Risks and Systematic Countermeasures of Private Banks in an Era of Hypercompetition


The establishment and development of private banks are of great benefit to improve the financial system in China, since it has been in an important period of the financial system reform. Despite such an excellent opportunity, private banks are still faced with many risks, such as imperfect legal environment, fierce competition in the banking sector, lack of outstanding management personnel and a proper market position. In order to address these issues, the government should improve the legal environment, and enhance effective supervision. On top of this, private banks need to expand profit channels through financial innovation, have an appropriate market position and improve the management level. Systematology by Bertalanffy (1937) is valuable for analysis of the problem.

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Lu, M. , Meng, Q. and Zhang, Y. (2015) Risks and Systematic Countermeasures of Private Banks in an Era of Hypercompetition. Open Journal of Social Sciences, 3, 15-22. doi: 10.4236/jss.2015.37003.

1. Introduction

Recently, there are increasingly great calls for introducing private capital to the banking sector, and the government has issued a series of regulations and policies. The “The Twelfth Five-Year Plan of financial sector development and reform” in 2012 made a determination that the government would support the development of private finance in a standardized way, encourage and guide private capital to participate in the capital increase and restructuring of financial institutions, and promote private capital to participate in the establishment of small and micro finance institutions. These decisions put this proposal recommending private capital to enter into the banking industry, up to the level of financial strategy in China. A year later, the State Council promulgated an administrative regulation called “Guidance on adjustment and upgrading of economic structure in the support of finance”, which emphasized again the importance and urgency of private capital stimulating the vitality of financial industry.

At the same time, prosperous development of private enterprises makes material preparations for introducing private capital into the banking sector. A convincing example is Suning Holding Group, which stands first in 500 private enterprises in China in 2014, with revenue of nearly ¥ 280 billion. And China Banking Regulatory Commission (CBRC) approved the proposal from Suning on the establishment of a private bank. While the government strongly advocates the foundation of private banks, we have found an unfavorable condition where the profit and market share of newly-founded private banks are squeezed by competitors, especially State-owned Commercial Banks and stock commercial banks. Unless they can find a development path matching their existing resources, such as financial services for small and micro enterprises and Internet finance, it is not easy to have a share in the finance industry. The fact that state-owned capital accounts for about 89% among the nearly 4000 independent legal domestic banking institutions is a real challenge for private banks. With respect to the degree of openness to private capital into the banking sector, China still lags behind developed countries. According to statistics from Federal Deposit Insurance Corporation (FDIC) in the United States, there have been 6544 licensed community banks (belonging to private banks) among a total of 7083 banks by the end of year 2012, with assets of $ 2 trillion, making up 13.89% of the total assets of all banking institutions [1]. Private banks in China are in the early phase of development, so there are inevitably various problems, such as imperfect regulatory system, lack of human resources, management level etc.

With the advance of the Internet finance and promotion of reformation of financial system, the traditional model is outdated where commercial banks rely on interest rate margins to make great profits. Consequently, it will be difficult for banks to obtain a clear competitive advantage over other competitors. D’Aven put forward the concept of Hypercompetition in the book “Hypercompetition: Managing the Dynamics of Strategic Maneuvering”. He found it increasingly difficult for companies to maintain a competitive advantage in the hypercompetition environment, and these advantages are created, eroded and eliminated with an accelerating trend. Therefore, enterprises should have courage to destroy the existing advantages and create new ones in a dynamic perspective [2]. If private banks fail to find their unique mode or identify the market position, it is impossible to survive in the intense competition, not to mention developing. In addition, financial reform promotes the progressive internationalization of the finance industry. Private banks will have more competitors both at home and abroad. Last but not least, consumers’ increasingly diverse needs drive them constantly innovate. That is to say, the banking sector is entering a Hypercompetition era or environment. Relationship between private banks and traditional commercial banks in the hypercompetitive era and how to improve their service level through innovation have become new academic and financial concerns.

2. Relevant Research

In fact, most scholars are in favor of the proposal that we should accelerate the pace of private capital entering the banking sector. Fulin Shang (2015) suggested that China should expand the pilot of private banks by expediting the provision on it and improving the regulatory framework. At the same time, the government also encourages private capital to enter banking institutions through multi-channel. In order to achieve this goal, we should expand the pilot of consumer finance companies, increase private capital ratio in rural banks and support private capital to participate in the establishment of rural banks. Ma (2014) proposed that it is necessary to establish a sophisticated access mechanism, a clear operating standards and a risk warning and exit mechanism when he explores supervision and management system of the private bank [3]. Xu (2004) holds it is pressing to break up the ownership restrictions on private capital into the financial sector. And then, we can open the private banks step by step through market mechanism [4]. Although the majority of scholars and experts agree with this opinion in recent years, opposite views were also common a few years ago. Wang (2002) denied the feasibility of establishing private banks in consideration of the domestic financial environment at that time, he thought privatization of city commercial banks and rural credit cooperative was more practical, instead of found new private banks [5].

There are also many foreign researches into private banks. FDIC (2012) defines community banks (equivalent to the domestic private banks) as financial Institutions with less-than-$ 1-billion total asset, more-than-50% core deposit proportion (to total assets) and greater-than-33% loan proportion ( to total assets).What’s more, it also limits the amount of agencies around the country [6]. Indian scholars Roy, Vaijayanthi, Shreenivasan, Preetha and Sinha (2012) surveyed the customers of banks in Chennai, Tamil Nadu and other places. The findings confirmed a relatively higher level of satisfaction in the Private sector bank, attributed mainly to channel management aspects including bank facilities, ATM facilities, on-line banking services and telephonic banking. The customers of the Public sector bank were more satisfied with the front end services [7].

Based on opinions mentioned above, there is a gap between China and other developed countries both in practical and theoretical aspects. Discussion of private banks in China now gradually shifts from an initial outlook period to a strategic planning phase, but there are few documents about systematic analysis of private banks’ establishment and development. It is of great value to analyze the problems private banks have to face and impacts it has on the finance system based on Systematology. Finally, feasible countermeasures will be put forward.

3. Research Methods: Systematology

Systematology (1937) was first proposed by Bertalanffy, which describes and derives general principles applicable to a variety of systems. The theory focuses on the relationship between various subsystems and emphasizes the synergy between subsystems and elements. It also attaches great importance to changes of the state of the system [8]. It makes sense to analyze problems in promoting the construction of private banks, give some countermeasures and maximize system functions through systematology.

3.1. Relationship between Elements in the System

Systematology believes that there is a boundary in the system. Similarly, the system of private banks also has a limited range (Figure 1) [9]. First, private enterprises (two at least) applies to CBRC. Not until they obtain the approval can the sponsors square away their plan. That is what we call the entering mechanism of the system. Private banks build relationships with borrowers, depositors and consignors by conducting business like taking deposit, lending and intermediary business. It is so-called ‘resources’. As sponsors, private companies can raise capital for themselves within the law. Other elements in the system get economic benefits too, which realizes the ‘function’ and achieve a win-win situation. Nonetheless, the external environment imposes ‘pressure’ on the system, such as defective legal environment, fierce competition among banks, etc. Furthermore, ‘pollution’ will be produced during operation. Depositors may suffer economic losses due to poor internal governance of the bank. Finally, a reasonable exit mechanism must be included in the system. In short, the more effective a system is, the more ‘pressure’ it can bear and the less pollution it will bring about.

3.2. System Functions

The Private bank is independent, efficient, professional and flexible as a result of the unique ownership structure and operational forms it has. Private banks play an important in the multi-level financial system, which alleviates the plight of small and micro enterprises’ financing and provide more convenient financial services for farmers and community residents. The establishment of private banks promotes fair competition in the domestic financial market, and ultimately improves the efficiency of social capital.

As long as the elements in the system develop in coordination and a sophisticated balance mechanism exists, the system can maintain a normal and stable operation. What we want is that the overall function of the system is greater than sum of functions of elements separated. As in:

indicates function of the whole system, namely, the state of banking sector when private banks develop stably; Pi represents the “function” of each element which refers to government agencies, private capital, private banks, lenders, depositors and other financial institutions. It is a state where each one obtains best interests with

Figure 1. The relationship between elements in the system of private banks.

low risks as possible as they can.

4. Systematic Analysis for Establishment and Development of Private Banks

4.1. “Pressure” of the System from Environment

4.1.1. Imperfect Regulations on the Development of Private Banks

Currently, departments guarantee the quality and control the quantity of private banks, since they are still in the pilot phase. “Measures for the Implementation of Administrative Licensing Matters for Chinese Commercial Banks” in 2013 made strict rules for its lead time. For example, preparation period is six months after approval. If banks failed to finish on schedule, they shall submit a report to the CBRC for one month preparation period and the maximum is three months. Apparently, It is hard for a private enterprise unfamiliar with banking management to establish leadership team, formulate a governance system. If there is anything wrong during the period, opening will probably be delayed. What’s worse, it may lead to bankruptcy of the plan.

On top of this, The People’s Bank of China (PBOC) has stringent requirements about mode of operation. Customers must go to the bank branches personally when they want to open an account. With the rise of online banks, “Notice on Regulating the banking financial institutions to open RMB personal electronic accounts (draft)” comes out, on which allows weak real-name electronic account when customers open an account remotely. However, this kind of account can only be used in purchasing financial products. These provisions means a higher switching cost for private banks with internet genes, which is spent on converting internet users to bank depositors. The newly-built private banks have to invest huge upfront cost into network construction. Therefore, in terms of the regulations, private banks face great challenges.

4.1.2. The Trend of Lower Margins with Promotion of Interest Rate Liberalization

Traditional banks strongly rely on spreads between deposit and lending rates. The fact can be confirmed by the proportion of net interest revenue. According to statistics from 7 typical commercial banks in China, the average proportion is still up to 75% despite declining in the year 2012-2013. Bank of Communications has the highest proportion, about 83% in 2013. The phenomenon fully illustrates the importance of the interest rate for banks.

If newly-established private banks may intend to lower lending rate and increasing deposit rate to attract more customers. As a result, net interest income will shrink. Interest rate liberalization is an inevitable trend, which leads narrower spreads. Changes in interest rates have become part of daily operations and risk management. The average net interest margin of global top-ranking banks in 2010 such as Bank of America, JP Morgan Chase, Citigroup and 9 other international banks, is about 2.88%. Net interest margin of developed countries is 1% - 1.5%, less than half the average level of that in China. Another example is Taiwan. Interest rate liberalization in Taiwan took place in the late 1980s, bringing about remarkable effects. Shortly after that, deposit rates rose by 20 percent to 50 percent. And then, spreads narrowed substantially, with the average bank spreads at about 3.11% in 1989. The nominal interest rate in 2011 was only 1.41% based on the statistics. Therefore, risk of interest rate is an obstacle to private banks with promotion of interest rate marketization.

4.1.3. Strong Competition with Other Banks

There is no denying that in China, most of the financial assets are occupied by state-owned commercial banks because of the low openness degree and financial repression. Information of banking institutions assets in 2014 shows (Figure 2), state-owned commercial banks take procession of a large amount of assets, approximately 42.26%, while other joint-stock commercial banks is about 18.05%. According to these data, the private banks face enormous pressure from existing commercial banks, especially large state-owned commercial banks and joint-stock commercial banks. Customers of high credit prefer to state-owned commercial banks. On the contrary, some customers with poor credit fail to take out a loan from state-owned banks and turn to private banks, which will undoubtedly increase the risk of bad debts for private banks. Private banks are inferior in the asset size and personnel, which places them in a tough situation.

When regulators released that allows private funds entering the banking sector, lots of private enterprises were eagerly for applying for a licence. Many enterprises witnessed the boom, including ‘Internet group’ like Suning Appliance, Zhongguancun Administrative Committee, Alibaba, ‘group of local private enterprises’ like Wenzhou Commercial Bank, Huafeng Group, Junyao Group and ‘group of small finance corporation’ like Blue Ocean financial Group, Chongqing invested, Cangnan Comerica microfinance Limited. We can see all the banks

Figure 2. Share of assets of financial institutions in 2014.

approved concentrated in eastern regions which is in an economic boom. That doesn’t comply with the purpose to establish private banks to support small and micro enterprises and fill gaps of traditional financial services. It also easily causes vicious competition among private banks, and ultimately homogenization occurs. In contrast, in the United States, only few community banks establish in New York and western California, about 10% - 15%, while in some of areas where the economy is relatively backward, the proportion is up to about 75%.

4.1.4. The Relatively Lower Level of Management

Lack of senior management personnel leads to decline in bank management because many outstanding financial professionals would rather stay in large state-owned banks and joint-stock banks. The financial industry is highly specialized, while majority of the companies applying for the license are non-financial enterprises. So, internal redeployment can’t meet the increasing demand for experts talented for finance, and how to make up for it by hiring talents from outside has become a top priority. In a hypercompetitive era, traditional banking management are not able to meet the needs, and people with both Internet and financial thinking are preference to private banks. Private banks are desperate for talents and have multiple requirements, such as having a strong network of relationships, rich experience in different banks and sense of pioneering innovation.

Strict as the standards are, the reality is that a lot of senior management personnel have no enthusiasm in it and take a wait-and-see attitude. What they are worried about is whether they will have real decision-making power. If the final say is tightly grasped only by chairman, which will obviously affect their will. A number of management staffs are very concerned about the background of the shareholders. For example, RAE banks established by JuneYao and Metersbonwe don’t appeal to talents in Shanghai financial circles. Enthusiasm for private banks is quite high since the introduction of the policy. However, the environment is not fully equipped to attract top talents. Therefore, lack of senior management staffs leads to the relatively lower level of management.

4.2. “Pollution” from the System

4.2.1. Greatly Influence on Financial Stability of Internal Governance of Private Banks

Besides huge profits from margins, another reason why a lot of private companies are eager for private banks is that it eases their own financing difficulties. However, if private companies exceed legal limits, related lending will become an inevitable problem, and whether transfer of benefits will occur directly tortur governance and ethical standards of banks. Banks are public companies, and they don’t just provide services for the sponsor. They usually obtain plenty of funds through deposits from the public, with a lower financing cost than other channels, especially banking license is still relatively scarce resources in China. If they can’t make timely financial resources go back to serve the public, then the private banks will have suspect of illegal fund-raising.

To solve this problem, regulators have issued a number of regulations. Pilot banks must have co-founders instead of only one sponsor, that is, each sponsor have no less than two private enterprises, with less than 20% of the proportion of equity in an attempt to achieve balance through decentralization. In addition, initiate shareholders with actual control are also requested to be legal citizens within the territory of mainland of the People’s Republic of China and their property must be within the territory of China. However, there are always something faulty in external supervision, such as information asymmetry, lag of regulatory. Currently, the financial regulatory system has difficulty in adapting to fast-changing development. Inadequate external supervision is a major challenge for private banks’ internal governance. If a risk of internal governance happens, private banks will become a financing tool for sponsors, which will affect the stability of the financial sector.

4.2.2. Potential Credit Risks in Development of Private Banks

Compared with state-owned banks, private ones without national credit guarantee have higher credit risk. As the gragh shows, in 2014, the rate of non-performing loan (NPL) in domestic commercial banks is quite high (Figure 3). The credit risk pressure and risk exposure in the banking sector has increased infuenced by the trend in domestic economic slowdown and restructuring in some industries. At the end of 2014, scale of non-performing loans was very large, about ¥ 842.6 billion, with an increase of ¥ 75.7 billion over the end of the third quarter, and an increase of ¥ 250.6 billion over the end of 2013. Non-performing loan ratio was 1.25%, 0.25% higher than the previous year [10].

Credit risk of traditional commercial banks constantly rises in recent years. Private banks differ with existing commercial banks in market position, and always position themselves in community banks and small micro- banks. They avoid head-on collision with large state-owned banks by means of dropping high-quality customers which increases the proportion of bad loans, and finally they have higher credit risks.

5. Countermeasure to Reduce Risks in Private Bank Development

Since we have found causes of risks, appropriate measures should be formulated in order to maximize functions of the system. There are effective countermeasures such as stepping up entry and exit mechanisms by legislation, a clear market positioning, continuous financial innovation and improving the management level.

5.1. Improving the Legal Environment

Laws related to private banking are still in absence. At present, “The Pilot of Private Banking Supervision and Management Approach (Draft)” hasn’t been officially implemented. In order to speed up the construction of le gal environment, the government should improve the efficiency of the audit, and start the local pilot as soon as possible, and then extend the approach to the whole country.

Now let’s take the entry and exit mechanism as an example. Unless entry mechanism has been standardized, financial institutes will be admixture of good and evil. Sponsors of private banks are across different industry, so

Figure 3. Non-performing loans of commercial banks table.

national uniform standards should be launched as soon as possible. Improvement of exit mechanism is built on the deposit insurance system. As the “Deposit Insurance Act (draft)” (“Regulations” for short) mentioned: commercial banks, rural cooperative banks, rural credit cooperatives and other financial institutions involved in banking deposits that establish in the territory of People’s Republic of China should be insured in accordance with the provisions of “Regulations”. It shows that deposit insurance in our country is compulsive, which will protect the interests of depositors and enhance the credibility of the private banks.

5.2. Creation of an External Risk Monitoring Mechanism

Effective execution is also of great significance. Therefore, we need to establish a wide range of monitoring mechanism, so that we can reduce risks from the source. This can be realized through a series of specific methods. One method is on-site inspections where account information, documents are reviewed by supervisors, and other methods such as inquiry and discussion are conducted to analyze, inspect and evaluate financial institutions. Regulators need to pay attention to legitimacy, capital adequacy and liquidity. Off-site supervision is a complement of on-site inspection, problems found in on-site inspection can be monitored continuously [3].

Regulation is the responsibility for both executive branches and the public. Therefore, mandatory disclosure of information is necessary. At the same time, we must pay attention to off-balance sheet disclosures and private banks must promptly inform the public of changes in the major events and policies.

5.3. Reducing Dependence on Interest Rate Margins by Innovation

Banks is confronted with risks of profit decline because of narrowed margins. If Rate-Sensitive Asset (RSA) and Rate-Sensitive Liability (RSL) maintain consistency in amount, and the lending rate reduces faster than deposit rate, shrink of bank net profits are inevitable. Major commercial banks have their own intermediary business, so newly-established private banks would better create a unique business according to their own characteristics and advantages. This characteristic can not only be reflected in their product, but also in service quality, and then they are gradually formed as the core competitiveness. In a word, private banks should get rid of dependence on spreads through financial innovation.

Nowadays, direct-sale banks are quite popular. The so-called direct-sale means that banking center has direct contact with the end customer via web, telephone, mail, etc. to carry out business, independent on branches of banks. Currently, Minsheng Bank and Industrial Bank has launched this service. The direct model is the result of the development of Internet technology. Although it doesn’t have a substantial innovation in product, technological innovation is also worth promoting.

5.4. Having a Right Market Position

An appropriate market position is also important for banks and implementment of national policies. Currently, models of five pilot banks are different. Alibaba and Vientiane locate themselves on small depositors and small loans with limited deposit ceiling and wealth. Tencent and Baiyeyuan focus on large deposits and small loans and set a lower limit in deposits. Nanhui is engaged in public loans and deposits. In terms of capital and quality, they are inferior to other banks, so a right position helps to reduce competition.

As for target customer, small and medium enterprises may be a better choice. Asymmetry in economic structure and financial structure is embodied in lack of financial institutions supporting small and micro enterprises. Therefore, private banks have the opportunity to enter the market segment and gain competitive advantages. Private banks can locate themselves in community. There is an example like Bank of China Postal Savings, it has already provided services for agriculture, rural areas and farmers, small and micro enterprises and community in advantage of its fully coverage of urban and rural areas [3].

5.5. Enhancing Management Level

Improvement in management level relies on cultivation and attraction of talent. In order to attract and retain senior management personnel, banks can learn from some of the practices in consulting firms, accountants and law firms. They usually have Employee Stock Ownership Plan or Partnership System to attract these people with the “golden handcuffs”. Furthermore, rational management magnitude and clear relationship between rights and responsibilities are necessary for effective management. Private banks should reduce layers of management to the greatest extent, to make decision more flexible, which makes the bank more sensitive to market change.

Banks also need to pay attention to internal control and comply with basic principles of segregation of incompatible duties. ‘The Pilot of Private Banking Supervision and Management Approach (Draft)’ makes the following provisions on governance: Private bank shareholders commit to continuously recapitalizing the bank in absence of deposit insurance system and shareholders are jointly and severally liable for the residual risk, and they have to compensate to depositors when necessary.

6. Conclusions

6.1. Private Banks’ Confrontation with Great Opportunities

Private economy plays an important role in supporting economic growth, promoting innovation, creating jobs and increasing tax revenue. The development of private banks benefits from burgeoning of private enterprises and some favorable policies. Private banks are of much significance in financial system reform in China, and it is also an important supplement to the financial markets.

6.2. Further Support from the Society

Private Banks start later in China, and there is much room for improvement in the external legal environment as well as internal management capacity. Only by joint efforts from government, investors, the public and professionals can we sum up the experience and extend experimental unit sphere. We believe that the enthusiasm of private capital entering into the financial sector will be further mobilized with the implementation of the “Deposit Insurance System”.


This work was supported by Social Science Foundation of Jiangsu Province (13GLB007).

Conflicts of Interest

The authors declare no conflicts of interest.


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