China Financial Sector
THEME
2008 market survey: return to conservatism
■ Our 2008 survey on China’s financial services industry clearly reveals
the impact of an extremely difficult capital market. Households that
previously diversified their wealth allocation into various investment
products have returned to bank savings and life insurance products for
safety and protection.
■ We view this return to conservatism as a temporary disruption to the
long-term trend of wealth diversification among Chinese households.
Continual income creation is a powerful support to this long-term
structural trend and growth potential remains strong for non-bank
investment products such as life insurance, funds, stocks and bonds.
■ Moving into 2009, however, we do see some near-term challenges
facing banks and life insurance companies – despite our survey
showing increased product penetration. For banks, we expect
accelerating deposit intake and falling credit demand to pose
challenges to effectively preserving margins. Moreover, the
Agricultural Bank of China (ABC) has gathered fairly strong momentum
– placing more competitive pressure on banks overall. While life
insurance companies are seeing a favourable shift in product mix,
premium growth is likely to decelerate from a high base.
■ China’s financial sector remains UNDERWEIGHT, in the context of the
domestic market. Our China strategist has maintained an
UNDERWEIGHT mainly on banks while retaining an OVERWEIGHT on
insurance companies. With a base case of falling interest rates but a
remote risk of deflation, we argue that earnings risk is higher amongst
banks where the credit cost cycle tends to lag corporate profits. Our
top picks among insurance firms are: Ping An and PICC. We prefer
large banks – in order of preference – BOC, ICBC and CCB.

Return to conservatism
Our 2008 survey on China’s financial services industry shows households returning to
their old conservative favourites of banks and life insurance products. This clearly reflects
a difficult investment environment, which has dominated most of 2008 and will possibly
move into 1H09, at the very least. While our survey does reinforce the long-term growth
opportunity for the sector, it reflects a near-term shift towards more conservative financial
products, which pose different opportunities and challenges for banks and life insurance
companies. In general, we expect competition levels to rise for banks while product shift
should remain favourable, but with lower premium growth for life insurance companies.
Wealth diversification faces temporary disruption
The consistent increase in investment products’ penetration in our 2005-07 surveys has
faced a setback in 2008 when penetration dropped, particularly for stocks and bonds.
While the significant stock market volatility has caused this temporary glitch, we believe
the long-term structural growth story is supported by continual income growth among
households as total expenditure on investments continues to rise.
At the product level, room for increased bank account penetration is relatively low and
likely to be driven by more households moving up the income scale. Protection-type
insurance penetration remains much lower than overall penetration and offers good growth
potential. Stock penetration is relatively high among high-income groups and is likely to
remain volatile in the medium term; whilst funds penetration has been relatively stable
thanks to stronger distribution support by banks.
Banks: rising competition
Our 2008 survey indicates elevated competition among banks. This is reflected in the fastgrowing
momentum at ABC, which has shown both the greatest leap in account penetration
and a significant improvement in customer satisfaction. ICBC, on the other hand, has lost
some of its dominant position in account penetration, although overall customer satisfaction
has improved. CCB also managed to increase penetration in this survey but is the only bank
that has seen a slight slip in customer satisfaction which might signal customer retention risk.
BOC managed to maintain its account penetration level but its customer satisfaction has
shown noticeable improvement – this might reflect its recent strategy of focusing on further
cultivating its existing customer base. Apart from the big four banks, second-tier joint stock
bank retail franchises continue to lag. With the exception of China Merchants Bank and
BOCOM, the rest have hardly made an impact in our survey. CMB continues to do well while
BOCOM managed to preserve its results from last year.
Insurance: hitting a wall in 2009
Our survey suggests steady life insurance penetration, growing demand for risk and
protection-oriented policies, and a return to favouring participating policies at the expense
of unit-linked policies (which provided unsatisfactory returns). These conditions provide a
backdrop that is generally supportive of our 25-30% VNB (value of new business) growth
expectation for FY08.
In 2009, we believe growth will be harder to come by for the life insurers, particularly in
pure volume (rather than value) terms. Firstly, we expect the weak economic environment
to lead to a contraction in disposable income. This is expected to be compounded as the
rotation of investors become less pronounced as they move out of investment-linked
products and direct equity investment and into more conservative products with
guaranteed product features. Ultimately, we expect VNB growth to slow to 12% in 2009.
We believe demand for long-term products sold through the agent channel (the dominant
driver of VNB) will remain solid. However, we believe short-term single premium
investment-style products will be much weaker, given the high base from 2008 and the
absence of the investor rotation tailwind.

Wealth diversification faces
temporary disruption
Our 2008 survey, for the first time, showed a pick-up of penetration in conservative
financial products (such as bank deposits and life insurance policies) due to the
deteriorating investment environment. Specifically, penetration of bank accounts amongst
the surveyed households increased 6% from 71% in 2007 to 77%, a level that is
comparable to the 78% surveyed in 2006. Penetration in life insurance products also
staged a minor recovery in 2008 (+3% to 48%) after the big fall in 2007 (-7% to 45%). This
is consistent with the restoration of demand for insurance savings products as households
sought more capital-guaranteed products in conjunction with the falling equity market.
In contrast, stock penetration remained broadly flat (edging down 1% to 35%) whilst the
share of surveyed households owning bonds fell 3 percentage points to 8%. Penetration in
funds however continued to rise, albeit at a slower pace than in 2007 and reached 26%
(up 4% from 2007). We think if the survey had been conducted later in the year,
penetration of these three type of investments might have weakened even more. However
the overall results still show more of a temporary disruption to a long-term structural trend
towards continual diversification of household wealth in China. The sharp correction in
global capital markets and the devastating Sichuan earthquake in China were also
apparent drivers to the near-term disruption, in our view.

Behaviour varies slightly across cities
Some interesting variances in investment behaviour at the regional level include:
■ A significant pick up of penetration of life insurance policies in Chengdu (possibly
caused by the Sichuan earthquake earlier this year) and a significant rise stock
ownership among households surveyed in Shenzhen.

■ Across most of China’s cities there was an increased penetration of funds. However,
funds proved less popular in Shenzhen and Shenyang, where there was relatively
greater interest in stocks and bonds, respectively.
■ Fund penetration was also more successful in tier-three cities than tier-two cities. This
could be due to increased marketing efforts in tier-three cities where the presence of
securities brokers is higher than in tier-two cities.

Penetration amongst different income groups
While higher income households tend to own a wider range of financial products, the gap
between the high income and low income groups has narrowed compared to a year ago.
This is driven by: 1) a constant increase in the penetration of non-bank financial products
overall among the lower income households (especially those earning less than Rmb
1,999 per month) and 2) a faster decline in the penetration of life insurance and stocks
among the rich.
A breakdown by products shows, the penetration of bank accounts across various income
groups actually fell or remained the same as last year. The aggregate penetration of bank
accounts actually grew in this year’s survey and was clearly driven by income growth –
more households move up the household income scale. The implication for banks is that
opportunities for customer gains will be more likely to stem from tier-two or tier-three cities
where income growth potential is arguably higher.
For life insurance products, it is interesting to see that penetration (in the context of a takeup
of insurance) does not appear to increase materially as we move from middle to upperincome
brackets. In our view, this represents an opportunity for insurers: identifying and
effectively marketing to the 46% of middle to high-income earners who do not yet own an
insurance product provides a source of incremental growth. In addition, the penetration of
life insurance among higher income groups (with a monthly household income of
Rmb7,000 or above) fell noticeably from last year’s survey. This likely reflects terminations

in investment-linked products and suggests that protection type products have a much
lower penetration but greater future growth potential.
Compared to a year ago, stock penetration across the mid to high income groups is much
more volatile and can be reduced quickly when stock markets fall. On the other hand,
penetration of funds across income groups has been more stable compared to a year ago.
This could reflect perceived better diversified investment risk in funds relative to stocks
and/or bank’s much more effective marketing/distributing ability.
Figure 9: Higher-income homes cut investments more aggressively especially in life

Income growth counters falls in penetration
Whilst our survey shows some deceleration or decline in the penetration of financial
products, the renminbi amount disbursed to all financial products continued to rise, albeit
at a slower pace of 26% versus the 120% growth recorded in 2007. This is particularly true
for life insurance policies where total expenditure on life insurance increased the most
(38.5%) from a year ago compared to bank savings (up 18.8%) and investments (up
11.3%). While insurance penetration does not appear to be rising materially, the average
premium payable by each customer is clearly trending upward. This is consistent with
anecdotal evidence from life insurers who suggested average case size expansion was a
source of growth. We would expect this to be a less important growth driver going forward
given the potential easing of upward pressure on household incomes in a weaker
economic environment.
The rebound in penetration and the continued increase in expenditure on bank savings are
also consistent with the accelerated system deposits growth seen around mid-2008 as the
sharp correction in the stock market triggered a reversal of capital flow away from banks to
the capital market. While this improves liquidity in the banking system, it creates a different
challenge for managing yield (as credit demand should slow down along with decelerating
macro growth).

Our survey showed that penetration in investment products has either stalled or declined.
The fact that total expenditure continues to rise does reinforce the long-term growth story
that should be supported by continual wealth creation.
Shenzhen and Chengdu stand out as the two cities that invest the most in all financial
assets, while increased allocation across different asset classes proved to be fairly even.
Beijing follows closely on the heels of Shenzhen and Chengdu but increased investment
products (stocks, funds, bonds) take up a much higher share in Beijing than for bank
deposits and life insurance policies.

Finally, the reasons for allocating financial assets in different classes have also changed
slightly compared to previous years. The changes mainly reflect the reinforcement of certain
attributes of specific asset classes. For life insurance products, our survey highlights the
importance of protection over investment return as the key determinant of customer demand.
The value of the protection element appears to be resonating with customers: hence the
77% response rating versus the 57-62% rating in 2005-07 surveys. It is this focus on
protection that we believe underpins the relatively stable outlook for growth, particularly in
the agent channel where long-term, high-margin bundled products prevail.
For banks, the four main reasons for households to choose bank savings are all reinforced
with a four to six percentage points increase in weighting. It is interesting to note that
providing safe, low risk and stable returns dominate overwhelmingly the convenience that
banks provide for transacting. This should continue to add to state banks’ franchise value
on top of their distribution advantages.
While having a high investment return rate remains the most important reason for
households opting for investment products, perception has weakened slightly. With only
54% of respondents associating investment products with a high rate of return, volatility in
the capital market does pose a challenge to lifting the penetration of investment products –
that are managed only after a longer-term track record has been established and/or when
the continual accumulation of household wealth increases risk tolerance.