Here's why the new rules on foreign majority ownership in the financial sector is a boon for China banks

Its effect will be more pronounced amongst smaller financial institutions.

Last Friday, Chinese Deputy Minister of Finance Zhu Guangyao announced that China would allow foreign majority ownership of financial firms. Moody's said the announcement is credit positive for Chinese banks and non-bank financial institutions (NBFIs) because it will increase foreign investors’ involvement in domestic markets and improve financial firms’ risk management and corporate governance.

Better risk management and corporate governance will strengthen the creditworthiness of invested financial institutions and be a spur to improvements in the industry as a whole.

Here's more from Moody's:

This policy will grant national treatment to foreign investment in banks and financial asset management companies (AMCs), the latter of which is a type of specialist firm working out nonperforming financial assets. Currently, foreign investment in banks and AMCs is limited to 20% for a single investor and 25% overall.

The new policy will raise the foreign ownership cap on NBFIs (securities, fund management and futures companies) to 51% from 49%, and remove the cap entirely after three years. Foreign banks operating in China have had lower nonperforming loan (NPL) ratios (0.75% as of September 2017 versus the sector average of 1.74%) and higher NPL coverage ratios (289% as of September 2017 versus the sector average of 180%) than Chinese banks.

The new regime will promote the flow of foreign investment to Chinese financial institutions, improve their capital adequacy and buttress their risk-management capacities. This is in line with a key regulatory policy objective since January 2017 to strengthen the financial sector’s risk management.

Chinese regulators, trying to promote deleveraging and better transparency of complex financial transactions, have implemented a series of tightening measures to curb opaque shadow-banking and inter-financial institution activities.

The new policy also benefits international asset managers seeking to enter the Chinese market. Coinciding with the announcement, the Asset Management Association of China approved the registration of three international asset managers as wholly foreign-owned private fund managers: Invesco Ltd., the parent and guarantor of Invesco Finance PLC; Neuberger Berman Group LLC; and Value Partners Group Ltd. We expect more foreign firms to invest in majority-owned joint ventures and launch funds in China.

The new policy’s effect will be more pronounced among smaller financial institutions given the relative ease of making a majority investment in smaller targets. Large state-owned banks are less likely to be majority-owned by a foreign entity given the authorities’ priority of retaining control of strategic state-owned enterprises, including state-owned banks.

The sheer size of state-owned banks also challenges foreign investors’ financial capacity (the big five state-owned banks had assets of RMB92.1 trillion as of September 2017). For example, the fifth ranked state-owned bank, Bank of Communications Co., Ltd. had shareholders’ equity of RMB648.4 billion ($97.7 billion) as of June 2017, 18.7% of which is owned by The Hongkong and Shanghai Banking Co., Ltd.