As ‘Big Four’ Banks’ Capital Dwindles, Regulator to OK Perpetual Bonds

The top financial regulator plans to soon allow banks to issue perpetual bonds, its latest measure to expand the banks’ fundraising toolbox. The move is set to help Chinese banks, particularly the “Big Four,” meet capital requirements set under international standards.

In a Wednesday statement (link in Chinese) released on the central bank’s website, the cabinet-level Financial Stability and Development Committee (FSDC) said it’s researching measures to help banks replenish capital, including the issuance of perpetual bonds, as soon as possible.

The push for perpetual bonds — a type of security that doesn’t have a fixed maturity and can make interest payments to investors forever if needed — aims to tackle the challenge of China’s four global systemically important banks (G-SIBs) meeting their total loss-absorbing capacity (TLAC) capital requirement, a source close to the cabinet-level committee told Caixin.

The TLAC requirement was outlined by the Financial Stability Board (FSB) — an international body that makes recommendations for the global financial system and identifies G-SIBs — as a bottom line of risk buffers in case “too big to fail” financial institutions go bankrupt. In China, this capital requirement is currently applied only to the Big Four state-owned commercial banks — Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, and Bank of China. Fitch Ratings predicts that Bank of Communication is likely to be labeled a G-SIB within the next two years.

The central bank is still drafting detailed rules on perpetual bonds’ interest payments, terms, and other issuance conditions, according to the FSDC source. So far, no Chinese bank has issued perpetual bonds, and it’s unclear whether any banks other than the Big Four will be allowed to issue such bonds.

When the detailed rules are finally hammered out, Bank of China is likely to be among the first to actually issue perpetual bonds, as its board gave its stamp of approval to such an issuance earlier this year.

Many Chinese banks are running low on capital after a national deleveraging campaign required them to set aside greater amounts of capital to hedge their off-balance-sheet assets, and at the same time they have used a lot of capital to dispose of their mounting bad debts.

The shortage is particularly pressing for the country’s Big Four as the FSB requires them to meet the minimum TLAC requirement by 2025. To meet the minimum TLAC level, the four banks need 2.85 trillion yuan ($413.5 million) more than they have now, Moody’s Investors Service estimated.

It’s also likely that they will be trying to meet the requirement three years ahead of schedule, as it is predicted that China’s outstanding financial and nonfinancial corporate bonds will hit 55% of the country’s gross domestic product by 2022. This ratio is a trigger set by the FSB for the TLAC rules to kick in.

To achieve this replenishment of capital, banks have used preferred shares, private placements, convertible bonds that allow holders to convert debt into equity for fixed terms, and other instruments. Yet the restricted toolbox and limited scope of investors available have hamstrung efforts.

The central bank has been looking into perpetual bond issuance since 2016, Caixin has learned. However the current situation has led to regulators’ accelerating the process, with a report issued by the central bank this year encouraging the banking watchdog to quickly define which bonds can be used to meet the TLAC requirement.

Bond issuance aside, banks might also need to readjust their respective business structures to cope with the requirement, analysts say.

The G-SIBs’ strategy for meeting the TLAC requirement may include scaling back their business volume, securitizing assets, and bringing forward plans for introducing more instruments for capital replenishment, said Grace Wu, a Hong Kong-based banking analyst with Fitch Ratings, in a report last month. “We also expect more offshore capital issuance from Chinese banks, though attracting offshore investors could require greater transparency.”

“The key issue to ease banks’ pressure on capital replenishing is a change to their business and development model,” said Qu Xiangjun, a senior global managing partner at McKinsey & Co. Ltd., on a media panel Wednesday. “Banks must increase the efficiency of capital use to generate more profits, and tap into business that consumes less capital. Otherwise, replenishing funds will be an endless cycle.”

Contact reporter Leng Cheng (chengleng@caixin.com)