Case Study. raising the bar Bank of Shanghai [ Part 1 ] Highlights

• Since 2006, Bank of Shanghai has grown revenues by a compound rate of 26% a year and net fee-based revenues by 59%. • Bank of Shanghai’s revenue growth has been accelerating since 2005 and has started to outpace peers yet its net interest margin has risen steadily while its level of non-performing loans has fallen each year - meaning that Bank of Shanghai has been gaining market share at the same time as writing higher margin and higher quality business. • In 2008, the bank had a cost/income ratio 55% below the average for the top 1000 banks and 15% below domestic peers. • In 2008, Bank of Shanghai’s Return on Capital was 125% higher than the average for the top 1000 banks and 15% higher than domestic peers. • The bank has more than 13m accounts, 280,000 corporate customers, 7.4m retail customers, more than half a million transactions per day – but employs fewer than 370 full time IT staff.

Highlights

raising the bar

|

Bank of Shanghai

[ Part 1 ]

An examination of how – through early adoption of modern core

banking software and clear strategic planning – Bank of Shanghai

has readied itself for, and is already exploiting, the significant

changes taking place in the Chinese banking market.

May 2010

Contents

Retail Banking Corporate & Correspondent Banking Universal Banking Private Wealth Management Islamic Banking Microfinance & Community Banking

Executive summary

1

About Bank of Shanghai

4

An overview of the Chinese banking market

5

The Legacy System and its Limitations

11

The core system selection & implementation

13

How core replacement has facilitated the execution of

Bank of Shanghai’s corporate strategy

15

•

Customer service

16

•

Product innovation

17

•

Operational efficiency

19

•

Risk, compliance and management effectiveness

24

Conclusions

25

Appendices

26

Bank of Shanghai (BOS) is raising the bar and laying down a challenge to other

aspirational City Commercial and Joint Stock Banks. Through its early adoption of a

modern, flexible international core banking system, it has left itself extremely well

placed to take advantage of the deregulation taking place in the Chinese banking

market. Already, it is growing assets, deposits and revenue faster than peers –at the

same time as writing higher-margin and higher-quality business.

While economic boom and urbanisation in China have provided the benevolent backdrop in which all banks could post strong growth figures, the opening up of the market has increased competition and is forcing banks to improve efficiency at the same time as raising standards of risk management and customer service. In response to the deregulation and internationalisation of the Chinese banking market, Bank of Shanghai launched an aggressive plan for expansion, underpinned to a large extent by the decision to replace its legacy core banking system with a modern, integrated solution from Temenos; the first major bank in China to undergo such a significant core transformation using a packaged solution1_. As we have endeavoured to illustrate in this study, core replacement has rendered Bank of Shanghai a much more agile player in the market, capable of greater innovation and able to bring to market these products and services faster. What is more, because its core system is centralised and integrated, Bank of Shanghai is achieving these product and service level enhancements while also significantly improving operational efficiency, risk management and compliance and the quality of management information. 1 _{Several Chinese banks have attempted core banking replacement using an international software package. Most banks have been smaller in size than Bank of} Shanghai and few projects have so far gone live. Bank of Shanghai was the first major bank (significant tier 3 or above) to go live with an international packaged solution. 35% 59% 40% 40% 44% 43% 41% 37% 37% 20% 30% 40% 50% 60% 70% 35% 59% 40% 40% 44% 43% 41% 37% 37% 0% 10% 20% 30% 40% 50% 60% 70%

BOS BHB NCB BoCOM WUC CMBC HB CMB SPDB

Cost to Income Ratio: Bank of Shanghai vs. Domestic Peers

Source: Annual reports, Banker Database, Reuters, various broker reports

Cost to Income Ratio: Bank of Shanghai vs. International Peers

35% 57% 66% 53% 77% 54% 64% 49% 43% 79% 30% 40% 50% 60% 70% 80% 90% 35% 57% 66% 53% 77% 54% 64% 49% 43% 79% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

BOS EST BCP RFF AXA PIR BOT MB AIB ICICI

2 _{T24 went live in the corporate bank in May 2006 and in the retail bank in September 2008.} 3 _{We have benchmarked Bank of Shanghai against 21 City Commercial and Joint Stock Banks with similar asset bases. More details can be found in appendix 1.} The rationale for writing this study in two parts is that the cut over to the new system, TEMENOS T24 (T24), has taken place in phases2 _{and the benefits of modernisation are still manifesting themselves - especially as Bank} of Shanghai enjoys the significant scale advantages of adding more volume and customers onto an integrated platform. As regards customer numbers, for instance, Bank of Shanghai is adding around 700,000 new retail and corporate customers a year. Yet, given its modern infrastructure, the bank - directly and indirectly - only employs 367 IT employees. The resulting operational efficiency - which is likely to increase exponentially – has been profound: we estimate the bank has an IT cost to total operating cost ratio 70% below the industry average while its overall cost/income is 55% below the average for the top 1000 banks and we estimate 15% below the average for comparable City Commercial and Joint Stock Banks in China3_. But, not only is Bank of Shanghai enjoying the economies of scale afforded by modern technology, it is also using the associated flexibility and innovation to accelerate growth in revenues and, in particular, high margin fee-based revenue. The combination of greater efficiency and accelerating revenue has helped more than offset the costs associated with expanding its branch network across China. 6% 10% 14% 18% 20% 21% SDB WUC NB BON NCB HB 23% 6% 10% 14% 18% 20% 21% 0% 5% 10% 15% 20% 25% BOS SDB WUC NB BON NCB HB

Return on Capital: Bank of Shanghai Compared to Domestic Peers

Source: Annual reports, Banker Database, Reuters, various broker reports

Return on Capital: Bank of Shanghai Compared to International Peers

-1% 8% 8% 10% 17% 21% AXA EST RFF AIB ICICI MB 23% -1% 8% 8% 10% 17% 21% -5% 0% 5% 10% 15% 20% 25% BOS AXA EST RFF AIB ICICI MB Source: Annual reports, Banker Database, Reuters, various broker reports

4 _{Source: CBRC}

5 _{We have benchmarked Bank of Shanghai against 21 City Commercial and Joint Stock Banks with similar asset bases. More details can be found in appendix 1.} 6 _ibid

7 _{There are 10 City and Commercial Banks (CCBs) in our benchmarking and their average ratio of fee-based/total income is 5.7%. We believe this is broadly}

representative of CCBs and analysis from KPMG, albeit from 2007, shows the ratio to be c.5% - please see China’s city commercial banks: Strategic options.

8 _{We define Net Interest Margin as Net Interest Income/Average Interest Earning Assets.} 9 _{NPLs have fallen from 3.67% in 2006 to 2.23% in 2008, marginally below the peer group average of 2.3% and the industry average of 2.4% (source CBRC).} 10 _{Sources: The Banker – top 1000 banks and our benchmarking analysis.} Ningbo Office Furthermore, Bank of Shanghai’s above-market growth in loans in 2007 and 2008 has not come at the expense of asset quality or net interest margin (NIM)8_{. Rather, the reverse is correct: NIM has increased over the period - from 2.39% in} 2006 to 2.78% in 2008 (compared to 2.60% in 2008 for the peer group) - while the level of non-performing loans has also fallen significantly and, likewise, is superior to peers9_. Overall, the achievements in terms of higher productivity, writing higher-quality and higher-margin business and growing market share have translated into much higher returns compared to the overall banking universe and the Chinese market. In 2008, Bank of Shanghai had a return on capital that was 125% higher than the average for the top 1000 banks and, more importantly, was 15% higher than comparable domestic peers10_.

About Bank of Shanghai

Following approval from the CBRC in 2005 and with the help of outside investors,

Bank of Shanghai is expanding rapidly in and out of its traditional Shanghaiese base

– but all the while adhering to its founding principles of building long-term customer

relationships based on outstanding service.

Bank of Shanghai (BOS) was established on December 29, 1995 with initial capital of RMB2.6bn (c.USD300m) raised through a mixture of government, business and individual investment. It was set up to support the development of the local economy, serving primarily Small & Mid-size Enterprises (SMEs) and individual citizens in and around the city of Shanghai. Its guiding maxim is to “serve the customer with great care and grow together with our corporate customers”. While the bank has continued to be true to its founding principles and still operates chiefly in Shanghai, where it has a market share of approximately 10% of retail and corporate banking, it has grown strongly since its creation and begun to expand outside of its Shanghai base. Since 1995, the bank has recorded annual double digit growth in assets and revenues as the population of Shanghai has grown and it has captured market share. Further, after receiving permission from the Chinese Banking Regulatory Commission (CRBC) in November 2005, Bank of Shanghai began to open branches outside of Shanghai. It now has branches in Ningbo, Nanjing, Hangzhou, Tianjin, Chengdu, Beijing and Shenzhen. In total, the bank now operates more 200 branches across China and, as at end of 2008, had total assets of RMB368bn, approximately USD54bn. Ankang Branch Bank of Shanghai has earned many accolades for innovation and customer service. Within China, the bank has been variously awarded: “The best bank to offer loans for SMEs in China”, “The best customer service for SMEs”, “The best dealer in the China Inter-bank market”, “Most Famous Trademark in Shanghai” and “China Best Call Center Award”. Outside of China, Bank of Shanghai has been awarded “China’s Best City Retail Bank” by The Asian Banker for the last three consecutive years. In 2009, The Banker Magazine ranked Bank of Shanghai 256 in its top 1000 banks publication based on tier 1 capital, up 100 places compared to 2006. The success of Bank of Shanghai has attracted and, in turn, been reinforced by new capital from strategic foreign investors. The International Financial Company took a stake of 7% in Bank of Shanghai in September 1999, while HBSC and Commercial Bank of Shanghai (Hong Kong) took stakes of 8% and 3% respectively in September 2001. These investments have facilitated the growth and development of the bank, through the provision of funds for expansion but also through the provision of international management expertise that has helped Bank of Shanghai to adapt successfully to the deregulation of the Chinese market.

TemenosCase Study

An overview of the Chinese banking market

Over the last three decades, the booming economy plus the mass migration from rural

areas to urban centres - underscored by anti-competitive government regulations - has

created the conditions for all banks to grow, regardless of competitive differentiation.

However, this is changing. The government is opening up the Chinese market to greater

domestic and foreign competition at the same time as liberalising interest rates, ushering

in a new era of freer competition that will benefit consumers, but force banks to improve

innovation, customer service, risk management and operational efficiency.

Urbanisation has been driving the growth in the Chinese retail banking market...

China has become the world’s factory. The cost advantages – low relative cost of capital, energy, utilities, pollution, wages; tax subsidies – have seen much of the world’s manufacturing shift east. Since 1990, China’s exports have been growing at 18.5% a year11 _{and, at the start of this year, China overtook Germany as the world’s largest exporter.} China’s great industrialisation, however, has disproportionally benefited urban centres in terms of job and wealth creation. The disparity between rural and urban income levels has been growing and in, 2009, the mean per capital income for an urban citizen (USD2,514) was almost 3.5 times higher than for a rural citizen12_. The better prospects for income and employment have, in turn, led to a mass migration from rural to urban areas. In 1980, the rural population of China was 4.3 times as large as the urban population. By 2008, the rural population was only 1.3 times larger13_{. In 2008, there were 50 cities in China with over 1.5m inhabitants}14_. For the Chinese retail banking sector, rapid urbanisation has created highly benign operating conditions, especially given the protection from external competition afforded it for much of the last 30 years. The vast majority of the rural population in China is unbanked, whereas the majority of the urban population has a bank account15_. The explanation reflects both access as well as need, since in cities it is far more likely that employees will receive wages through a banking intermediary. Therefore, the movement of people to urban areas creates demand for basic banking services. A 7% average annual growth in the urban population since 1980 has allowed all banks to prosper and, crucially, without the competition for customers – characteristic of most developed economies – that obliges sustained improvements in customer service and operational efficiency. 200 300 400 500 600 700 800 900 0 100 200 300 400 500 600 700 800 900 1980 1984 1988 1992 1996 2000 2004 2008 Urban ( In million) Rural ( In million) Shifting Demographics:

Change in Rural and Urban Populations since 1985

11 _{Source: IMF} 12 _{Source: The National Bureau of Statistics China} 13 _ibid 14 _{Source: McKinsey Global Institute} 15 _{According to the People’s Bank of China statistics, cited on the UN website, around 65% of rural households are without access to basic banking services} Source: Population Division of the Department of Economic and Social Affairs of the United Nations

...while the booming corporate market has been concentrated at the local/regional level

The other big source of growth for the banking sector in China has been growth in corporate business. China’s unprecedented economic boom has led to a surge in corporate banking activity – basic transaction services, advisory services, loans and savings. Furthermore, corporate banking relative to retail banking is much more important in China than in more developed economies. Firstly, corporations are a more important source of GDP and GDP growth than in more developed countries, making their relative level of savings, for example, more significant16. Secondly, corporations invest so much more as a share of GDP in China than in more developed countries, making them a much more important source of loans relative to consumers. In China, business investment accounts for 42% of GDP and private consumption 36% of GDP compared to 19% and 71% respectively for the US. Although the competitive characteristics of the corporate market in China are different from the retail market, historic restrictions on geographical expansion limited effective competition. Compared to newly urbanised retail banking customers, corporations are more sophisticated users of banking services and the market is both more specialised and more contested. That said, corporations need to use banks with local branches and offices – to allow their employees to withdraw their salaries, to allow for face-to-face meetings, etc - and restrictions on banks’ domestic expansion coupled with restrictions on foreign entrants meant that choice (and competition) was limited. At the risk of oversimplification, what emerged in the corporate banking market was a kind of a duopoly, with large nationwide corporations using services from one of the big four banks and SMEs using services from one of the local City Commercial or Joint Stock Banks. 10% 15% 20% 25% 30% 35% 40% 45% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Urugua y Unit ed King dom Philippine s Br azil Ge rma ny Sw eden Cambodia Egyp t Finla nd Isr ael Mace donia Ne therlands Pol and Russia South Afric a Unit ed St at es Be lgium Chile Colombia Cos ta Ric a Denmark Fr ance Hong K ong Italy Mala ysia Me xi co Serbia Switz erland Taiw an Turk ey Ar gen tina Aus tr ia

Canada Ecuador Greece Hung

ar y Portug al Japan Ne w Z ealand Sing apor e Cz ech R epublic Indone sia Ir eland Lithua nia Sri Lank a Uk raine Cr oa tia Slo vaki a Aus tr ali a Bulg aria Ice la nd Romania Slo veni a Tha ila nd Kor ea Spain Es toni a La tvi a India Mong olia Solomon Isla nds Vie tnam China

Business Investment as a Percentage of GDP: China Compared to Other Nations (2004-2008)

16 _{According to the IMF, China’s GDP has grown by an average annual rate of 10% since 1980 and the biggest contributor to growth has been industrial}

output (roughly 60%). In China, industrial output accounts for half of GDP compared to, say, 19% in France. Source: IMF

TemenosCase Study

However, the Chinese government is deregulating the market...

Although the Chinese government spent many years putting in place the infrastructure to allow reform, banking deregulation and internationalisation did not begin in earnest until 2006. Internal reforms (1978 – 2006) Up until 1978, the Chinese operated a monobank system. The banking system was dominated entirely by the People’s Bank of China (PBOC), headquartered in Beijing, which acted as a central bank and the only commercial bank in the country throughout the pre-reform period 1949-78. Thus, the first step of modernising the banking system was to break up this one bank system. In 1978, the PBOC’s two functions were split – PBOC was designated as the country’s central bank, while its commercial banking activities were given to four state-owned specialist banks (the “big four”): China Construction Bank (CCB), Agricultural Bank of China (ABC), Industrial and Commercial Bank of China (ICBC) and Bank of China (BOC). The next step was to create greater internal competition. From the mid 1980s, China allowed the creation of new Joint Stock Banks (those funded by government and private shareholders) and Misheng Bank, set up in 1996, was the first such Joint Stock Bank to be majority-funded by private investors. The City Commercial Banks (CCBs) began to appear from July 1995 when city governments started to restructure the thousands of urban credit cooperatives into larger and more efficient institutions. From 2004, on achievement of certain operating criteria, the CBRC began to give approval for City Commercial Banks to expand outside of their base cities; a move that helped this group of banks to gain scale economies and begin to compete more effectively with the joint stock banks and the big four. In parallel with the expansion in number of banking institutions and to improve supervision, China also remodeled the banking regulatory environment. In 2003, it divided regulation of the banking sector between PBOC and a new entity, the China Bank Regulatory Commission (CBRC). The PBOC assumed responsibility for formulating and implementing monetary policy (under guidance of the State Council), while the CBRC took on the day-to-day supervision of the sector, determining and enforcing banking rules and regulations. One of the key objectives, and the major success, of the CBRC has been to raise the standards of risk management and corporate governance in the sector in preparation for deregulation: capital adequacy ratios, the level of non-performing loans and the loan classification system have all improved markedly17_.

Overview and Timeline of Chinese Banking Reforms to date

Source: Temenos, CRBC

17 _{For example, in 2002, the average level of NPLs for the big four was 23.36% compared with 2.45% at the end of 2008 – source CBRC}

1978-1984 1984-1996 1996-2001 2001-2006 2006-2009

PBOC given role of central bank Commercial activities given to 4 state-owned specialist banks (“the big four”)

PBOC given responsibility for monetary policy China Bank Regulatory Commission created for bank supervision Interbank market formed Securities and Insurance regulatory board Creation of new Joint

Stock Banks Emergence of City Commercial Banks (CCBs)

Allowing wholly foreign-owned banks to provide local currency services Elimination of some special regulations for foreign banks Allowing CCBs to operate outside of their home cities

Lending ceiling rate removed gradually Foreign bank stake raised to 25% Deposit floor rate removal

Breaking up the monobank system

Allowing more

Chinese Banking Chinese Banking Chinese Banking Sector Sector Sector

Overview of the Structure and Composition of the Chinese Banking Sector

Source: CRBC

Greater internationalisation and deregulation (2006-present)

Accession to the World Trade Organisation (WTO) has had the biggest effect in opening up the Chinese banking market. As part of its commitments to join the WTO, China agreed not only to reduce import and export tariffs, but also to open up various industries, including financial services, to foreign investment and competition. China had a five year deadline from its entry in 2001 in which to enact the necessary reforms. Although foreign banks were allowed to take minority stakes in local banks before WTO entry, there were many restrictions on such investments and it was not until 2006 that the most significant reforms came into effect.

The most significant reforms made since WTO accession can be summarised as follows:

1. Foreign-owned banks are allowed to provide local currency services to any customer in any city in China (taking of individual deposits, the granting of short-term as well as long-term loans as well as banking card business). Before the reforms, provision of local currency services was restricted to 25 cities and only to businesses and foreign individuals. 2. The restrictions on foreign ownership have been raised, such that a single foreign investor can now own up to 20% of a domestic bank, while foreign investors can hold up to 25% in aggregate. 3. The limit of RMB liabilities not exceeding 50% of foreign currency liabilities was removed, allowing foreign banks to expand their local deposit bases. 4. The number of products and services that foreign banks can provide now exceeds 100, including derivatives trading, QFII custodian business, personal wealth management, offshore banking service on an agency basis and electronic banking. In addition, China has made important steps towards interest rate deregulation. Between 1997 and 2008, short-term interbank interest rates, financial and Treasury bond yields and the corporate fixed income market were all liberalised. Most recently, ceilings on loan rates and floors on deposit rates were removed, giving banks the flexibility to set lending rates above the regulated floor. Importantly, however, a ceiling on deposit rates and a floor on loan rates are still remain in place, with only around two-thirds of loans taking place at rates above this floor.

...opening local markets to greater competition...

The reforms introduced since the 1990s have led to a rise in the number of domestic banks, increased domestic competition and, above all, a considerable influx of foreign investment, particularly in the form of new subsidiaries and branches post WTO entry. Since the creation of Shenzhen City Commercial Bank in July 1995, over 135 city CCBs have been created. What is more, the CBRC announced in 2004 that the strongest CCBs (those with NPL and CAR ratios below the average for Joint Stock Banks) would be allowed to expand their branch networks and compete on a national basis. Since that time, more than 30 CCBs have obtained approval for cross-region development and have expanded their networks to more than 20 new cities18_. The impact on local competition of this move is already manifesting itself - since 2005, City Commercial Banks gained 1.2 points of market share (more than 20%) at the expense of Joint Stock Banks and the big four. In terms of foreign investment, following WTO accession, this changed in form from taking minority equity stakes to subscribing to banking IPO’s and, ultimately, to direct investment in branches and subsidiaries. According to statistics from the CRBC, in the five years following WTO membership, the number of operational entities opened by foreign banks increased by 64%, despite several mergers19_{. Also according to the CBRC, the amount of foreign capital invested in the} Chinese banking system had reached USD82.3bn by the end of 2007 and 25 Chinese banks had partnerships with foreign investors. Foreign banks employed more than 27,000 staff in China by the end of 200820_. Whether directly, through branches and subsidiaries, or indirectly - through increased capital, improved management or higher expected returns – foreign investment has led to greater competition. Like CCBs and albeit from a much lower base, foreign banks have also been growing market share since 2005 (growing assets at a CAGR of 23% vs. the overall market of 19%), underlying the changing dynamics and increased competitiveness of the market. 700 500 600 700 400 500 600 700 200 300 400 500 600 700 -100 200 300 400 500 600 700 -100 200 300 400 500 600 700 2005 2006 2007 2008 SOCBs JSCBs CCBs Others -100 200 300 400 500 600 700 2005 2006 2007 2008 SOCBs JSCBs CCBs Others -100 200 300 400 500 600 700 2005 2006 2007 2008 SOCBs JSCBs CCBs Others

Share of Total Chinese Banking Assets by Banking Segment (RMB 100bn), 2005-2008

Source: CRBC

18 _{CRBC and Research in China}

19 _{CRBC, Report on the Opening-up of the Chinese Banking Sector, January 2007} 20 _{Data taken from 2007 and 2008 CRBC annual reports}

TemenosCase Study

...giving customers more choice and forcing banks to become competitive

The increase in the number of banks operating in China, coupled with the removal or relaxation of restrictions on where these banks can operate and how they can be funded, has given retail and corporate customers – particularly SMEs - more choice in terms of who they bank with and also what products they take, forcing all banks to do more to attract and retain customers and improve innovation. Furthermore, the gradual liberalisation of interest rates has enabled banks to begin to compete on price, underlining the importance of risk management and operational efficiency. It is our contention in this case study that this new competitive paradigm will force banks to change the way they do business (improving innovation, customer service, risk management and efficiency) and, inter alia, they will have to address their IT systems. The remainder of the case study is dedicated to showing how Bank of Shanghai, by replacing its core system, has left itself extremely well placed to take advantage of these changes in the Chinese banking market. Moreover, the influence of foreign banks – directly and indirectly – along with stronger domestic competition, is leading to greater product innovation. As the CBRC notes, “the entry of foreign banks also brings in advanced management skills and technology, as well as mature and market-tested products and services, and helps the Chinese banks to raise their financial innovation capacity”21_{. The innovations can be seen in the growing range and consumption of products and services around} derivatives trading, personal wealth management, electronic banking and credit cards. In 2008, 1.78bn credit cards were issued in China and credit card transactions grew by 27%, while the take-up of wealth management products grew by 372%22_.

21 _{CRBC, Report on the Opening-up of the Chinese Banking Sector, January 2007} 22 _{CRBC 2008 Annual Report}

The Legacy System and its Limitations

Bank of Shanghai’s legacy system suffered several shortcomings - not least its siloed

structure and its account- as opposed to customer-centricity - which made it expensive to

maintain, difficult to modify and not conducive to effective risk or customer management.

The first of the major problems with the legacy system was its siloed structure. The bank operated separate systems for retail banking, corporate banking, risk management and cash management. This clearly made risk difficult to manage adequately and maintenance expensive, but it also made it impossible for the bank to give seamless service – to assist a corporate customer with a personal transaction, for example, a teller would have needed to log into a different system, request new information from the customer. Furthermore, operating different corporate and retail systems made it extremely difficult to offer overlapping corporate and retail products - and, as we shall see later, Bank of Shanghai has enjoyed much success and leapfrogged competitors by offering joint corporate and retail banking products. Second, the system was account- as opposed to customer-centric. Under the old system, Bank of Shanghai was unable to get a complete view of the customer – only a complete view at the account level. Clearly, therefore, it was impossible to cross-sell effectively based on customer information and, like most banks who suffer from the same limitations, customer promotions tended to be generic rather than targeted. Similarly, it was also extremely difficult for Bank of Shanghai to differentiate in terms of customer service or pricing based on customer information – to offer preferential pricing, for example, to the most profitable customers – and therefore retain the best customers. Not having a single view, moreover, rendered impossible effective channel management – for example, a customer would have had different internet log-in details for each product. Lastly, it was unfeasible to get a consolidated view of risk at the client level – a customer might have had many products, each with an acceptable credit limit, but in aggregate giving him/her access to credit far in excess what would have been approved otherwise. Third, the system was extremely complex and badly documented. As can be observed in the diagram below, the legacy architecture was highly complex, with many independencies, and the systems were not only badly documented, but in parts hard-coded. As a consequence, routine maintenance was highly time-consuming and expensive – updating the systems for a change in interest rates, for example, was an overnight exercise involving six programmers compared to a 30 minute task now. Furthermore, not only did maintenance absorb developers’ time that could otherwise have been spent developing new products, but the act of launching new products was also highly cumbersome – involving code changes, replicating development across the different systems and a significant amount of testing – and taking many months.

TemenosCase Study Retail Retail Retail Retail Retail Retail Retail Retail Retail Retail Retail Retail Retail Retail Retail CNY CNY CNY CNY CNY CNY Debit Debit Debit Card Card Card Card Card Card Corporate Corporate Corporate CNY CNY CNY CNY CNY

CNY Foreign Currency Foreign Currency Foreign Currency / TF/ TF/ TF/ TF/ TF/ TF

Retail BFE Corp. BFE Corp. BFE Teller Terminals Security Agency CUP CNAPS House Funds PROP Funds Agency Audit Sys. Fee-based Seal Mgt. International Sett. Electric Pswd. Credit Mgt. Sys. Personal Loan Mgt. Finance Mgt. Currency Mgt. Report Sys. GL OA HR Capital Mgt. PBOC Funds Co. CUP Tax Bureau Custom Retail BFE Security Co. Others Enq. Machine Internet Banking Sys. POS ATM Telephone Mobile Mobile Call Centre

Depiction of Bank of Shanghai’s Legacy Core Banking System

Source: BOS 12 Lastly, the system lacked key functionality and was unable to support many of the bank’s international requirements. As noted above, China’s economy is being increasingly internationalised – and so it is no surprise that Bank of Shanghai’s customers are requiring an ever greater level of international services. Moreover, as Bank of Shanghai had anticipated, the influx of foreign competitors is bringing international standards and products. So, the bank was also keen to address many of the functional shortcomings of its legacy system – particularly around international payments, trade finance, working capital management - in order to compete effectively in a more internationalised marketplace and offer the products and services demanded of it in a more globalised world.

The core system selection & implementation

Bank of Shanghai ran a detailed selection process considering most of the important global

and domestic vendors, as well as the option of an internal build. In the end, the bank’s desire

to adopt international best practice caused it to come down in favour of an international

solution, with TEMENOS T24 (T24) being considered best based on level of integration,

functional coverage and references. Once selected, the T24 implementation was carried

in two stages – the corporate bank going live in May 2006 and retail bank going live in

September 2008.

The core system selection

By 2002, Bank of Shanghai had made the decision to replace its legacy system. At first, all options were considered – that is, a rebuild using internal and external resources; a packaged solution from a domestic vendor; and, a packaged solution from an international vendor. However, the first two options were quickly discounted – in the case of the first, the bank believed that this would take too long and the market was changing too quickly to allow this; and, in the case of the second, the bank considered that local vendors had insufficient knowledge of international practices. So, in early 2003, the bank began a selection process to choose a solution from an international vendor. The selection process lasted 10 months – from February to November 2003 – and four international vendors were invited to partcipate, namely Temenos, FNS (now part of TCS), System Access (now a subsidiary of Sungard) and i-flex (now Oracle Financial Services). The bank was looking for the following attributes in its chosen solution: customer-centricity; quick product development cycles (afforded by a high degree of parameterisation); strong out-of-the box process centred on international best practice; and full integration across the different banking functions (and a single customer view). Over the course of the company presentations, product demonstrations, workshops and reference visits, the different vendors’ products were scored against a range of criteria. Temenos and T24 emerged as the eventual winner on account of achieving top marks in the following categories: • Level of integration • Customer references • Implementation record • Functional coverage

TemenosCase Study

The implementation

A timeline of the implementation is shown below. In summary, the implementation took three and a half years to complete, was divided into two phases and involved a team of almost 250 people. That the implementation took such a protracted period reflects many factors: the localisation of the T24 system that was needed (to translate all of the system into Chinese, for example); the functionality that needed to be built (to comply with regulatory reporting requirements, etc); duplicating activities (like product launches) across the new and old systems; data migration (Bank of Shanghai had over 13m accounts by the time T24 went live in the retail bank); the level of process re-engineering undertaken by the bank (and associated user training); and, the extent of the testing necessary – technical and business. The project was divided into two phases in order to mitigate risk. The bank felt that, while corporate banking is inherently more complex than retail banking, embarking on the corporate banking roll-out first would be less risky given the much lower volumes and would provide the project team with the skills and experience to ensure that the retail banking implementation went as smoothly as possible. The implementation team comprised staff from Temenos, Hewlett Packard (who were selected as the main system integration partner at the end of 2004) and Bank of Shanghai. Roughly, there were around 20 people from Temenos, 20 people from HP and 200 from the bank involved in the project – although peak numbers were higher, well over 250 people. Bank of Shanghai went live with T24 in the corporate bank on May 22, 2006 and in the retail bank on September 22, 2008. Although there was a time overrun and an associated budget overspend, these were minor – and the bank considers this to be a very well managed project. More importantly, as the first major bank in China to go live on an international core banking system, Bank of Shanghai views this project not just as well-managed, but as a veritable tour de force. Several other international core banking replacements have been attempted in China, but most have been smaller projects than Bank of Shanghai’s and few have successfully gone live. As we shall see in the next sections, the T24 core replacement has endowed Bank of Shanghai with a level of flexibility unique among its peers; a level of flexibility, moreover, that it is leveraging to outmanoeuvre its competitors in a number of important ways. March 1

Kick off Corporate System go-liveMay 22 Retail System go-liveSept. 22

2004 Selection

2005 2006

Corporate banking

2007 2008

Retail banking system

Set up Temenos T24 demonstration server

Requirements analysis, familiarisation with new system Selection of HP as system integrator

System architecture designed by HP

Confirm requirements, system development

All branches go live with corporate system Stablisation of corporate system

Confirm requirements, system development Functionality testing

Integration testing Data migration

Retail system go live Ningbo branch go live with corporate system

Migration of GL to Peoplesoft Functionality testing

Timeline of the Core System Roll-Out at Bank of Shanghai

Source: BOS, Celent, Temenos 14

How core replacement has facilitated the execution of

Bank of Shanghai’s corporate strategy

By giving Bank of Shanghai (BOS) the means to launch products faster, to service

customers better, to take quicker and better-informed decisions, to price risk effectively

and extract IT economies of scale, T24 has acted as a catalyst for market share gains and

superior returns.

The overriding objective of Bank of Shanghai’s core replacement was to introduce greater agility into the organisation, to capitalise on the internationalisation and deregulation of the Chinese banking market in order to realise its ambitious growth prospects. As shall be demonstrated, by affording a single view of the customer, T24 has made possible significant improvements in customer service; T24 has dramatically reduced the cost and time to market for new products; T24, as an integrated and robust solution, has allowed the bank to extract IT economies of scale and thereby redeploy resources to other purposes, like branch expansion; and, by offering up-to-date, integrated and complete information, T24 has considerably improved risk governance and management decision-making. As shall also be demonstrated, these operational improvements have translated into better absolute and relative financial performance. In 2008, Bank of Shanghai’s financial performance began to outperform peers: growing assets, deposits and revenues faster at the same time as writing better quality and higher margin business – as evidenced by a higher net interest margin (NIM) and lower non performing loans (NPLs). Overall, this has allowed BOS to record higher returns than peers.

TemenosCase Study Customer Service As regards serving the customer, the biggest change engendered by core replacement was to afford Bank of Shanghai a single view over its customer relationships. This unique view has given Bank of Shanghai the tools to be able to provide better service to all – through enhanced channel management for example – while giving highly differentiated service to its best, most profitable customers. This has helped to attract new business – allowing Bank of Shanghai to grow faster than peers – while also helping it to earn higher returns through greater cross-selling, greater fee-related income and lower levels of NPLs. Channel management has improved significantly with T24. With the siloed legacy system, Bank of Shanghai customers suffered small, everyday frustrations – like having to log in more than once to view information about their different accounts. And while these frustrations are not uncommon among banking customers and, to a surprising degree, are still tolerated, they have now been eliminated for Bank of Shanghai customers. Internet users, tellers, call centre staff all view data that is complete and up-to-date, improving the customer experience by speeding up transaction and query times. One of the manifestations of this improvement is the number of customers who are now happy to conduct the bulk of their banking affairs over the internet. In 2008, the number of retail banking transactions carried out over the internet by Bank of Shanghai customers rose by 685%, more than 6 times faster than the overall market23_. Decisions can now also be taken faster. Because customer information is up-to-date and complete, it takes less time to gather the information needed – and run any checks – for the bank to be able to take decisions. The time taken to approve and grant a mortgage, for example, has been reduced 75%; it now takes just one week. A complete view allows Bank of Shanghai to differentiate. Firstly, on a practical level, T24 makes it possible for the bank to flag a priority customer in the system – by allowing the bank to set up specialist groups within the customer file. Before, the bank had to use non-system measures, like issuing a separate card, to distinguish its best customers. Secondly, an overview of customer relationships – as opposed to just an account-level view – allows the bank to take into account all of the products and services a customer consumes and, importantly, to calculate profitability by client. Armed with this information, Bank of Shanghai can, and does, tailor service in order to retain its most valuable customers. For instance, VIP customers benefit from a different channel – the green channel – at branches to remove the need to queue; a dedicated account manager; lower fees; privileged products; a lower deposit requirement for home loans; and, better rates on loans (to the maximum extent possible given government limits). And, the enhanced customer service is clearly translating into better financial performance. In 2008, Bank of Shanghai moved from a situation of in-line performance to one of clear outperformance. It grew loans at 18% compared to the average for Joint Stock Banks (JSBs) of 15%24 _{and the peer group average of 16%}25 _{and it grew deposits at 21% compared} to the average for JSBs of 14% and the peer group average of 19%. Moreover, because its system now allows better, more personalised service (as well as a superior product offering – see later), BOS has also begun to accelerate higher margin activities like fee-based revenues (which have grown by a CAGR of 59% over the last 2 years) and cross-selling (we estimate that revenue per customer rose by 16% in 2008) – helping it also to record higher returns than peers (see later). 23 _{According to China CCM Market Research Centre, the growth in online retail banking transactions was 100.8% in 2008} 24 _{Source: CBRC} 25 _{For peer comparisons, we have benchmarked BOS against 21 City Commercial and Joint Stock Banks with similar asset bases} 16 Mr. Jiang

Vice President, Bank of Shanghai

All BOS customers will have noted an improvement in

service since T24 was introduced.

All BOS customers will have noted an improvement in

“

All BOS customers will have noted an improvement in

service since T24 was introduced.

_”

information is up-to-date and complete, it takes less time

685%

growth in online internet transactions in 2008

75%

Product Innovation The time taken to launch new products has been shortened significantly since Bank of Shanghai adopted T24. Whereas under the legacy architecture, product launches took typically several months, they now take between 2 to 4 weeks in general. Some products, like the recent guaranteed return deposit, are taking even less time – in this case, under a week from conception to launch. The bank estimates that product development times have, on average, been reduced by between 60 and 75%. The effort involved in launching a new product has also been cut considerably. In the old system, product development would have necessitated changing the core code. It would have required, furthermore, duplicating the developments across all of the disparate systems affected – retail, corporate, debit cards, etc. This meant, in practice, that product development was an activity that consumed several full-time technical resources for extended periods. In contrast, with T24, the act of launching new products is limited to changing parameters with the system, meaning that development effort is minimal. The effort is concentrated instead on testing and, given the much less complex development undertaken, testing is also significantly reduced under T24 compared to the legacy environment. Overall, therefore, not only have product development cycles been reduced dramatically, but also the development effort – meaning that development costs have been cut by an even greater percentage, probably in excess of 90%. As a result, Bank of Shanghai is launching more new products, and in more rapid succession. Since the introduction of T24, the bank has been releasing a new product on average every 1-2 weeks. What is more, not only is the bank launching more products, it is also launching more innovative products. For example, BOS was the first bank in China to offer a combined retail and corporate card. The card acts like a corporate credit card, except that it allows spending to be debited directly from a corporate bank account. Further, like a corporate credit card, the corporation can set a limit that cannot be exceeded, but unlike a credit card, this limit can be applied individually or in aggregate across many cards. This can be useful in controlling spending on a particular project for example, and the limits can be reset easily, meaning that the same cards can be re-used for several projects. The card also displays some retail card characteristics, like the employee can charge the corporate card with money to use for personal purposes. The card was originally designed for use by government agencies, to help control spending on certain projects, but its usage has been extended to all government and corporate clients with significant success.

Mr. Zhao Gang | General Manager, Product Innovation Department

T24 has enabled Bank of Shanghai to launch a number of truly innovative and pioneering

products, in particular by combining corporate and retail products. Not only that, but T24 has

also dramatically reduced the time to market for new products – by a factor of several times.

“

products, in particular by combining corporate and retail products. Not only that, but T24 has

also dramatically reduced the time to market for new products – by a factor of several times.

_”

A new product is launched every 1-2 weeks.

Other new innovative products have seen very strong take-up. An all-in-one account, which combines different deposits (current, term) with wealth management products (like principal protection), FX products and direct debit, was launched by BOS in April 2009 and had seen over 500,000 adopters by November 2009. Similarly, when Bank of Shanghai was the first tier 2 or 3 bank to introduce Electronic National Bonds (ENBs), it took more than 450m RMB (c. USD70m) in new customer funds in less than 3 months. ENBs were introduced by tier 1 banks in March 2009 and, because of its flexible systems, Bank of Shanghai was able to replicate the features and introduce the same product three months later. ENBs bring together aspects of government bonds – fixed coupon, low risk investment – with aspects of a normal savings account, where interest is paid regularly rather than just at the end of the bond’s life when the principal is returned. BOS customers can buy and sell ENBs with their regular savings passbook and BOS, in addition to a small interest spread, also earns fees on every transaction. Like enhanced customer service, improvements in product innovation are reflected most clearly in market share gains, although they are also a contributing factor in BOS’ superior returns. As described in the last section, in 2008 Bank of Shanghai grew assets and loans faster than the market and faster than peers. The same is also true of overall revenue, which it grew 4% faster than peers, and in particular fee-based revenues. At the end of Q3 2009, BOS’ level of fee-related income was 8.9% of total operating income, 1.6 times higher than other City and Commercial Banks and 1.2 times the peer group. All in all, higher cross-selling, greater fee-based income and a stickier deposit base have helped to increase Bank of Shanghai’s NIM – to a level that is now superior to peers. In 2006, BOS’ NIM was 2.36% compared to the peer average of 2.49%, whereas it now stands at 2.78% compared to 2.60% for peers26_. 26 _{For peer comparisons, we have benchmarked BOS against 21 City Commercial and Joint Stock Banks with similar asset bases. More details can be found in} appendix 1. 3% 4% 4% 2% 2% 3% 3% 4% 4% 0% 1% 1% 2% 2% 3% 3% 4% 4%

BOS CB CEB CMB SPDB CMBC HB SDB BOB BON

0% 1% 1% 2% 2% 3% 3% 4% 4%

BOS CB CEB CMB SPDB CMBC HB SDB BOB BON

2006 2007 2008

Net Interest Margin: Bank of Shanghai Compared to Domestic Peers, 2006-2008

Source: Annual reports, Banker Database, Reuters, various broker reports

TemenosCase Study

Mr. Bai, IT General Manager

It is still early days in terms of achieving economies of scale. T24 gives

us a centralised and robust platform which will allow us to scale our

business at the same time as leveraging our IT investments.

It is still early days in terms of achieving economies of scale. T24 gives

“

us a centralised and robust platform which will allow us to scale our

business at the same time as leveraging our IT investments.

_”

Courtesy: China Daily Operational efficiency Banks that run legacy solutions are notoriously poor at extracting IT economies of scale. With T24, Bank of Shanghai is already setting itself apart in this regard. In some areas, like maintenance, costs have fallen in absolute terms. As an example of how this is possible, consider the process of updating the system for rate changes. When the government changes rates, the banks must reflect these changes overnight. This is a complicated process in that the government mandates rates across many different areas – personal loans, home loans, deposits – and across many different terms and currencies (see the matrix below as an illustration). With the legacy system, Bank of Shanghai was only able to meet the overnight deadline by having a team of six programmers work through the night to make the changes (writing the new code) and carry out the testing. With T24, the rate adjustment setting process has been fully parameterised based on a comprehensive set of rules, reducing the process to a 30 minute activity for two IT staff (one to change, the other to verify).

The process of updating the system for rate changes has been transformed from an overnight

development exercise requiring 6 programmers to a 30 minute activity for two IT staff.

Example of Interest Rate-Setting Matrix (following rate changes in December 2008)

continued ...

Source: BOS

ITEM TERM Before rate

adjustment After rate adjustment 2008.11.27 2008.12.23 Current deposits - 0.36 0.36 Term deposits

Time deposits 3 months 1.98 1.71

6 months 2.25 1.98

1 year 2.52 2.25

2 years 3.06 2.79

3 years 3.60 3.33

5 years 3.87 3.60

Periodic principal deposits and withdrawal all at maturity

1 year 1.98 1.71

One-sum Deposit at start and withdrawal

periodically

3 years 2.25 1.98

principal deposits at start and withdraw the interests only in periods

5 years 2.52 2.25

Time or current deposits at

option 60% of the rate for time deposits of the same term

Call deposits 1 day 1.17 0.81

7 day 1.71 1.35

Agreement deposits - 1.53 1.17

Retail, corporate customer saving rate

Annual rate᧡

ITEM (USD) (EUR) (HKD) (JPY) (GBP) (CAD) (CHF) (AUD)

Current 0.1200 0.1000 0.0200 0.0001 0.1250 0.0100 0.0001 0.2500 7 day call 0.1200 0.3750 0.0200 0.0005 0.1750 0.0500 0.0005 0.3000 1 month 0.3000 0.5000 0.1500 0.0100 0.2500 0.1000 0.0100 1.2500 3 months 0.5000 0.6500 0.4000 0.0100 0.3500 0.1500 0.0100 1.3125 6 months 0.7500 0.9500 0.5000 0.0100 0.6000 0.3000 0.0100 1.3250 One year 1.2000 1.1000 0.8000 0.0100 0.7500 0.4000 0.0100 1.5000 13 months 1.2500 - - - - 15 months 1.3000 - - - - 18 months 1.4000 - - - - 2 years 1.5000 1.1500 1.1000 0.0100 0.7500 0.4000 0.0100 1.5000

Forign currency Saving rate

TemenosCase Study

Item Before Rate change After rate change 2008.11.27 2008.12.23 Short-term <= 6 Months 5.04 4.86 6 moths to 1 year(included) 5.58 5.31

Medium-long term years(included) 1 year to 3 5.67 5.40

3 years to 5 years (included) 5.94 5.76 Above 5 years 6.12 5.94 Individual education loan

- follow the one year short term loan rate regardless of the terms

Discount - Determined by the

rediscount floor rate plus margin

Determined by the rediscount floor rate

plus margin

Loan Rate

Item Before rate change After rate change 2008.11.27 2008.12.23 <= 5 years 3.51 3.33

Above 5 years 4.05 3.87

Individual housing fund loan rate

Source: BOS 29.1% _27.1% 23.7% 18.7 29.1% _27.1% 23.7% 18.7 2005 2006 2007 2008

Bank of Shanghai: G&A expenses as a Percentage of Total Costs, 2005-2008

Source: BOS Annual Reports

In most other areas, costs have fallen in relative terms. The high levels of automation and Straight Through Processing (STP) achieved with T24, coupled with the ease of making changes to the system, mean that it is simply not necessary for the bank to increase IT spending to the same extent as other costs as it grows. Full automation/STP, for example, has been achieved across many of the banks activities, like fee charging, credit checking and loan authorisation.

Bank of Shanghai European Banks

IT Cost to Income

IT Cost to Op. Cost

IT Cost to Total Assets

IT Cost to FTE 2% 5% 5bps 23bps EUR 2,650 EUR 20,000 14% 9%

Bank of Shanghai’s IT Cost Metrics Compared to European Retail Banks

Source: BOS, BCG

27 _{The source of IT spending ratios for European retail banks is Boston Consulting Group, IT Performance in the European Banking Industry, BCG’s sixth}

annual IT Cost Benchmarking Study, June 2009.

TemenosCase Study

22 As a further illustration, consider the costs of branch expansion. Expanding its branch network has been an expensive exercise for Bank of Shanghai. Each time it opens a new branch, it needs to locate the branch, rent the location, fit it out, hire the staff to run it, advertise, etc. However, the IT costs associated with opening a new branch are minimal. Whereas under the legacy system, significant modification would have been needed to add a new branch to the various disparate systems, there exists a function in T24 to add a new branch and the operation takes less than an hour to configure. Moreover, while the legacy system required each branch to have at least one server, this is not necessary with the T24 architecture – it is just a matter of adding more traffic to the existing infrastructure, allowing the bank to leverage its IT hardware investments. In 2008, Bank of Shanghai grew its operating income by 28%. It is adding around 700,000 new corporate and retail customers every year. It is undergoing a significant expansion programme (in 2008, it opened up operations in Tianjing and Chengdu). Yet, in 2008, it added only 68 new IT staff (internal and external) and its ratio of IT to full time employees stood at just 4.97%. We estimate its ratio of IT costs to total costs to be around the same level – at 4.8%, translating into an IT cost to income ratio of 2.0%. To put these figures in context, the bank’s IT/Total Cost and IT/Income ratios are, respectively, 71% and 82% below the average for European retail banks27_.

71% lower – BOS’ ratio of IT costs to total costs compared to European retail banks

82% lower - BOS’ ratio of IT costs to income compared to European retail banks

44% lower – BOS’ ratio of IT cost to total assets compared to other Chinese banks

35% 59% 40% 40% 44% 43% 41% 37% 37% 20% 30% 40% 50% 60% 70% 35% 59% 40% 40% 44% 43% 41% 37% 37% 0% 10% 20% 30% 40% 50% 60% 70%

BOS BHB NCB BoCOM WUC CMBC HB CMB SPDB

Cost to Income Ratio: Bank of Shanghai vs. Domestic Peers

IT Spending Effectiveness: Split of IT Spending by Maintenance and Enhancements, Bank of Shanghai vs. Domestic Peers

Cost to Income Ratio: Bank of Shanghai vs. International Peers

35% 57% 66% 53% 77% 54% 64% 49% 43% 79% 30% 40% 50% 60% 70% 80% 90% 35% 57% 66% 53% 77% 54% 64% 49% 43% 79% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

BOS EST BCP RFF AXA PIR BOT MB AIB ICICI Source: Annual reports, Banker Database, Reuters, various broker reports

Chinese Banks BOS

Enhancements Enhancements Enhancements 40% 40% 40% Maintenance Maintenance Maintenance 60% 60% 60% 60% 60% 60% Maintenance Maintenance Maintenance 35% 35% 35% Enhancements Enhancements Enhancements 65% 65% 65% Source: Celent, BOS Source: Annual reports, Banker Database, Reuters, various broker reports

28 _{Data for total bank assets in China comes from the 2008 CBRC annual report. Data for aggregate bank spending on IT comes from Celent, IT spending in the}

Chinese Banking Industry, December 2009

29 _{According to the BCG report, Renewing Core Banking IT Systems: Open-Heart Surgery for European Banks from May 2006, European banks’ IT costs per}

total assets is 23bps.

30 _{Source The Banker – top 1000 banks 2009}

31 _{Boston Consulting Group, IT Performance in the European Banking Industry, BCG’s sixth annual IT Cost Benchmarking Study, June 2009.}

Comparing Bank of Shanghai’s IT efficiency against domestic peers is more difficult since, to our knowledge, no comprehensive benchmarking has been performed. Nonetheless, using data from Celent and the CRBC, we calculate that, on average, Chinese banks’ IT costs per total assets is 9 basis points28_{. While this compares favourably with European banks}29_, the ratio for Bank of Shanghai is 5 basis points – that is, 44% lower than the average for domestic banks. Furthermore, compared to domestic peers, BOS’ ratio of G&A costs to total operating costs is also 20% lower – also pointing to lower relative infrastructure and IT spending. Certainly, Bank of Shanghai’s overall cost to income ratio is materially below both domestic and international peers and lower IT spending would seem to be a significant source of the differential. Compared to the average for the top 1000 banks, BOS’ cost to income ratio is 55% lower30_{; compared to the average for European retail banks, BOS’ cost/income is} 41% lower 31_{; and, compared to domestic peers, its cost to income is 15% lower.} What is clear also is that the lower relative IT spending at Bank of Shanghai does not reflect lower relative spending on IT enhancements; instead, it reflects the inverse. Because BOS runs an integrated, highly parameterised system that absorbs much lower maintenance spend than BOS’ legacy system or the systems run by peers, in relative terms BOS is able to allocate 60% more of its IT budget towards new IT spending/enhancements than its peers. Effectively, this means that the bank can spend a relatively much lower amount on IT yet at the same spend a relatively much higher amount on IT enhancements.

Risk, compliance and management effectiveness Before T24, Bank of Shanghai had a separate risk management system, which made it extremely difficult to manage risk effectively. For instance, there were lags. Under the old system, it was impossible for example to prevent a transaction from being executed when a customer had exceeded his or her credit limit, since limits could not be queried in a sufficiently short space of time. With T24, such a transaction could not be executed and, clearly, given the high probability that supra-limit borrowing will become delinquent and ultimately need to be impaired, this is helping BOS to reduce its level of Non-Performing Loans (NPLs). With the old system’s account-centricity, credit was granted on the basis of accounts, not individuals. It was feasible under the old system, for example, for a customer to have two loan accounts, one paid-up and one in serious arrears, but be able to secure more credit. Similarly, it was possible for a customer, by having more than one account, to achieve a level of credit greater than would have been granted on the basis of a complete assessment of his or her circumstances. Since T24 can give BOS this complete view of its customers – their total borrowings, their repayment history, etc – Bank of Shanghai is able to price and allocate credit more effectively than in the past, also helping to reduce its level of NPLs. Bank of Shanghai’s level of NPLs has fallen continuously since 2006. In 2006, BOS’ level of NPLs was 3.6% versus 3.4% for the peer group. By the end of 2008, BOS’ level of NPLs was 2.2% compared to 2.3% for the peer group and 2.4% for the banking sector as a whole32_{. Within the peer group, the level of NPLs among other City Commercial Banks was 2.8%.} Not only does T24 provide better quality and more timely information for managing risk and customer relationships, it also helps management with broader decision-making. In addition to a complete view of risk and customer relationships, T24 gives BOS a complete view of product, employee and branch performance and the bank makes use of a data warehouse tool to carry out more detailed analysis on this data. Furthermore, the data is not just more comprehensive, but more timely too. Take financial reporting, under the old system, it was not possible to accrue interest and management was only able to view a complete income statement once a quarter. With T24, management has access to a daily profit and loss statement. 32 _{Source for NPLs for the whole market is CBRC. For more details on the peer group, please see appendix 1.} Mr. Jiang

Vice President, Bank of Shanghai

T24 has brought us complete and real-time data, which clearly

has big implications for our ability to manage risk, but also for the

quality and timeliness of the information that management uses

for day-to-day decision making.

T24 has brought us complete and real-time data, which clearly

“

quality and timeliness of the information that management uses

for day-to-day decision making.

_”

TemenosCase Study

Conclusions

A booming economy and mass urban migration are creating the conditions for accelerated growth in the Chinese banking sector. However, the Chinese government is simultaneously deregulating and internationalising the market and so competition is intensifying. Thus, despite the scale of the opportunity, it will only be the most agile players that truly capitalise on the opportunity – those that can generate long-lasting and self-sustaining growth based on strong client relationships, a high-quality portfolio of assets and the realisation of scale economies. Recognising both the opportunity and the preconditions to achieve that opportunity, Bank of Shanghai (BOS) launched a strategy for growth that necessitated the replacement of its core banking system. In 2002, it underwent a selection process that evaluated the option of an internal build alongside the option of taking a packaged solution from an international or local vendor. In the end, the bank’s desire to adopt international best practices saw it come down in favour of an international solution and, among the systems considered, T24 from Temenos emerged as the clear preference based on customer references, level of integration, implementation record, functional coverage and strength of business processes. Bank of Shanghai is the largest bank in China to have gone live with an international core banking solution. The project was started in 2004 and T24 went live in the corporate bank in 2006 and in the retail bank in 2008. A complex implementation involving high levels of localisation and process reengineering, the project was delivered fundamentally on time and on budget. Since going live, T24 has acted as an important catalyst for Bank of Shanghai’s strong recent absolute and relative financial performance. By affording a single view of the customer, T24 has made possible significant improvements in customer service. Customers receive seamless customer service across all channels, faster decisions (mortgage approvals, for example, are given 75% faster than before) and a differentiated experience. Overall, better customer service is translating into faster growth: in 2008, Bank of Shanghai grew loans at 18% compared to the peer group average of 16% and it grew deposits at 21% versus the peer average of 19%. We also estimate that the bank grew revenue per customer by around 16%. T24 has dramatically reduced the cost and time to market for new products. Development times have been reduced by between 60% to 75% and development costs by even more. BOS is launching a new product on average every 1 to 2 weeks and many of these products are truly pioneering - BOS was the first bank in China, for example, to launch a joint retail and corporate card. In the last two years, the bank has grown fee-based income at a compound rate of 59%, to a level that is 1.6x the average for City Commercial Banks and its Net Interest Margin, for the first time in 2008, overtook the level of peers. T24, as an integrated and robust solution, has allowed the bank to extract IT economies of scale as it has grown. In 2008, Bank of Shanghai grew its operating income by 28% and added around 700,000 new corporate and retail customers yet its IT headcount increased by only 68 people. We estimate BOS’ ratio of IT costs to total costs to be around 4.8%, translating into an IT cost to income ratio of 2.0%. To put these figures in context, the bank’s IT/Total Cost and IT/Income ratios are, respectively, 71% and 82% below the average for European retail banks. Furthermore, BOS’ ratio of IT cost to total assets is 44% lower than other Chinese banks. By offering up-to-date, integrated and complete information, T24 has considerably improved risk governance and management decision-making. Non-Performing Loans (NPLs), for instance, have fallen continuously since 2006. By the end of 2008, BOS’ level of NPLs was 2.2% compared to 2.3% for the peer group and 2.4% for the Chinese banking sector as a whole. In 2008, Bank of Shanghai’s Return on Capital was 125% higher than the average for the top 1000 banks and 15% higher than domestic peers

Appendices

TemenosCase Study

Appendix I: Peer group for benchmarking

Abbreviation Bank Name Joint Stock (JSC) or City Commercial Bank (CCB)?

Website

BON _{Bank of Nanjing} CCB www.njcb.com.cn

CB Citic Bank JSC www.citic.com/wps/portal

CMB China Merchants Bank JSC http://english.cmbchina.com

CMBC China Minsheng Banking Corp. JSC www.cmbc.com.cn

HB Huaxia Bank JSC www.hxb.com.cn

IB Industrial Bank JSC www.industrial-bank.com

BoCOM Bank of Communications JSC www.bankcomm.com

BOB Bank of Beijing CCB www.bankofbeijing.com.cn

NCB Ningbo Commercial Bank CCB www.nbcb.cn

CEB China Everbright Bank JSC www.everbright165.com.hk

SPDB Shanghai Pudong Development Bank JSC www.spdb.com.cn

SDB Shenzhen Development Bank JSC www.sdb.com.cn

GDB Guangdong Development Bank JSC www.gdb.com.cn

DCB Dongguan City Commercial Bank CCB www.dongguanbank.cn

BHB Bohai Bank CCB www.cbhb.com.cn

NB Nanchang Bank CCB

WUC Wuhan Urban Commercial Bank CCB www.whcbank.com

QCC Qingdao City Commercial Bank CCB www.qdccb.com

SRCB Shanghai Rural Commercial Bank RCB www.shrcb.com/rxcms/cn/

DCC Dalian City Commercial Bank CCB

ACB Anshan Commercial Bank CCB www.asccbank.net

Appendices

Appendix II : Abbreviations used in the report

CAGR CAR NIM RCB SMEs GDP IPO CI G&A SOCB WTO RMB FX NPL JSCB ENB STP G&A CBRC EST BCP RFF BCO PIR AIB ICICI BOT MB AXA Compound Annual Growth Rate Capital Adequacy Ratio Net Interest Margin Rural Commercial Bank Small & Mid-size Enterprises Gross Domestic Product Initial Public Offering Cost to Income Ratio General and Administrative State Owned Commercial Bank World Trade Organisation Renminibi Foreign Exchange Non Performing Loan Joint Stock Commercial Banks Electronic National Bonds Straight Through Processing General & Administrative Cost China Banking Regulatory Commission Erste Bank Banco Comercial Português Raiffeisen Bank Banco Cooperativa Piraeus Bank Allied Irish Bank ICICI Bank Bank of Taiwan Maybank AXA Bank Europe