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Local banking regulators have urged foreign lenders to strengthen supervision of renminbi trading amid mounting market risks due to China's rapidly growing foreign-exchange market.

But experts said overseas players were more competent and experienced in dealing with the risks brought by relaxing controls on interest rates and the forex regime compared with domestic players.

Instead, they should be more concerned about the potential risks posed by changes in government policies, which are more likely to influence the interest rate and foreign exchange rate to a larger extent than market forces, said experts.

Last week, the Shanghai bureau of the China Banking Regulatory Commission (CBRC) said that recent inspections of foreign banks found they had failed to "localize" their market risk management. For that reason, they continue to base their risk management procedures on the models established in other markets where government influence is deemed to be of much less importance.

"It's particularly noticeable that most foreign lenders have yet to set up departments for market risk management in China," the CBRC said. "And the people in charge of monitoring and control are mainly based overseas."

As a result, foreign players in Shanghai were told to perfect their risk control measures and gradually localize their risk management functions.

"Foreign banks should establish independent and effective risk control departments in China, with sufficient and competent risk-control personnel supervising their renminbi operations," the CBRC said.

Foreign lenders were also required to evaluate their risk exposure and profits and losses more accurately, providing reliable information and data for authorities to better control market risks.

But in the face of warnings from Chinese authorities, foreign players were in a hurry to defend themselves with allegedly reliable risk management frameworks.

Banks found with ineffective market risk management in China "excluded HSBC," Europe's biggest lender, a spokeswoman for the company said yesterday.

"HSBC has already finished localizing its risk controllers, and about 50 people, most of them from Shanghai, are involved in the operation of market risk control in the city," she said.

She also said that a risk management system set up exclusively in China was "very complete and reliable."

Other overseas players echoed the remarks.

A spokesperson for Citigroup, the world's biggest financial services company, said yesterday: "Citigroup has long been committed to localization across all facets of our business in China, including risk management.

"We recognize the necessity of having people on the ground who have in-depth knowledge of the local market, and have established a robust and comprehensive risk management framework in China, run by highly qualified local personnel," the spokesperson added.

Tao Changyu, a sub-branch director for the Bank of East Asia, said the sub-branch's risk control was administered at the upper level.

The bank set up independent compliance managers and internal controllers when the CBRC demanded commercial lenders establish a compliance department, Tao said.

"The inner control department is stationed in Shanghai with on-the-spot risk management," he added.

Foreign players including HSBC, Citigroup and Standard Chartered accounted for 27.2 percent of renminbi forward transactions on China's foreign-exchange system and 6.9 percent of spot trades last year, the central bank said last month.

According to statistics from the banking commission, 57 foreign lenders have opened branches in Shanghai, more than a quarter of the combined number of branches opened by overseas players in China.

Up to the end of 2005, the total assets of foreign players in China drew close to 700 billion yuan (US$87.5 billion), with 55 percent of them invested in Shanghai.

Banking regulators have warned that China's banking sector faces increasing risks as the country gradually opens its capital account and improves the renminbi's exchange rate mechanism as robust growth in the renminbi business continues.

"It's very important to strengthen the management of market risks, especially the supervision of market risks," said the CBRC Chairman Liu Mingkang in June. Interest-rate risk will gradually become the primary market risk for the financial sector, as interest rate liberalization deepens, he said.

Foreign exchange risk is also rising as the market increasingly plays a greater role in affecting the renminbi exchange rate mechanism.

"Strengthening foreign exchange management and supervision has become more and more important," he said.

But some experts warned that keeping a keen eye on new regulations and policies might even outweigh paying close attention to increasing risks from relaxing controls on interest rates and the forex regime.

"The expertise of foreign banks comes from their long-time understanding of and responding to a ripe market," said Li Hong, an analyst with the Shanghai University of Finance and Economics.

"But in China, which is in transition from a planned to a market economy and from an agricultural to industrial society, it's important for foreign players to respond in a timely way to new regulations and policies."

According to Li, the administrative factor is more likely to influence the interest rate and foreign exchange rate to a larger extent than market factors.

"A broader picture shows that the trend is steady for the renminbi to appreciate," which is easier for foreign lenders to anticipate and be prepared for, Li said.

Also, the interest rate in the Chinese market is still too low to take its toll on overseas players, he added.

"The fluctuation of the interest rate on the Chinese market is far from acute," said Zeng Gang, an analyst with the Chinese Academy of Social Sciences.

"Foreign banks are more cost-efficient they might increase their input when it's necessary. By contrast, domestic players should enhance their risk management strategies amid mounting risks due to increasing foreign exchange rates," he said.

The China Construction Bank lost 1.3 billion yuan (US$162.5 million) last year owing to a strengthening yuan, according to the lender's annual report.

(China Daily August 2, 2006)