Foreign banks hope China's new leaders will loosen up regulators By Gabriel Wildau and Kazunori Takada SHANGHAI (Reuters) - For all the hopes that China's forthcoming leadership change will herald a new wave of market reforms, foreign bankers don't expect to get the level playing field they crave any time soon. Trends are positive, but progress can be frustratingly slow. My outlook is basically optimistic, particularly in the medium term. The near term is always always uncertain," Christian Murck, president of the American Chamber of Commerce in China and independent director of J.P. Morgan Chase (China) Ltd, told Reuters. A lighter regulatory touch on bond writing, derivatives and funding channels are seen as crucial to foreign banks' growth in China. But the best they can hope for in the short term is that the new faces in the Communist Party's standing committee adopt a broadly pro-reform stance that gradually works through to front-line regulators, whose discretion on licensing and product approval can mean the difference between feast and famine. "The attitudes that they take towards whether market reform needs to be accelerated again is absolutely crucial," Murck said. Foreign banks in China had their best year ever in 2011. After-tax profits grew 115 percent to 16.7 billion yuan ($2.68 billion) in 2011, according to a survey of 41 banks by accounting firm PricewaterhouseCoopers (PWC). Onerous regulation and unequal treatment compared to domestic rivals still restrain their growth. Foreign banks' assets rose by 24 percent last year, but their share of China's total banking assets remained under 2 percent. "Officials would like to say it's a level playing field for the foreign banks, but in fact that's still not exactly the case," said a senior financial services professional with experience working with foreign banks in China, who requested anonymity for fear of offending the Chinese authorities. Every year they do relax things a bit more. They give you one or two more products every year, but not all in one go," he added. Foreign banks consistently struggle to fund their lending in China. They are subject to the same 75 percent loan-to-deposit ratio that governs their local counterparts. But attracting deposits is a much greater challenge due to the slow and difficult process of receiving approvals to open new branches. Our branch network is nowhere near complete. We need to expand further to meet the demands of our clients," said an Asian banker, who declined to be identified because he is not authorized to speak to media. It's like, how many years do we need to wait to open a branch here? Consequently, most foreign banks rely on their offshore head offices for a large portion of their funding. But China's tight capital controls mean that increases in capital, via debt or equity, require regulatory approval. China expanded the aggregate long-term debt quota for foreign banks earlier this year, but banks still want more. The State Administration of Foreign Exchange has cut short-term debt quotas in recent years, according to the European Chamber of Commerce's 2012 position paper on financial services. Chinese authorities want foreign banks to rely on local sources of funding. But the chamber noted that China's onshore forex funding markets are still immature. A foreign bank whose offshore parent could borrow dollars at the Libor rate may pay 30-40 basis points more to borrow dollars onshore. Gaining access to the lucrative bond underwriting business ranks at the top of foreign banks' wish list, according to PWC's survey. China's bond market has nearly doubled in size since the end of 2009, with total bonds outstanding reaching 24.1 trillion yuan at the end of September. But as of mid-2011, only three foreign banks - HSBC, Standard Chartered, and JP Morgan - were approved to underwrite Chinese government bonds, which make up the largest share of the market. That compares to 57 domestic banks. New rules brought in last year established a process to allow foreign firms to underwrite commercial paper and medium-term notes in the corporate bond market - the fastest growing segment of China's bond market. But so far only HSBC has been approved, though it is not permitted to serve as lead underwriter. Foreign banks would also like to leverage their expertise in derivatives, a strictly regulated area, to sell structured products in China aimed at corporate treasurers or wealthy individuals. These investment products use derivatives like options or swaps to connect the value of the product to movements in interest rates, currencies, commodities, or equities. But approvals to roll out such products can often take months or years. ($1 = 6.2372 Chinese yuan) Editing by Simon Cameron-Moore