Bankers believe Bank of China is coming under severe pressure to find acceptable investors ahead of its international IPO in 1H05 now that international heavyweight HSBC has tied the knot with Bank of Communications and UBS and Deutsche have reportedly quietly pulled out of discussions.

UBS and Deutsche have declined to confirm or deny that they have lost interest in taking a stake, as stated in a mainland news report. The report added JPMorgan, Citibank, Sinopec, Petrochina and two privately-owned companies were on the shortlist of strategic investors.

Hong Kong observers are sceptical about the US banks, however.

Citibank in particular may be held back by its 5% investment in Shanghai's Pudong Development Bank, which it acquired with a view to entering China's credit card market. It is also currently in the process of digesting its most recent acquisition: Koram Bank in Korea

Price is also an issue.

With BoC's registered capital at a fraction over Rmb186 billion, buying a significant stake would not be cheap. HSBC paid just over Rmb14 billion for a 19.9% stake Bank of Communications. An equivalent stake in BoC would around Rmb36 billion (almost $5 billion) and given the huge legacy problem, would offer a much lower chance of a speedy return.

In contrast, Citibank paid around $2.6 billion to swallow over 90% of Korea's seventh-largest bank in one of the most prosperous Asian economies.

One US banker says that the Chinese banks would be a hard sell to investors back home, especially with the spate of scandals that have plagued Bank of China.

This leaves BoC in a tricky position.

The bank desperately needs a strategic investor to boost its IPO. Such an investor gives comfort to retail investors thanks to its much greater capacity for due diligence. Such an investor can also be relied on to help the bank grow through know-how and additional cash infusions.

JPMorgan and Citibank likely gained credence as being potential partners since they are not pure investment banks. But nor is JPMorgan a pure retail bank.

Perhaps in a sign of its increasing desperatio, it has been suggested that the investment could take a novel form. As one banker comments, "What's particularly has surprised people is the news that JPMorgan and Citibank could be asked to consider a non-cash investment."

Due to the perceived risk of investing in the state giants, it has been mooted that the US banks might provide technology, fixed assets and other forms of non-cash inputs.

This is covered under China's company law. But it is a strange twist on most sino-foreign deals, when the Chinese partner normally contributes the land and the facilities and the foreign partner contributes the hard cash.

Neither Citi nor JPMorgan would comment on the report.

With HSBC making a preference for the least damaged of the state banks clear, ICBC, BoC, CCB and ABC are having to face the fact foreign investors may need a lot of winning over.

The restructuring of so many branches, many of them not linked by a uniform IT system, is taking time. BoC recently announced it had still not completed its reorganization into a joint stock company. However, it is likely this will be finalized this month.

Although the presence of PetroChina on the short list may appear unexpected, a subsidiary, set up on 2001, of the onshore oil company has already been active. The subsidiary recently bought Rmb 6 billion of non-performing assets in Guangdong off Huarong asset management company, following a acquisition worth Rmb 3 billion last year.

Sinopec's interest can best be explained, say mainland sources, as an attempt to combat a negative impression caused by the draining away of its own strategic investors: BP and Shell have already sold their stakes at the beginning of this year, and market rumours abound concerning the likelihood Exxon Mobil will follow. The hope is that sharing in an important IPO would reap favourable publicity.

But both oil companies could be interested in entering the banking business for its own sake..

"Lots of SOEs, and especially the oil majors are sitting on huge amounts of cash," points out China banking expert Wei Yen of Moodys.

Hence, they are keen to find ways of managing their cash hoard and generating some returns, he says.

It is not likely there would be a substantial conflict of interest, as there are rules about how much Chinese banks can lend their corporate shareholders, namely, not more than their equity investment, he notes. Still others argue that it does not say much for China's stated aim of encouraging greater commercial discipline on its banks, if it increase the ties between lender and borrower rather than loosens them.

It has already been revealed that numerous SOEs hold a stake in the recently-established joint stock company of China Construction Bank, also aiming at a listing early next year. The State Grid Corporation of China, Baogang Steel and Changjiang Power have around 10%, with the balance held by Central Huijin Investment Company. The latter was set up to represent government ownership in both CCB and BoC after the government injected $45 billion into BoC and CCB in a bid to recapitalize them earlier this year.

Another aspect making the Chinese banks less attractive are their corporate governance mechanisms. BoC currently only has a single independent board member out of the total of ten. International best practice suggests one-third to one-half of board members should be independent.

Bank of China reported improved figures last month, with a NPL ratio of just under 6%, down from 16% at the beginning of the year, and operating profit of Rmb 38 billion for the first seven months of this year, up 21% on-year.