Barely has the ink dried on the announcements that April’s inflation rate had come in at a higher than expected 5.3% and that China’s trade surplus has surged again, than the central bank has announced that commercial banks’ reserve ratio requirementswill be raised for the eighth time since last October by 50 basis points from May 18. This latest dab of the liquidity sponge will lift the capital reserve ratio to 21% for the largest banks. With capital inflows still running strongly, we doubt that this will be anything like the last round of tightening/sterilization despite the resumption of the central bank’s sales of 3-year bills and a hefty 50 billion yuan ($7.7 billion) auction of 3-month bills.
Tag Archives: capital adequacy
As the 11th National Committee of the Chinese People’s Political Consultative Conference, the country’s top political advisory body, meets in Beijing to ratify a new five-year plan to rebalance the economy and to tackle inflation and rising property prices, two comments from western China illustrate the Morton’s fork China’s economic policymakers find themselves somewhat uncomfortably stuck by.
The first occurred at a recent meeting of regional managers from one of the large state-owned banks. A manager from Xinjiang, we are told, complained that credit quotas imposed by the banking regulators were constantly tightening in the cause of the national fight against inflation, making his bank’s branches unable to meet the local demand for loans, demand that was rising because of the development priority now been accorded to the region by Beijing.
The central bank is repeatedly dabbing up as much of the excess liquidity in the economy as it can through interest-rate hikes, higher capital reserves requirements on banks and administrative measures such as new-loan quotas. The goal is to dampen inflation and to let down the asset bubbles inflated by the lending spree triggered by the post-global-financial-crisis stimulus.
Yet it is precisely through fixed-asset investment that the government has been able to deliver the constant economic growth that the Party sees as essential to legitimize its monopoly on power. The second comment, from Xinjiang regional chairman Nur Bakeri just this week, spells out how raising living standards through economic development is key to maintaining social stability. “Development is our top priority and stability is our greatest responsibility. Without development, there would be no stability and vice versa,” he said.
Such local political pressures lie behind not just the continued pace of new bank lending this year, but also the discovery in February by the banks’ regulator, China Banking Regulatory Commission (CBRC), that more than half of new bank lending wasn’t meeting its new credit rules designed to mitigate the fear that China’s banks are sitting on a potential dung heap of bad loans. The rules require banks to meet tougher credit and risk standards with new loans. As far as the banks are concerned it is a case of old habits die hard. For years and years and years, China’s growth has been fueled by fixed asset investment financed through government-directed bank lending. Flash the cash and the devil take the hindmost.
Beijing had to bail out the big banks once to cleanse their loan books. After a couple of years of stimulus fueled record lending, it worries it may have to do so again. The recent turn to the capital markets by the big four state-owned banks has been in part to replenish threadbare capital cushions.
The CBRC has recently read the riot act to the banks for their continued lax lending. More detailed — for which read, stricter — regulations on things like capital adequacy and leverage ratios are likely to be announced later this month or early next, once the horse trading between the regulators, the industry and the myriad of official agencies with an oar to shove in to in these particular waters, has been completed. These will bring China broadly in line with international standards, and in some cases be much tougher.
They won’t completely mitigate the regulators’ darkest fears about bad loans. The CBRC is still acutely concerned about banks’ lending to the captive investment vehicles of local governments intended to get round restrictions on direct capital raising from banks. Banks had lent at least $1.2 trillion this way to local governments as of June 30th, with 23% not backed by cash flows. The CBRC’s new rules in February were particularly tough in this regard, as they were for real-estate lending. As we noted earlier, regulators have reportedly told banks to recalculate their capital levels using higher risk weightings for their loans to local governments via captive investment vehicles. It will be a nervous-making wait for the results. As the finance ministry noted in its budget report, “local governments face debt risks that cannot be overlooked”.
How much the Party can risk slowing down the economy to minimize the risk of a hard landing if bubbles go pop and yet still keep real living standards rising is the calculation that now has to be made in Beijing. Late last month Prime Minister Wen Jiabao set an expectation that annual growth rates will slow. He said the government would target 7% annual GDP growth for 2011-15, though it wasn’t so long ago that growth of 8% a year was said necessary to generate sufficient jobs to absorb new workers coming onto the labor market and thus ensure social stability. Diverting GDP growth into social services and income-tax cuts to offset the effects of inflation is now seen as a greater guarantor of stability than providing jobs, it appears, to a government that is seemingly increasingly if unnecessarily rattled as it enters a period of economic, political and foreign-policy transition.
China’s central bank is acknowledging a badly kept secret, that it is applying different capital reserve requirements to different banks. Xinhua reports that 40 regional banks with low capital adequacy ratios, rapid lending growth and a high risk loan book have been the subject of individually differentiated reserve requirements.
Capital reserve requirements are one of the main tools used by the central bank to mop up the inflation-driving excess liquidity in the economy. Last week, there was a further 0.5 percentage points rise in the benchmark ratio, the eighth increase since the beginning of last year. Large banks are now required to maintain capital ratios of 19.5%. Small and mid-sized banks will have to set aside upwards of 16% of their deposits as reserves, Xinhua says. Some banks are already said to have had a 20% ratio imposed.
Meanwhile, Bloomberg reports that regulators have told banks to recalculate their capital levels using higher risk weightings for their loans to local governments via captive investment vehicles used to get round restrictions on raising capital from banks directly. We have noted the risks inherent in these before. Banks had lent at least $1.2 trillion this way to local governments as of June 30th, with 23% not backed by cash flows. It is these latter loans that particularly concern regulators and to which the highest new risk weightings, 300%, will be applied.
No official word on any of this that we’ve seen, but Bloomberg says the deadline for recalculation is March 31st, and it could reduce the capital ratios of the country’s five biggest lenders to near the regulatory minimum. Last year, authorities cracked down on such lending after a surge fueled concern that it could lead to a wave of defaults that could rock the banking system.
China’s anti-inflation ratchet is clicking ever more frequently. The People’s Bank of China is again raising banks’ capital reserve-ratios. An increase of half a percentage point will come into effect on February 24th, taking the ratio to 19.5% for most large banks, and 20% for some.
It is the second time this year that the reserve ratio has been raised and eighth time over the past two years. It follows an increase in benchmark interest rates earlier this month (the third since the central bank started raising rates last October) and a January consumer price inflation number, 4.9%, which dashed any lingering hopes that inflation had peaked last November.
The central bank has been struggling to drain off the excess liquidity in the system. New bank lending in January was 1.04 billion yuan ($158 billion). The early months of the year tend to see a surge in new lending as banks clear their backlog of applications held from the previous month so they could stay in touch with their annual lending quota. But on top of the growing trade surplus swelling China’s foreign-exchange reserves and the yuan not appreciating that quickly to compensate, this means the central bank is facing an uphill battle to sterilize all those funds. We expect the click-click of the ratchet to continue.
More evidence of the growing concern about inflation among China’s economic policymakers. The People’s Bank of China announced another rise in the reserve requirements for banks only hours after word of October’s larger than forecast trade surplus, at $27.1 billion. A 0.5% increase to 18% will come into effect on Nov. 16.
This is a move to drain liquidity from the system more than one to fatten the banks’ cushion against bad debts. Inflation in October is thought to have hit 4% year-on-year, a two year high. Few officials now expect the full-year number to come in anything but above the 3% target. Hot money from investors speculating on the yuan’s revaluation, foreign exchange reserves that now top $2.6 trillion and the side wash from quantitative easing elsewhere all risk reinflating the asset bubbles that the central bank has been working hard to let down without mishap.
Liquidity management has forced itself to the center of the central bank’s policy concerns. While this was the fourth rise in reserve ratios this year, we believe a further rise in benchmark interest rates to follow last month’s surprise increase, the first in nearly three years, is also likely sooner rather than later.
China Construction Bank, one of the two of the big four state-owned banks that fell below the regulators’ required capital adequacy ratios in March, is scaling back its rights issue to 61.7 billion yuan ($9.2 billion) from the originally proposed 75 billion yuan. The bank has just got regulatory approval to go ahead with the capital raising in Shanghai and Hong Kong. China’s big banks have been arm-twisted into raising new capital to shore up their balance sheets and meet new capital adequacy ratios as Beijing frets about possible bad debts coming back to haunt them after the stimulus-fed new lending spree of the past two years. The modest scaling back of the rights issue and record quarterly earnings announced last week by the largest state-owned banks suggest such anxieties may be easing, if only a tad. The great unknown remains what bad debt lurks in the unregulated underground banking system that operates at the county and city level and where as much as 20% of the loan assets of China’s banks lie.
The great shoring up of China’s state-run banks continues with Bank of China’s announcement that it is seeking to raise 60 billion yuan ($8.9 billion) of new capital through a shares issue in Shanghai and Hong Kong. This follows the $5.9 billion that the bank, the country’s fourth largest lender, raised via convertible bonds last month. Bank of China was one of two of the four big state-run banks (China Construction Bank was the other) that fell below the regulators required capital adequacy ratio in March,
Agricultural Bank of China, the no 3 lender, is looking to raise $23 billion through what would be the world’s largest initial public offering (final pricing due on Tuesday). ICBC and China Construction Bank, the two biggest lenders, have also said they plan to raise new capital.
We hear that institutional investors have modestly oversubscribed their part of the Agricultural Bank’s issue, unlike the manic demand that surrounded the last round of Chinese state-bank capital raising in 2006. They are not alone in their nervousness. In May the state council reduced its targets for the big four’s capital raising to a total of 287 billion yuan, down from the original 331 billion yuan seen a necessary to boost the banks’ balance sheets following the record lending undertaken over the past couple of years as part of the government’s stimulus program.
Quite how many bad loans will turn out to be sitting in those swollen loan books is the million dollar question. With as much as 20% of the loan assets of China’s banks now sitting in the unregulated underground banking system that operates at the county and city level, often hand in glove with local officials, we may not know until it is too late.