Just because China's financial institutions have not experienced any serious competition since the nation joined the World Trade Organization (WTO) does not mean that this will never come.

In fact, China's financial industry will encounter real challenges from foreign competitors in the coming five to six years.

Domestic financial institutions should not lower their guard, just because they have not experienced much competition over the past three years.

China pledged to gradually open its financial sector to foreign companies upon its WTO accession in late 2001.

Many government departments and research institutions have predicted that foreign banks will seize 15 per cent of China's foreign exchange savings' market and 5 to 20 per cent of the renminbi savings' market five years after the nation's WTO accession.

They are also set to capture more than one-third of China's foreign exchange loans' market and about 15 per cent of its renminbi loans' market.

This means that China's financial institutions will face great challenges from foreign competitors both in terms of profits and personnel.

But the competition faced by foreign financial institutions is currently far from serious.

Foreign financial institutions' market share is also much less than anticipated.

Some foreign institutions have also encountered difficulties on the Chinese market, although they entered the market quickly.

Between February 2001 and July 2002, 22 foreign insurance companies and 30 representative offices pulled out of China.

Some insurance companies, which had previously opened representative offices in different cities across China, thought there was no need to keep open so many offices, something that was proving very costly.

Some other companies also reorganized their China operations as a result of the mergers of their parent firms.

Some firms were also forced to streamline their operations, due to a big drop in their profits following the September 11 terrorist attacks on the United States.

More importantly, some foreign insurance companies found that their lack of awareness of the local market meant that, despite their advanced technology and rich experience, they failed to drum up enough business in China.

The localization of foreign insurance companies, including information collection and product design, could take at least two to three years.

Similar events are taking place in China's banking industry.

Foreign banks had 190 business operations and 214 representative offices in China in 2001, but these figures dropped to 180 and 211 in 2002.

The number of foreign banks to open branches or representative offices in China began to pick up again in 2003 and 2004.

By October 2004, foreign banks had set up 223 representative offices and the same amount of business operations in China, a record level.

These banks' total assets had also increased.

By October 2004, the combined assets of foreign banks were 12 times their 2001 level.

More importantly, foreign banks' profit capability increased greatly.

They reported profits of US$235 million in 2003, an increase of 20 per cent from 2001.

Foreign financial institutions' business expansion in China helped bring vigour to the country's financial market.

This was beneficial in terms of breaking financial monopolies and improving financial efficiency. This was good news for consumers.

Foreign financial institutions' participation in the Chinese market also helped bring in advanced management experience and promote financial renovation.

Foreign financial institutions will also bring challenges for China's financial industry.

The market expansion of these institutions will result in the shrinkage of domestic companies' market share.

The shrinkage of market share and a reduction of quality clients will lead to a decrease in profitability for domestic financial institutions.

For example, domestic banks will be at a disadvantage during competition, because they had heavy historical burdens.

Foreign financial institutions may also pose a considerable threat to domestic companies in terms of core personnel.

Domestic financial institutions should not underestimate the negative impact from their foreign competitors, just because the impact has so far not been felt.

The real challenge will be in the next five to six years.

Facing this challenge, domestic financial institutions should try to solve historical issues through reforms and try to find a way towards sustainable development.

China's four major State-owned banks, the Industrial and Commercial Bank of China, the Agricultural Bank of China, Bank of China and China Construction Bank, ranked 16th, 25th, 15th and 37th among the world's top 1,000 banks.

But the non-performing asset (NPA) rate of the China Construction Bank, whose NPA was the lowest of the "big four," was more than 8 percentage points higher than any banks ranking higher than it.

Despite the central government's injection of US$45 billion in China Construction Bank and Bank of China and the writing off of part of non-performing assets of the "big four", their average NPA remained at 15.62 per cent at the end of last year.

There is not an integrated securities market in China, because shares are divided into tradable and non-tradable ones.

The country's total market capitalization was 3.7 trillion yuan (US$446.5 billion) in 2004, according to figures from the China Securities Regulatory Commission. Tradable shares were only valued at 1.16 trillion yuan (US$140.8 billion).

The ratio of non-tradable stocks to total market capitalization accounted for as much as 68 per cent.

It will also take some time before State shares and shares held by State-owned institutions become tradable.

The separated stock market leads market performers to indulge in greater speculation, bringing with it high risks.

Under these circumstances, State-owned companies are keen to "take money from investors' pockets," while the return on their equity has declined.

Investors tried to make a short-term profit. And some securities firms conducted illegal operations.

But the regulatory body has beefed up its efforts to force unqualified listed companies out of the market.

If the government fails to properly solve these issues, China's financial system will be at risk.

The industry could easily be affected by external factors.

Both the government and domestic financial institutions should regard the opening as a kind of motive force.

Domestic financial institutions' hidden problems should be tackled, while their competitiveness should be improved.

Key attention should be given to solving these fundamental problems.

The sustainable development of China's financial industry will have to be built on the basis of a perfect ownership system and excellent corporate governance.

(China Daily April 4, 2005)