Banks risk losses on billions of yuan in bonds
With rate rises imminent, the values of the assets are sinking
Everyone knows that Chinese banks hold billions of yuan in non-performing loans. But another category of poor-quality paper is also lurking like a time-bomb in their balance sheets: low-performing bonds.
As at the end of April, China's state banks held 2.7 trillion yuan in long- and medium-term low-interest bonds, whose value is plunging on the prospect of higher interest rates this year and next. These bonds, mostly treasury bills, account for more than 10 per cent of the assets held by the Big Four state banks, three policy banks and 122 commercial banks.
As of the end of last year, China Merchants Bank had amassed 30 billion yuan of medium- and long-term bonds bearing interest of less than 4 per cent.
China Minsheng Bank held nearly 10 billion yuan of bonds at less than 3 per cent.
The bond market has turned sharply bearish this year.
On May 27, the treasury market index closed at 93.8, down from 97.6 on April 1 and 104.1 on September 29 last year.
The value of the second tranche of 30-year bonds issued by the Finance Ministry in 2002, for example, has fallen to about 70 yuan this year, against its face value of 100 yuan. Bond values are sinking on the risk that interest rates will rise over the next two to three years as the central bank tries to cool the economy and curb inflation.
Banks will have to pay depositors rates higher than those they receive from the bonds, while open-market bond prices will be substantially lower than par value.
If interest rates start to rise from current levels, the banks will have two options. They can hold the bonds, which will enable them to avoid booking losses but will cost them the opportunity of lending the money out at higher interest rates. Or they can obtain the money they need for lending by selling the bonds, realising huge losses in the process.
Chinese commercial banks were castigated for their bond buying by no less a personage than Zhou Xiaochuan, governor of the central bank, who told a seminar in Beijing on May 21 that they had showed astonishing ignorance of interest-rate risk.
'We are no longer in a planned economy, but in a market economy,' Mr Zhou said. 'Cycles are inevitable. In a market economy, you must make your own judgments.
'We cannot criticise an ordinary person [for misjudging the interest-rate cycle]. But the big banks have their own research. Despite that, they have bought huge amounts of low-interest bonds, which exposes the inadequacy of their long-term risk evaluation.'
As the banks see it, Mr Zhou's critique is too simplistic and ignores the role the government has played in recent years.
They argue that their bond purchases were in large part compulsory, as the state cranked out bonds as if it were printing currency over the past six years.
Since 1998, the Finance Ministry has each year issued a progressively higher volume of treasury bonds, including 91 billion yuan in long-term construction bonds, to finance infrastructure projects and curb a bulging budget deficit.
The ministry has calculated that these construction bonds contributed to between 1.5 and two percentage points of GDP growth each year.
The state banks have been the principal buyers of these bonds. Before 2001, only the banks could buy them, notes Wei Qi, an analyst at Hua Xia Securities.