THE STIMULUS APPLIED to restore the economy post-pandemic has done nothing to lessen the fragility of an overleveraged financial system. If anything, Covid-19 has slowed the drive to reduce the debt overhang in the banking system.
Authorities have now issued long-awaited draft rules to ensure the capital adequacy of its global systemically important banks (G-SIBs, or those ‘too big to fail’).
The regulations from The People’s Bank of China and the China Banking and Insurance Regulatory Commission (CBIRC) stipulate that from the start of 2025, G-SIBs must be able to absorb losses of at least 16% of their risk-weighted assets, or at least 6% of their total exposures. From 2028, those ratios increase to at least 18% and 6.75%, respectively.
The four biggest state-owned commercial banks are listed as G-SIBS by the Financial Stability Board (FSB), the G20 body set up after the 2008 global financial crisis to monitor the global financial system. They are Bank of China; Industrial and Commercial Bank of China, Agricultural Bank of China and China Construction Bank.
The credit rating agency S&P said last month that the quartet fell short of the capital requirement by 2.25 trillion yuan ($330 billion) as of the end of 2019 and that without raising further capital would be around 6 trillion yuan adrift by 2024. The draft rules will be out for public comment until October 30.
Several regional banks have required bailouts, including Bank of Jinzhou, Hengfeng Bank and most notably Baoshang Bank, which has been allowed to fail, the first Chinese bank to do so in decades.
A national plan was drawn up in May to speed up capital replenishment across the banking system and to put in place the necessary bulwarks against a potential systemic banking collapse by giving central government more coordinating power over provincial-level and below supervision of such actions. Local governments will bear the brunt of the financial burden of recapitalising the banking sector as they own or control either directly or through local SOEs and investment holding companies hundreds of the weakest lenders.
Earlier this year, CBIRC’s vice chairman, Zhou Liang, said that 4,000 of the country’s 4,600 licensed banking institutions were small and midsize banks that together accounted for about a quarter of the sector’s total assets. More than 600 of them are undercapitalised, and more than 500 characterised as of ‘high risk”. That is mainly the result of a combination of lax oversight, poor or policy-driven lending decisions and corruption.
Forced provincial-level mergers of weaker banks are likely, along lines already seen in Shanxi and Sichuan.
Assuming any local political obstacles to restructuring can be removed, there will remain the need to inject better corporate governance, lending standards, risk management and accountability into banks. Whether local authorities have the capacity and expertise, let alone the financial wherewithal to do that is another question. On the last, Beijing is allowing local governments to use 5% of this year’s 3.75 trillion yuan quota of special-purpose bonds for bank recapitalisation.
However, that also raises questions of how far public funds should be used for bank bailouts, as that potentially shuffles where the risk lies rather than reduces it. The same argument can be made about suggestions that the sovereign wealth funds’ investment arm, Central Huijin Investment, should take stakes in financial institutions in need of repair, as it has already done in the recapitalisation of Hengfeng Bank.
The bigger bullet to bite is whether more insolvent banks should be allowed to go bust, although the stalled bankruptcy law for financial institutions needs to become law first.