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China's banking sector will inevitably go into mixed operations in the future to compete with foreign financial firms, the annual conference of the Boao Forum for Asia was told.

Li Jiange, deputy director of the State Council Development Research Centre, said that mixed operations were a must if local banks wanted to move forward with the tide of economic globalization.

Financial institutions in China are currently licensed to operate only in one type of business, such as banking, insurance, securities or fund management.

They are monitored by separate regulatory commissions, each of which reports directly to the State Council.

But China has started pilot projects in mixed operations, allowing banks to set up fund management companies last year. However, their credit capital is not allowed to flow directly into the stock market.

"In the near future, as the trials go on, we will see more new models of mixed operations," Li said, addressing a meeting on the reform of China's banking sector during the conference at the weekend.

He added that a handful of cross-market financial products and financial holding companies would emerge in China with the development of the financial market.

Chinese banks' profits mainly come from interest earnings at present, and that makes them vulnerable, said Vincent Cheng, chairman of Hong Kong and Shanghai Banking Corporation Limited (HSBC).

"The government needs to seriously consider allowing them to offer new services and disperse their risks."

Kevan Watts, chairman of Merrill Lynch International Inc, agreed that it was necessary to enhance banks' capabilities to compete.

China's banks are excessively dependent on interest earnings to generate revenue, he said.

It has been estimated that the ratio of fees and commissions to the total income of China's banks was less than 8 percent in 2003. In comparison, Citigroup earns about 46 percent of its net revenue from non-interest income, HSBC 43 percent and Bank of America 40 percent, according to Watts.

The opening up of financial services in China is also behind the desire of banks in China to adopt mixed operations, Li said.

Under China's commitments to the World Trade Organization, the country will fully open its financial industry to foreign banks at the end of this year. Chinese banks will then face direct competition on the domestic market with foreign financial groups.

While mixed operations enable the sharing of resources and a higher level of liquidity, they will pose challenges for domestic companies and regulatory authorities since corporate governance and risk management systems are relatively underdeveloped in China.

(China Daily April 24, 2006)