Big Banks Vow to Buy More Local Government Bonds

* Banks’ pledges to buy more local government bonds come as the country’s policymakers are introducing measures to inject liquidity into the interbank market to support economic growth

* Banking regulators have not confirmed whether they will allow the risk weighting of banks' local government bond holdings to be reduced to zero from the current 20%

(Beijing) — China’s big state-owned banks have pledged to buy more local government bonds despite uncertainty about whether a reported incentive to grant them risk-free status will take effect.

China Construction Bank Corp. said that it has already increased its holdings of local government bonds, and will buy more as it sees fit over the next half-year. Bank of China Ltd. and Bank of Communications Co. Ltd. have also promised to boost purchases of local government bonds.

The banks’ pledges to buy more local government bonds came at a time when the country’s policymakers have eased off a campaign to deleverage the financial sector, introducing measures to inject liquidity into the interbank market to support economic growth.

Along those lines, Beijing has been pushing local authorities to speed up the sale of special-purpose government bonds to finance spending on infrastructure projects.

Unlike local government bonds, which are paid back with general fiscal revenue, special-purpose bonds are repaid by income from projects they fund, which include government land and toll-road projects.

China created special-purpose bonds in 2015 to reduce local government reliance on the opaque “shadow banking” sector for financing and to get local government debt under control.

The Ministry of Finance set this year’s quota for special-purpose bond issuances at 1.35 trillion yuan ($197.7 billion), a 69% increase over last year’s 800 billion yuan. The Ministry of Finance has ordered local governments to use up to 80% of their quotas by the end of September, and the rest by the end of October.

Banking regulators have not confirmed whether they will allow the risk weighting of bank’s local government bond holdings to be reduced to zero from the current 20%. For banks, local government bonds would suddenly be deemed as safe as the risk-free 10-year Chinese government bond. The change would make local government bonds very attractive because it would allow banks to hold the bonds without having to set aside any extra capital as a cushion against losses. Such requirements exist to protect depositors and ensure banks stay solvent.

There has been a wide range of reactions to the news of the potential regulatory change, which the China Securities Journal first reported on Aug. 21.

Some sources close to the regulators told Caixin that local debt will be weighted risk-free for the simple reason that local governments will not be allowed to go bankrupt. The worst-case scenario would be a transfer of government debt, presumably from the local governments to the central government.

Because the change to a risk-free weighting is controversial, the matter is unlikely to be settled soon, a person familiar with the issuance of local government bonds told Caixin.

It is possible that regulators will relax the policies for regulating local government bonds in order to allow local governments to spend more, a decision-maker at one major bank told Caixin. However, it remains uncertain whether changing the risk weighting for local government bonds will be the way that regulators ultimately decide to relax policy.

Contact reporter Charlotte Yang (yutingyang@caixin.com)