It was a painful lesson. In May – months before the words credit crunch became common currency – China’s fledgling sovereign wealth fund, China Investment Corporation (CIC), backed the flotation of the Blackstone private-equity group to the tune of $3 billion (£1.5 billion). The investment bought it a stake of almost 10%.

The timing was disastrous. As the summer unfolded and the credit crunch took hold, the value of private-equity funds slumped. Blackstone’s share price tumbled. CIC has made a paper loss of more than 20%.

But last week, the news that CIC is putting $5 billion into Morgan Stanley gave a new perspective to Chinese involvement in the West’s largest financial institutions. The sheer scale of the Morgan Stanley deal was striking. And over the past few months, investment from the Far East has become almost commonplace.

China Development Bank and Temasek of Singapore pumped $4.4 billion into Barc-lays, securing a 5.2% stake. Citic Securities put $1 billion into Bear Stearns. The deal with Morgan Stanley is only the most recent of agreements to be struck. The Chinese dragon has become a familiar – and surprisingly welcome – presence on Wall Street.

In contrast to the protectionist fervour that forced a Dubai company to sell several American ports that it acquired through the takeover of Britain’s P&O, there has been barely a murmur of opposition to this trend.

But as America’s stance on foreign money has changed, so has that of the Chinese. Since the embarrassment of Blackstone, the Chinese appear to have learnt their lesson. The Blackstone deal was a risky investment; now they are after solid returns.

Morgan Stanley was in a weak position when it negotiated with the Chinese: news of the CIC investment came alongside the disclosure that the American investment bank was writing off a $9 billion slug of its exposure to sub-prime debt.

Chief executive John Mack bent over backwards last week to emphasise that the bank’s regulatory capital position was never in jeopardy. But, he said, Morgan Stanley’s self-imposed targets made it necessary to raise capital.

Details of the Chinese investment show that CIC is to receive 9% on its money, plus the right to buy a 9.9% stake in the bank – a meaty return by anyone’s standards, and an indication of Morgan Stanley’s desperation to raise funds.

The deal illustrates perfectly the confluence of two driving forces. On the one hand, investment banks that have been hit hard by losses on sub-prime exposure need the cash to repair their balance sheets. And on the other, China is brimming with foreign-exchange funds to invest, the product of its huge current-account surplus with the rest of the world.

China is not alone, of course, in having money to spray around – and not alone in showing interest in buying stakes in investment banks. Singapore has put $11 billion into UBS. The Abu Dhabi Investment Authority has put $7.5 billion into Citi. Money from Dubai has gone into Standard Chartered and HSBC. Only two days ago came news that Singapore’s Temasek is in talks to take a stake in Merrill Lynch.

IN many ways, this is a good time to buy in – bank shares are heavily depressed. But investors are still making Wall Street pay through the nose for capital. Abu Dhabi’s $7.5 billion injection into Citi comes with an 11% coupon – even higher than CIC’s return on its Morgan Stanley stake.

Nobody – least of all a bank whose balance sheet is in tatters – would deny that $5 billion is serious money. But the funds put into Morgan Stanley are small beer in the context of the $200 billion that CIC has to invest.

“These are relatively small stakes and they are going to be passive investors,” said Richard Portes, professor of economics at London Business School.

However, the politics of such investments are sensitive. UBS’s investors have voiced concerns that Singapore has become one of the bank’s backers: Singapore is a competitor to Switzer-land as a financial centre.

But Portes pinpoints the crucial issue for the banks that have been so willing to accept money from sovereign wealth funds: “Can America really afford to be too snooty about what sort of investment it accepts?” Put bluntly, beggars cannot afford to be choosers. And in the present climate, banks really are beggars.

The list of international banks swallowing write-offs has lengthened week by week. And so has the list of international banks welcoming investment – from China and elsewhere – with open arms.

But how much longer will it continue? Jon Peace, a banking analyst at Lehman Brothers, said: “We are anticipating that some European banks will have to take charges, but the size of them shouldn’t be so great that they have to seek a partner. But, for the American banks, there is probably more in the pipeline. It now seems certain that Merrill will announce a write-down and a recapitalisation.

“And for Citi, it seems inevitable that they will need more write-downs and probably more capital-raising.”

EAST-WEST ties are not purely a one-way street. China needs western expertise to develop its financial services. Before cash became such a scarce commodity, several British and American banks, including Bank of America and Citi, took stakes in Chinese lenders. The idea was to tap into soaring valuations but also get in on the ground floor of a liberalising, fast-growing market with more than a billion customers.

Ser-Huang Poon, a professor of finance at Manchester Business School, said: “China, being China, is very cautious. But they are keen to do joint ventures.”

But Portes, at the London Business School, is sceptical about the speed with which western banks will make headway in China. “The knowledge transfer has been rather more limited than western banks had expected,” he said.

“They are very different culturally and the Chinese banks are subject to political constraints in their lending. It is not so easy for a western bank to introduce the credit evaluation and risk analysis that they are accustomed to using.”

Peace, at Lehman Brothers, said: “The story that the banks are spinning is that there are synergies to be had. But will that have any value in the short term? Having said that, because China is such a closed market, Morgan Stanley may gain from having a tie-up with the government.”

Royal Bank of Scotland has already established a foothold in China and shown that it is possible for a western bank to make headway. It has issued 2m credit cards in China through its two-year-old partnership with Bank of China. Shareholders were initially fearful that the Bank of China deal was little more than hubristic empire-building, but RBS won over the doubters.

The value of its £900m investment in Bank of China – in return for a 5% stake, since diluted to 4.2% – has increased to £4 billion.

But chief executive Sir Fred Goodwin is eyeing a bigger prize. From his position on the board of Bank of China, still more than 70%-owned by the Chinese government, he hopes to influence how China develops its banking market.

RBS has at least made a good start, advising on everything from marketing of financial products to running the back office. Beyond credit cards, RBS has set up ventures alongside Bank of China covering wealth management and corporate lending, where $2 billion of transactions have been financed so far.

And government links can bring advantages. Bank of China has struck a deal which, in effect, out-sources the job of chasing up credit-card customers who fall behind with repayment. The people who do the chasing are the Chinese police.

For RBS, the Chinese connection is interesting, but not a matter of life and death. For Wall Street banks desperate for funds, the Chinese connection has been crucial to their recovery.

CIC WANTS TO BE A STABILISING FORCE IN WORLD MARKETS

IT may have made two multi-billion dollar overseas investments, but the China Investment Corporation (CIC) is “just a newborn baby”, according to its chairman.

The latest sovereign wealth fund to splash its cash in the West was inaugurated only at the end of September. It is still advertising for managers to run four global portfolios.

Internationally, however, CIC has been treated as an adult from the start. Chairman Lou Jiwei, a former vice-minister of finance, has already been drawn into the tense battle between Rio Tinto and BHP Billiton – only for CIC to deny that it intended to act as a white knight for Rio.

CIC has $200 billion (£100 billion) to spend, its first slice of China’s $1.5 trillion of foreign-exchange reserves that have so far been tucked into low-risk, low-return assets such as US treasury bills.

Of its initial capital, only a third has been earmarked for overseas investments. Another third will be used to take over Central Huijin, a government holding company that has controlling stakes in many of China’s largest banks and brokerages. The rest will be spent at home, recapitalising some of the remaining state banks and looking at other assets. CIC invested $10m in the Hong Kong flotation of China Railway.

Jiwei has not been slow to set out his stall. At a City of London dinner this month, he said that CIC wanted to be a stabilising factor in world financial markets.

But he warned foreign governments not to use national security fears as an excuse for protectionism to block deals.

Increasing CIC’s disclosure is not on the cards, though. Jiwei said: “If we are transparent on everything, the wolves will eat us up.”

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