THE evolution of the yuan into an international currency creates new opportunities for both foreign and domestic banks in China. The race for innovative products to serve the trend is on.

Banks are particularly anxious to capitalize on the burgeoning business in trade settlements and other international payments, driven by gradual deregulation of the yuan. Standard Chartered Bank said recently that international use of Chinese yuan has increased more than eight folds since December 2010.

HSBC forecasts that the yuan will become one of the top three global currencies for trade settlements by 2015 and will be made fully convertible in five years.

The Chinese arms of Western banks have been first cabs off the rank in offering new yuan-related products, but Chinese banks aren't far behind.

In March, HSBC China introduced a new service to help integrate the process of cross-border yuan payments and collections for multinational companies with subsidiaries on the mainland. The centralized settlement system was developed to reduce redundant transactions and foreign-exchange risk for customers, said the British bank.

Last month, Citigroup launched a multicurrency cash management product for mainland companies. The US-based lender said it was the first to offer such a liquidity management tool with yuan capability in China. So called "multicurrency notional pooling" is widely used in international financial centers like London and Singapore.

"This is a very appealing business for foreign banks," said Yu Yihua, a banker at another American bank based in Shanghai. "With regulatory approval, more foreign banks will scramble on board."

Niche market

HSBC, Citi and other global banks are capturing this niche in the market by leveraging their brand stature into new products. They said their aim is to boost the use of the yuan in overseas markets, helping to nudge the currency along toward more international status.

Foreigners have the advantage in treasury management because of their longer global reach, but Chinese banks are intent on closing the gap.

The Big Four Chinese banks are among the world's biggest companies, giving their ambitions clout. The Industrial and Commercial Bank of China, the world's largest lender by capitalization, topped the 2013 Forbes Global 2000 list as the world's biggest public company, followed by the nation's second-biggest lender, China Construction Bank.

The Big Four - Industrial and Commerce Bank, Construction Bank, Agricultural Bank and Bank of China - earned combined net profit of 722.9 billion yuan (US$116.9 billion) in 2012, more than twice the total of the top four US-based banks.

Cross-border treasury

Chang Qingshan, a banker at Bank of China, said his institution will launch a multicurrency notional pooling tool with yuan capability when the time is ripe.

But, at this stage, mainland lenders are not as competitive as foreign counterparts in developing new products to keep up with fast-changing trends.

Bank of China is the most international of the Big Four. It has a cross-border liquidity management facility that relies heavily on its overseas subsidiary in Hong Kong to provide "cash sweeping" for customers.

"As yuan internationalization advances day-to-day, demand for using the yuan grows stronger for cross-border businesses," said Chang. "We know that valuable customers who have been banking with us for many years are more comfortable talking to us than talking to foreigners. Trust comes easier with the same culture. And we know we will start losing them if foreigners can offer something they want but we don't have."

He added, "We are not able to provide some products that Western global banks are offering, mainly because we don't have the network to support it."

Without powerful global networks and novel products, some Chinese banks have resorted to back-door channels to meet customer needs for liquidity management.

On the back of China's growing trade with neighbors, they have forged closer relationships with regional Asian banks. That opened the door to one back-channel route to extend yuan loans to clients via offshore markets in Taiwan, Hong Kong, Singapore, and Thailand.

"We first make a certificate of deposit that works as the onshore guarantee, and then get a loan from an offshore bank for our customer. It's like a go-between business," Maggie Huang, a loan officer at a Chinese bank in southern China, told Shanghai Daily.

"If a customer deposits 10 million yuan with us, we can help him get up to 9 million yuan in Taiwan," she explained. "He needs only to pay us a 0.8 percent fee for issuing a certificate of deposit. Sometimes he can negotiate to have a larger loan because the future interest provides him growing collateral beyond the 10 million yuan."

She admitted it's against regulatory rules to lend the client more than 9 million yuan and said regulators also require banks to verify the use of funds in the overseas market - something not usually done.

Underground market

"But a lot of lenders are risking it," she said. "The customer will find a way to transfer the money back from Taiwan to the mainland. Maybe through the underground market. Then he will deposit the 9 million yuan he got in Taiwan and get another 8.1 million yuan loan on the island.

"Because the mainland has much higher interest rates than Taiwan," she went on, "the customer enjoys an interest surplus for his lending (to the Chinese bank) and borrowing (from the Taiwan bank). The more the money goes back and forth across the Strait, the more interest he earns, and the more income we earn."

She said rumors are rife that Chinese regulators are about to halt such transactions amid concerns that the circulation of money for profit and not for real business endeavors is creating a bubble.

"When there's a loophole in the framework, there's arbitrage behavior," said Huang.

"But this go-between business is also helping to build and expand offshore yuan markets by activating the use of yuan in those markets. I think that's the reason why the government hasn't halted the business before now," she added.