(FORTUNE Magazine) – The boy from Brooklyn had come a long way. There he was, standing in the May sunshine with ex-Presidents Ford, Carter, and Bush, two former Secretaries of State (Henry Kissinger and James Baker), as well as Bill Clinton, Al Gore, and a gaggle of America's corporate elite. The occasion? A lobbying effort in aid of a bill granting China permanent normal trade relations (PNTR). "I couldn't believe my eyes," marvels Sandy Weill, who as chairman of Citigroup is perhaps the world's most powerful banker. "These were people straight from the history books."

So is Citigroup's story in China. The bank had a glorious run from the time it opened its first office in 1902 to the moment Mao's communist army threw it out of its stately headquarters just off Shanghai's Bund in 1949. The bank set up shop again, quietly, in 1984, and has been plugging along ever since. Now that China looks likely to win normal trading status with the U.S. (the Senate will vote in September) and enter the World Trade Organization, Citigroup's dream is that it is about to enter a new and even more glorious chapter in a country where the tug of profit and history remains strong. "China will be a fantastic market for us," Weill exults.

Weill's optimism may sound wearily familiar--the Chinese market has beguiled Western capitalists for centuries--but there are grounds for it. Right now, China's banking environment is so restrictive that Citibank is allowed to make local-currency loans only to foreign multinationals and their joint venture partners. In investment banking, Citigroup's Salomon Smith Barney Securities arm can raise capital for Chinese companies only in offshore markets like New York or Hong Kong. Complains Richard Stanley, who heads Citibank's China operations from a small office in Shanghai's skyscraper-strewn but eerily empty Pudong business district: "To be embedded in the local market, you need local currency. Otherwise you're just a suitcase banker flying in and out."

Given these limits, it's no surprise that Citibank's China business is thin, accounting for a small share of its Asian profits. "In terms of revenues, we probably do in China about 20% of what we do in Korea," sighs Steven Long, who heads Citibank's Asian operations out of Hong Kong. "We've been pretty disappointed." Long won't say whether the business is profitable.

WTO is supposed to be Citigroup's liberator. The idea is not to grow into a branch-driven retail powerhouse--"The days of brick-and-mortar banking are over," sniffs Stanley--but to cater to two main markets. The first is China's elite corporate customers. Under WTO provisions, red-hot Chinese companies, such as personal computer maker Legend, electronic goods maker Konka, consumer appliance maker Haier, and telecom service provider China Telecom, will be able to turn to Citibank (or other foreign banks) for local currency loans by 2002. Salomon Smith Barney, for example, would be free to raise money for these fast-growing companies on equity and debt markets in Chinese cities like Shanghai and Shenzhen.

The second market is selling consumer financial services like credit cards and home mortgages. Under WTO rules, such services will be open to all by 2005. Citibank senses a killing. Rhapsodizes Long: "It's the last great frontier left in the world today." The pent-up demand for credit cards is visible even to the naked eye, most obviously in the chic pubs and discos of Shanghai, where Chinese yuppies carry around thick wads of currency just to pay off their beer and champagne tabs. Financing private-home ownership could also boost Citibank's fortunes.

Business-to-business commerce is another potential gold mine. As more Chinese businesses conduct commerce over the Internet, the proliferation of Net-related financial services is almost assured. Citibank has hooked up with U.S.-based B2B site Commerce One, for instance, to run its Net-based payment systems. Citibank could provide the same service for Chinese exporters.

No doubt this dazzling frontier was beckoning on that May afternoon as Weill watched one ex-President after another get up to argue for normal trade relations. But China has a way of turning dazzling projections of future growth into years of frustration. No business odyssey in China is complete without a twist in the tale--usually in the form of a knife in the back. Weill knows this. In 1995, Citibank thought it had scored a coup when it was one of the first foreign banks to be issued a local-currency license. Surely this was the crack into the retail market it had been waiting for. It didn't happen. In order to protect domestic banks from competition, the Chinese government imposed a limit on how many branches Citibank could open and told foreign banks whom they could lend to, from where, and in what amounts. The rules went on and on.

That won't happen this time, Weill believes. "They [China] have no reason not to do what they've said they'll do," he reasons. "But it will take time. We know that." For an ancient civilization like China's, time is an elastic concept. But clearly for the 67-year-old Weill and his China team, the twin deadlines of 2002 (opening of the corporate market) and 2005 (opening of the retail market) are critical. So much so, they say, that stern measures will be taken if China doesn't keep its word. "If China breaks its promises, we would do everything we could to bring them to the WTO table," says Long. "The WTO will be a pretty strong voice for the rule of law."

Why would China want to stall this time around? Consider this nightmare scenario: Foreign financial behemoths like Citigroup get unfettered access to China's retail customers, with their stagnant pool of perhaps $550 billion in savings. As Chinese households realize that the foreign banks can provide better products and services, they start to take their money out of Chinese banks and put it in foreign ones. China's banks are then forced to stop lending to the country's state-owned enterprises, most of which are losing money. Starved of capital, those companies go bankrupt, precipitating dangerously high unemployment.

This is not far-fetched. The four most important state-owned commercial banks (Industrial & Commercial Bank of China, Agricultural Bank of China, Bank of China, and Construction Bank of China) control 70% of all financial assets in China. Bad loans now amount to roughly 30% of their loan books--higher than in crisis-racked Thailand and Indonesia. In China's case, almost all the bad loans are owed by state-owned enterprises, which siphon off close to half of the total loans in the system. There is, in short, no way that many of the bad loans are ever going to get paid, or even serviced. "The banking system in China has been nothing but a way to channel funds from consumers to sick state-owned enterprises," says Richard Stanley. There's a direct correlation between opening up the retail banking market and reforming the state-owned enterprises. If the Chinese move too fast on opening up the banking market, it'll suck the lifeblood right out of these sick companies.

To make things worse, there's a sticky political dimension to China's bad-loan mess. State-owned enterprises are usually tied to local officials who dole out factory jobs as party favors. Because such party officials are often shielded from punishment, their financial profligacy flourishes. "China's banking system is an economic time bomb," concludes Dong Tao, an economist with Credit Suisse First Boston Securities in Hong Kong.

A gradual flight to quality, of course, wouldn't hurt China; in fact, it would help it. The whole point of competition, after all, is to jolt fat, established companies into improving their game. And heaven knows China's banks could use improvement. Even the most mundane banking chore in China becomes a challenge worthy of Hercules. If a company "in Shanghai has to pay someone in Beijing, then its checks won't work because a Beijing bank won't honor a Shanghai check," explains Anand Pande, the Shanghai-based vice president of Citibank's Global Cash & Trade business in China. Oh, and checks are valid for only ten days. So a check will often expire before payment is made.

Dong estimates that cleaning up China's bad loans will cost $300 billion, or 30% of China's annual GDP. If China's economy nose-dives, the price will rise. Even so, Dong believes the problem is manageable. "The government has the financial resources to fix this," he says, pointing to China's $156 billion in foreign reserves and the hundreds of billions more healthy state-owned enterprises like China Telecom, Petro China, and China Unicom are worth on global equity and debt markets. And China is not shying away from the problem. In 1999, Zhu Rongzhi's reformist Finance Ministry created four asset-management companies, each one paired with one of the four troubled state banks, and ordered them to collect, repackage, and then sell more than $100 billion of bad bank assets. Such a mammoth undertaking is fraught with risk, of course, the main one being that investors are not exactly salivating over the chance to buy, say, an overstaffed steel mill in Wuhan.

Citibank is thus caught in a net of circumstances not of its own making. Its infiltration of China hinges on how fast China's sickly banks can get better, which depends on state-enterprise reform, and that depends on political factors entirely outside Citibank's control. Banking reform "can happen," says Pande, "but it's going to be very, very difficult."

The underlying, unspoken fear is that it could take a decade or more for China to fix what's broken. In the meantime, Beijing could artfully sidestep its WTO obligations through nontariff barriers and other kinds of surreptitious foot-dragging. Citibank has hardly any choice but to be optimistic, and officially swears that it is confident that this won't occur. "It's true China has not honored many of its bilateral trade agreements," admits Citigroup's chief PNTR lobbyist, Lionel Johnson. "But once China is in the WTO, it will no longer be a bilateral issue but a multilateral one. There will be more pressure on China to abide by the rules." Maybe, but it's impossible to imagine the Chinese government risking a collapse of its banking system and fragile state-owned enterprises just to please WTO bureaucrats in Geneva. It's also hard to imagine those same Geneva bureaucrats mustering the courage to confront China if it breaks the rules.

Weill and the other bigwigs assembled at the White House last May know that there are dark forces under the frothy surface of Chinese economic life. They've lived with them. But they reason that keeping China out of the world trading system would only aggravate matters. It would play "into the hands of those against banking and state-enterprise reform," argues Johnson. "Of course, China's banking problems must be addressed by China. But by joining the WTO, assistance will also be given along the way so that China can meet its commitments." That's the hope. The fear is that until China does the heavy lifting it needs to do to stabilize its financial institutions, the heady promises it gave to Citigroup are likely to remain just that. Promises.

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