Caixin View: Banks’ New Fundraising Tool Won’t Help Cash-Starved Firms

* Get ready for a deluge of perpetual bonds issuances as banks use the new debt instrument to strengthen their balance sheets

* But don’t expect banks to squander their new-found lending resources on the private sector – the old obstacles to lending are still very much in place

China’s banks are stuck between a rock and a hard place. Amid an ongoing crackdown on financial risks, they’ve been forced to bring shadowy off-balance sheet debts back onto their books. And, as China’s economic growth slows, they’re also under huge regulatory pressure to lend more to credit-starved parts of the real economy, particularly small and privately owned firms. These factors are putting pressure on banks’ capital adequacy ratios (CARs) — a measure of how well banks can absorb losses and that is calculated by comparing the amount of capital they hold with their risk-weighted assets. Riskier loans to small companies require more capital to be held and thus put extra pressure on CARs — this was a major reason for banks’ reliance on off-balance sheet financing in the first place. But partly because of the pressure to boost this type of lending, banks have to raise extra capital to strengthen their balance sheets in order to have the ability to make the extra provisioning required on higher-risk lending.

Under current domestic regulations, which differ from those set out in the Basel III global banking framework, lenders must have a CAR of at least 10.5%, and a CAR for core Tier 1 capital of at least 7.5%, while systemically important banks’ requirements are 8.5% and 11.5% respectively. At the end of September, the average CAR of China’s banks was 13.8% and their average Tier 1 CAR was 10.8%, both marginally higher than a year earlier, according to data from the banking regulator. But the International Monetary Fund, among others, has called for China’s banks to increase their capital buffers, citing rapidly rising levels of debt. Uncertainty about how well official figures reflect banks’ actual lending also complicates the picture.

Raising extra capital is especially important for China’s so-called Big Four state-owned lenders, which have been identified by the international Financial Stability Board (FSB) as global systemically important banks. These four alone will need some 2.85 trillion yuan ($422.98 billion) more than they currently have to meet the Basel III requirements by 2025, Moody’s Investors Service has estimated.

In July, we said that more measures to help banks replenish their capital would be a likely focus for policymakers and they’ve come thick and fast over the last few weeks. At the end of December, the cabinet-level Financial and Stability and Development Committee gave the final go-ahead for banks to issue perpetual bonds, debt instruments with no fixed maturity, to shore up Tier-1 capital. Then last week financial regulators announced two measures to boost the attractiveness of perpetual bonds both for the banks issuing them and for buyers, the big financial institutions, by offering ways to trade them.

● the People’s Bank of China (PBOC) announced that it would allow perpetual bonds held by primary dealers in its daily open market operations to be swapped for central bank bills that can be used as collateral to borrow from the PBOC and other financial institutions. They can also be used as collateral for longer-term loans from the PBOC via tools such as the Medium-term Lending Facility.

● the China Banking and Insurance Regulatory Commission allowed insurance companies to buy perpetual bonds and Tier 2 capital bonds issued by certain banks

With everything in place, Bank of China, one of the Big Four, kicked off what’s likely to be a deluge of perpetual bond offerings, selling 40 billion yuan ($5.92 billion) of the securities at an interest rate of 4.5%. The issue could increase its Tier 1 capital adequacy ratio by 0.3 percentage points, according to a statement from the PBOC.

Perpetual bonds will be a big help to banks in bolstering their balance sheets, and with a bigger capital cushion it will give them some incentive and additional funding to increase lending to the real economy, as the government is demanding.

However, given the pressure to control risks banks won’t want to throw that funding away, and consequently, the smaller, most credit-starved firms are unlikely to see a significant benefit. That’s because, as we have pointed out before, even to a bank with better capital buffers, many of these firms are simply not good investment. Some companies simply lack the necessary collateral to get loans. Consequently, as long as deleveraging and reducing financial risks remain policy priorities, banks have little incentive to lend to these companies.

Calendar

Jan. 30-31: Vice Premier Liu He visits the U.S. for consultations on Sino-U.S. economic and trade issues

Jan. 31: National Bureau of Statistics releases manufacturing Purchasing Managers Index (PMI), nonmanufacturing PMI, and Composite PMI Output Index for January

Feb. 1: Caixin releases Caixin China General Manufacturing PMI for January

Feb. 3: Caixin releases Caixin China General Services PMI and Caixin China Composite PMI for January