Agricultural Bank of China’s exposure to rural economies a potential drag rather than a driver | The Investor Audit

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Agricultural Bank of China’s exposure to rural economies a potential drag rather than a driver

June 29,2010

China’s urbanisation trends could run against the bank’s ambition to generate significant revenue from China’s less developed rural areas

1.	Rural residents have lower disposable incomes compared to their urban counterparts and the rural-urban income gap is widening making China’s urban areas a more lucrative market for a bank’s business
	A majority of ABC’s 320 million individual customers reside in China’s counties where the economy is associated largely with rural sectors Rural residents’ disposable income is a third of city dwellers and the gap is widening We believe the gap will not be getting closer any time soon. Thus, relatively speaking, city dwellers will continue to be more attractive for banks than rural residents
2.	Residents in counties supply cheap funding for ABC. However, revenue contribution is minimal due to low loan account penetration
	Residents in China’s thousands of counties provide 40% of total deposits, which provides a cheap and stable funding source for ABC However, due to an inadequate social welfare system in rural areas and lack of stable income, most of them are not borrowing from bank Thus, loan account penetration is low for residents in county areas where personal loan accounts are only 1.1% of personal deposit accounts
3.	Branches in counties lag far behind those in cities in terms of revenue generation, making them more of a performance drag than propeller
	Over 50% of ABC’s 23,000 networks are in counties where economy is associated largely with rural businesses The revenue generated from these networks is only half that of branches in cities, which already lag far behind other major commercial banks

1.	Rural residents have lesser disposable income and the rural-urban income gap is widening, suggesting that China’s urban areas are more lucrative for any bank’s business

Agricultural Bank of China (ABC), the country’s third largest by assets as of end of 2009, lends more to residents in rural parts of China compared to its peers. 28.8% of its loan portfolio comprises borrowers residing in China’s thousands of counties where the economy is heavily dependent on the agricultural sector, rural areas and farmers. Lower disposable income among this demographic, could be limiting for the bank’s growth potential in county-level economies in the near future. Also, the gap between urban residents and rural residents is widening. The chart below shows that in the past decade and a half, the gap of disposable income between Chinese rural residents and those in the cities has widened six-fold with city dwellers earning three times more, despite the government’s efforts to close the gap. In 2009, rural residents had a disposal income of RMB 5,153 ($750). The limited success of the social welfare system in rural areas further limits rural economies’ potential to drive ABC’s performance. Rural residents have much less disposal income than city dwellers and the gap is widening Source: The Asian Banker Research

2.	Residents in counties supply cheap funding for ABC. However, revenue contribution is minimal due to low loan account penetration

County-level nominal GDP has grown by 16.8% (compound annual growth rate), higher than the national average of 15.5%. However, bank loans from China’s counties make up less than a fifth of total loans, although the percentage of county level GDP to national GDP is increasing. This indicates that customers in county-level economies are less willing to take loans from banks or can hardly get loans from banks with satisfactory terms. At the end of 2009, for ABC’ county level segment, personal loan accounts accounted for only 1.1% of personal deposit accounts and corporate loan accounts accounted for 2.9% of corporate deposits accounts. Unless the social welfare systems for rural Chinese improve significantly and disposable income increase notably (which we believe unlikely to happen in the near future), the situations is not going to change much. Loans to customers in counties accounts less than 20% of total loan portfolio Source: The Asian Banker Research

3.	Branches in counties lag far behind those in cities in terms of revenue generation

ABC boasts it has the largest branch network in China and has a footprint in 99.5% of all counties in China. However, the operating income per branch in counties was RMB 6.7 million ($0.98 million) and it was as just half of that of branches in cities. Thus, some of its network in counties would be more a performance drag than a propeller. Overall, ABC’s branch profitability lags far behind its peers. ABC’s branches in counties are performance drag Source: The Asian Banker Research

4.	Even China’s urbanisation may go against the bank’s ambition to generate significant amount of revenue from the rural related economies

By the end of 2009, China’s urbanisation rate has reached 46.6%. We believe the rate will exceed 50% in a couple of years’ time. Based on our study of the urbanisation in developed countries such as The United States, South Korea, and Japan, we find that population migration actually follows largely a predetermined route: from country side to cities, from small cities to large cities, from urban areas of large cities to suburbs, and lastly the urbanisation of suburbs. We also find that whenever the urbanisation rate reaches around 50%, the second stage will start to dominate the migration and big cities that have the most opportunities will be the magnet for talent and wealth. Historical trends in developed countries suggest, as Chinese start to migrate from small cities to large cities, we will see China’s three metropolitans, i.e. The Yangtze River Delta (Shanghai), Pearl River Delta (Guangzhou-Shenzhen-Hong Kong), and Bohai Economic Rim (Beijing-Tianjin), will present even more opportunities for banks than any other places in China. Banks would be much better off diverting every possible resource to these areas to catch up China’s forthcoming era of metropolitan economies. These three metropolitans, not the rural areas, would be the growth engines for banks in China

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