Mainland banks seen safe from yuan fallout

PUBLISHED : Monday, 25 July, 2005, 12:00am
UPDATED : Monday, 25 July, 2005, 12:00am

Access to range of hedging instruments tipped to shield lenders from forex risks

The yuan's slight appreciation against the US dollar on Thursday will not immediately dent the operations and capitalisation of mainland banks, analysts say. But they say the banks eventually will feel the pain unless they gain access to a broader range of hedging instruments to ward off currency risks.

The switch from a US dollar peg to a managed float based on a basket of currencies drove the yuan up 2.1 per cent against the greenback - effectively marking the first revaluation of the yuan in 11 years.

Analysts do not expect the yuan's rise to hurt mainland banks seriously, as they have typically only a fraction of their assets in foreign currencies.

Bank of China (BOC), the country's largest foreign-exchange lender, is a noticeable exception with about 45 per cent of its assets - most of it attributable to its Hong Kong unit - denominated in foreign currencies.

Mainland banks are required to keep outstanding foreign currency loans at less than 85 per cent of outstanding foreign currency deposits, enabling them to absorb losses from non-loan foreign currency assets, international ratings agency Standard & Poor's (S&P) noted.

On the whole, the banks' foreign currency assets and liabilities are matched, analysts said.

But the revaluation will have an immediate impact on the capital ratios of three of the Big Four state banks - BOC, China Construction Bank and the Industrial & Commercial Bank of China - which together received US$60 billion cash infusion from the state since late 2003 to recapitalise themselves.

It is understood the banks must keep the cash injections in US Treasury securities and may not trade them for securities in other currencies or convert them into cash.

As a result of the revaluation, the three could suffer a 'manageable' maximum currency loss of 9.6 billion yuan, S&P said.

'We've estimated that even a larger, 10 per cent revaluation will not have a huge impact on the banks' capital ratios,' said May Yan Meizhi, an analyst at Moody's.

The three banks are expected this week to announce that they have taken measures to hedge the cash injections' currency risk as required by the government.

'The impact of the revaluation on China's business environment and wider economy will probably be more important for the country's banks than the immediate financial impact on the banks themselves,' S&P credit analyst Ryan Tsang wrote in note.

S&P said borrowers whose incomes were largely denominated in foreign currency, particularly US dollars, and whose costs and liabilities were in yuan would most likely feel some pain if their foreign-currency exposure was not hedged.

Morgan Stanley economist Andy Xie Guozhong expected the 2 per cent revaluation to squeeze the export sector's already thin margin by 10 per cent to 20 per cent.

Mr Tsang said the indirect impact on banks could be cushioned by borrowers' ability to pass on currency losses to customers.

Both bank officials and analysts expect the revaluation to present a new business opportunity to mainland banks that are traditionally over-reliant on interest income.

'We believe banks may generally benefit from the increase in fee income, as corporates may need more foreign exchange services to hedge risks or speculate in a more market-oriented foreign exchange market,' investment bank Goldman Sachs said in a research note.

For the longer term, banks may need to strengthen their currency risk management. 'The main issue is they don't have the necessary instruments to do so,' Ms Yan said.

Mainland banks are banned from hedging currency risks with other instruments, such as currency options. It is unclear whether they are allowed to engage in large active trading in the offshore currency forward market.