China plans to tighten capital requirements for banks, threatening to curb the record lending that’s fueled a 60 per cent rally in the nation’s stock market, three people familiar with the matter said.
The China Banking Regulatory Commission sent draft rule changes to banks on August 19 requiring them to deduct all existing holdings of subordinated and hybrid debt sold by other lenders from supplementary capital, said the people, who have seen the document. Banks have until August 25 to give feedback, said the people, declining to be named as the matter is private.
As a result, banks may need to rein in lending or sell shares to lift capital adequacy ratios to the 12 per cent minimum. Chinese stocks briefly entered a so-called bear market this week on concern the government would stymie new loans that exceeded $1 trillion in the first half.
A news department official at the regulator declined to comment by phone and didn’t immediately respond to a faxed inquiry.
“This move will cut one of the most important funding sources for banks,” said Sheng Nan, an analyst at UOB Kayhian Investment Co in Shanghai. Banks will “have to either raise more equity capital or slow down lending and other capital consuming businesses to stay afloat.”
Hong Kong’s Hang Seng Index slid 0.6 per cent at the 4.00 pm close, after having risen as much as 0.5 per cent. China’s benchmark Shanghai Composite Index rose 1.7 per cent to close at 2960.77, paring earlier gains of as much as 2 per cent.
China’s banks have sold 236.7 billion yuan ($34.6 billion) of subordinated bonds so far this year, almost triple the amount issued during all of 2008.
The banking regulator estimates about half of the subordinated bonds in circulation are cross-held among banks.
“We understand the regulator’s concerns about the proportion of subordinated debt,” Shenzhen Development Bank Co Chairman Frank Newman said on an earnings conference call today. The bank hopes that any new rules are applied only to future debt sales, Newman said.
The subordinated debt sales came as new loans rose to a record 7.37 trillion yuan in the first half. Lending in July fell to less than a quarter of June’s level. About 1.16 trillion yuan of loans were invested in stocks in the first five months of this year, China Business News reported on June 29, citing Wei Jianing, a deputy director at the Development and Research Center under the State Council, China’s cabinet.
“I’m worried about a correction in a market that has been driven by cheap money,” Devan Kaloo, who oversees $11.5 billion as head of global emerging markets at Aberdeen Asset Management Ltd, said August 19.
The Shanghai Composite Index almost doubled during the first seven months of this year through August 4, after falling 65 per cent in 2008. Since reaching this year’s high on August 4, it’s plummeted 15 per cent.
The index on August 19 briefly fell 20 per cent from this year’s high, the threshold for a bear market, before ending the day down 19.8 per cent.
The gauge rebounded yesterday, rising 4.5 per cent.
The weighted average capital adequacy ratio of 205 commercial Chinese banks at the end of 2008 was 12 per cent, up 3.7 percentage points from a year earlier, according to the industry’s annual report. The weighting was strongly affected by the nation’s five-largest banks, which account for 52 per cent of assets in the industry.
The banking regulator has indicated it’s concerned about excessive credit creation. Last month, the commission ordered lenders to raise reserves against non-performing loans, to ensure loans for fixed asset investments go to projects that support the real economy and announced plans to tighten rules on working capital loans.
Banks are allowed to count subordinated bonds they sell as supplementary or lower-Tier 2 capital. In the event of bankruptcy, holders of subordinated notes receive payment only after other debt claims are paid in full.
The regulator’s rule change requires banks to subtract all existing holdings of subordinate bonds issued by other lenders from their own subordinated bonds being counted as supplementary capital. The Wall Street Journal and Reuters reported earlier that the regulator was considering this measure.
In addition, the new rules also limit the amount of subordinated or hybrid bonds banks can hold, the people said. A bank’s holding of subordinated and hybrid bonds issued by a single bank can’t exceed 15 per cent of its core capital, the people said. Holdings of all subordinate and hybrid bonds issued by banks can’t exceed 20 per cent of core capital.
The regulator has called on small publicly traded banks to have a minimum capital adequacy ratio of 12 per cent by year’s end, up from the current 10 per cent. The ratio, a measure of how much in losses a bank can absorb, is calculated by dividing capital by risk-weighted assets. A bank’s risk-weighted assets are comprised partly of loans.
After deducting subordinated bonds issued by other banks, lenders must either raise core capital or reduce their loans to meet the capital adequacy ratio requirements.
“It’ll be hard for commercial banks to sell subordinate bonds because much of the debt is sold to their counterparts,” said Xu Xiaoqing, a bond analyst at China International Capital Corp in Beijing. “This rule would tighten lending by commercial banks, especially small and medium sized banks that have relatively less capital.”
