The Bank That Ate the World

By MICHAEL SCHUMAN / HONG KONG

Scotman Thomas Sutherland, a manager at a shipping company, wisely recognized the profits to be had in the burgeoning trade in a developing market like China. The bank he helped start, Hongkong and Shanghai, now called HSBC, became one of China's top financial institutions within just a few years of its founding. That was in 1865.

Today history is going full circle. The London-based megabank--the world's second largest bank by market value in mid-January--is returning to its roots. China, the world's fastest-growing economy, is the hottest market in global finance, sending international banks on a mad scramble for acquisitions and customers.

And HSBC is sitting pretty. It boasts the most extensive branch network of any foreign bank on the mainland, with 20 outlets spread from Chengdu in the far west to Tianjin on the northeast coast. The bank has invested more than $4 billion since 2001 to buy stakes in Chinese financial institutions, including nearly 20% in both Bank of Communications, China's fifth largest bank, and Ping An Insurance, its second biggest life insurer. Compared with the same period in 2004, pretax profits in China increased sixfold, to $161 million, in the first half of 2005. As a sign of its renewed influence in the Middle Kingdom, the bank resides today in a new skyscraper called HSBC Tower in Shanghai's up-and-coming financial district of Pudong, across the Huangpu River from the bank's old, domed office on the Bund. "We've been here 140 years, and we'll be here another 140 years, at least," says Richard Yorke, CEO of HSBC in China.

Despite its history, HSBC needs to do far more business in developing markets like China to spur growth. After focusing much of its energy over the past seven years on mature economies, it is locked in a global contest with its chief rival, Citigroup, to tap the pocketbooks of the world's newly rich. From South Korea to India to Brazil, HSBC is expanding its branch network, launching new financial products and marketing its brand. In December HSBC acquired 10% of Vietnam's Techcombank; in November HSBC said it planned to launch the first independent investment bank in Saudi Arabia; and in late October it purchased 70% of an investment bank called Dar Es Salaam in, of all places, Iraq. Says Stephen Green, HSBC's global chief executive, who in November was named the bank's next chairman: "These are markets into which we should be prepared to invest significant dollars."

Much of the world remains unbanked. China's 1.3 billion people, for example, carry about 10 million credit cards, compared with 1.2 billion in the U.S. In Mexico only 1 in 5 people has a bank account. Rising middle classes in developing countries are low-hanging fruit for multinational financial-services companies. "In the next 25 years, you'll see economic wealth distributed more evenly with the world's population," says John Bond, HSBC's outgoing chairman. "Demand for financial services in emerging markets is going to grow consistently and probably grow faster than it will in the more mature markets."

But with high growth come high risks, including dramatic booms and busts, political instability and worse. Michael Smith, Hong Kong-- based CEO of HSBC in Asia, found that out one day in 1999 in Buenos Aires, where he was managing the Argentina operation. He had made some enemies while stamping out suspected fraud. As he drove from his office, armed men in two cars ambushed him and riddled his car with bullets. Smith got shot in the thigh but managed to smash his blood-splattered sedan through his assailants' vehicles and outlast them in a long chase. "It was real James Bond stuff," says Smith, 49. And that wasn't even his worst day. Two years later, he and 1,000 other HSBC employees were trapped in their offices by a mob that tried to burn down the building during another of the country's economic crises.

The risks in mature economies aren't so lethal. Instead there is potential treachery of the bottom line. Bank analysts are worried that HSBC has become overly dependent on slow-moving, mature markets, such as in Europe and the U.S.--which could slow growth. Goldman Sachs estimates HSBC's profit growth will sink to a more-than-respectable 9.8% a year from 2005 to 2007, after expanding an average of 19% a year from 2000 to 2004.

Call it the downside of getting global. In the mid-1990s, HSBC's business was based primarily in Hong Kong and Britain. Since 1998, however, the bank has completed more than 50 acquisitions, the biggest coming in the U.S., where HSBC previously had only a minor presence in the form of Marine Midland Bank, which it bought in the '80s. In 1999 HSBC acquired Republic New York Corp. for $9.7 billion. In 2003, in a move that signaled HSBC's determination to shift into higher-margin consumer businesses, HSBC paid $14.4 billion for Household International, a provider of car loans and credit cards to less affluent Americans. Bobby Mehta, CEO of HSBC in North America, believes there is still potential in the U.S. market. He says strong loan growth in the third quarter of 2005 produced a 9.5% jump in profits for all of HSBC's U.S. businesses. "We don't believe there is any credit cataclysm coming" in the U.S., Mehta says. "When you compare the U.S. market to other developed markets, it looks attractive."

The result of the acquisition binge: HSBC's asset base exploded, from $472 billion in 1997 to nearly $1.5 trillion by mid-2005. The bank has a global footprint matched only by that of Citigroup, which has slightly larger assets than HSBC. HSBC has also become a very, very different bank. In 1997 nearly half its revenues came from emerging markets; today less than 20% does, according to Morgan Stanley.

Making emerging markets a bigger part of HSBC's business will probably be the primary challenge facing Green, 57, as he takes the bank's helm. A low-profile company insider who joined HSBC in 1982, Green was tapped in November to become HSBC's new chairman after the dapper and dynamic Bond retires in May. A part-time deacon, Green penned an unusual book in 1996 titled Serving God? Serving Mammon?, in which he strives to reconcile the money-hungry world of Big Business with the Christian ideal of love for humanity. "The kingdom of God can be found in the thick of the markets, and God calls some Christians to take the risk of being there," he writes. Not much risk taking is expected from Green, though. Ian Smillie, a bank analyst at ABN AMRO in London, calls Green "classic HSBC," which he describes as "considered" but "never cutting edge." Green will certainly need to sort out the bank's underperforming investment-banking business.

There's not necessarily a need for Green to take ungodly risks, but he could have a devil of a time competing against international rivals like Citi, Standard Chartered and General Electric and entrenched local banks.

That's not to say HSBC can't compete and win. To get a head start in the virtually untapped Chinese credit-card industry, HSBC in July formed a joint venture with its partner Bank of Communications. Although the operation is 100% owned by the Chinese bank, the cards will be co-branded with HSBC, which plans to acquire a stake when regulations allow. "We always try to be the first through the door," says Yorke, HSBC's China chief. In India HSBC employs mobile marketing teams that push its services at stalls set up in shopping malls, office buildings and residential complexes in order to reach people beyond the bank's limited branch network. In Malaysia, where the majority of the population is Muslim, HSBC offers Islamic banking--conducted without interest charges, which are banned under Islamic law--along with its regular services.

In Mexico HSBC acquired and recapitalized a local bank, Grupo Financiero Bital, for $1.9 billion in 2002, and now that country is the fourth largest profit generator for HSBC globally (after the U.S., Britain and Hong Kong). The success in Mexico has been spurred by an unusual marketing campaign. Executives discovered that the HSBC name is a tongue twister in Spanish, so it launched ads to teach Mexicans how to pronounce the brand correctly. In one TV spot, a man in an HSBC tie leads a crowd at a soccer match in an H-S-B-C cheer.

The true irony facing Green is that his legacy may very well depend on getting the bank back to where it started. Although HSBC's pretax profits from emerging markets jumped 45% in the first half of 2005, according to Morgan Stanley, some bank analysts believe that Green will have to make even more major acquisitions to keep up that pace, especially in Asia. "It is a critical part of the potential growth," says Smith, HSBC's Asia CEO. "It is very important that we get it right." If HSBC does, its future may well be as storied--and profitable--as its past.

[This article contains a table. Please see hardcopy of magazine or PDF.]

HSBC has been expanding rapidly and has assets nearly equal to Citigroup's CITIGROUP HSBC Holdings $48.43 Share price (1/17) $84.04 Up 4.8% 6 mos. to date (6/30) Up 5.5% 100 Countries of operation 77 $10.51 (Up 64%) Net income in billions (Chg. from year ago) $7.98 (Up 5%) $1.54 Assets in trillions $1.47 $41.4 (Up 1%) Revenue in billions (Chg. from year ago) $29.9 (Up 9%)

With reporting by Peter Gumbel and Adam Smith/London