public.

At that time, China required that serving agriculture, rural development and farmers organically link with commercial operations, and that we strengthen our self-autonomy and control risk. If we broke up ABC, not only would it break up the Agricultural Bank of China brand built up over nearly 60 years and the advantages we hold across towns and cities, but the internal staff's reaction would have been fierce. Splitting up would make them feel abandoned and affect the stability of the workforce. In addition, management and supervisory costs of split-ups are very high, and internal transactions would be very complicated. After taking a comprehensive look, it was decided that, on the whole, going public was better.

Caixin: Seventy-five percent of ABC's business is in the cities. Only 25 percent involves agriculture. Even so, is the nature of your business for agriculture, rural development and farmers different than your city business? Is this a difficult issue for management?

Xiang: Based on assets, currently about 37 percent of ABC's assets are located in the countryside. All ABC business activity in the countryside has a driving function, a radiating function and direct service function for agriculture's development, rural economic prosperity and the well-being of farmers.

Currently, farm loan risk not terribly high. The financial environment in the countryside has changed a lot. Farmers are highly likely to pay back loans on their own. The interest earned on loans to farmers is higher than in the city by dozens of basis points, meaning the combined profit margin in rural lending is higher than in the city. Our branch in Heilongjiang Province hands out a relatively large number of loans, and the profit we earn on a 10 billion yuan loan there is equal to the profit we earn on a 16 billion yuan loan in Beijing. If you do it well, you can make money.

Concerns about agriculture, rural development and farmers are prejudiced. In the process of urbanization, many farmers have become quite well-off. Take our clients in the countrysides of Zhejiang and Jiangsu, for example. Our profits from them are more than our profits from our city clients.

Caixin: To promote agriculture, rural development and farmers, ABC set up an agriculture, rural development and farmer financial services department. But it's actually a countryside service department. Is this divided by region and not by service?

Xiang: The establishment of the agriculture, rural development and farmer financial services department was an internal framework meant to provide commercial service to agriculture, rural development and farmers. Its purpose is to clearly examine and calculate each service's cost and profit. From the main bank to the provincial banks to every county and every person, it should clearly show how much was spent. So, the agriculture, rural development and farmer financial services department system is a type of management framework, the key to which is to transform our thinking.

Caixin: Of all the many reform initiatives over the past three years, which do you think were most critical?

Xiang: The most important was the reforming of ABC according to a modern commercial banking model, framework and thinking. The closest to the core was the construction and transformation of corporate culture and thinking. If thinking remains closed, no matter how you change, it's useless. If you don't have a good corporate culture, a good system won't work for long. Only if you instill a culture of risk management into every staff member can you encourage them to act on their own.