China's Banking Expansion: Attracting Global Investment Amid Geopolitical Tensions

The expansion of China's banking sector has resulted in it becoming the world's largest based on total assets, and its bond and equity markets have grown rapidly despite geopolitical tensions. This note from the 2021 China Banking Monitor series by Natixis analyzes investment flows into China and offers insights into future trs.

For foreign direct investments, China is sharing more of its financial sector by allowing full ownership in various institutions, with a higher interest shown in insurance and securities sectors. In the life insurance industry, foreign participation has risen; however, for banks, the situation is less favorable due to tougher capital requirements in parent countries and higher costs compared to Chinese counterparts.

Net interest margins indicate China as an attractive market for foreign banks despite underperformance relative to local peers. For fund companies, their share of the foreign market has declined with the emergence of local competitors. Therefore, the extent of foreign participation will dep on whether China can establish a level playing field in its financial markets.

Conversely, portfolio inflows into Chinese bonds and equities have increased over recent years due to lifted capital controls and development of Bond and Stock Connects through Hong Kong, which has led to index inclusion. The foreign ownership share in equities jumped from 1.1 in 2015 to 4.3 in 2020, while the bond share surged from 1.4 to 3.2.

For the global community, China's financial opening presents both opportunities and challenges. Australia's direct investments, trade finance with China have decreased due to geopolitical tensions, but exposure in Hong Kong has grown recently as transactions are redirected through this channel. Japanese financial institutions, on the other hand, have increased their onshore exposure while reducing that of Hong Kong, rsing concerns for Hong Kong's displacement from China's domestic market and beyond.

China is advancing its financial openness primarily for its own strategic interests such as supporting RMB internationalization and improving banking sector cleanliness. Geopolitical risks may act as a deterrent due to tensions being factored into risk premiums. Nevertheless, the growing size of China's financial markets and attractive yield differentials will continue to draw foreign investors despite geopolitical dynamics.

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