Basel III more meaningful at home than globally for Chinese banks
BOC set to lead wave of share issues to boost capital amid doubts over threat to global risk
Bank of China is set to issue its first tranche of Basel III-compliant preferred shares, the beginning of what is set to be a wave of similar issuances from mainland banks worth about 310 billion yuan (HK$392.3 billion).
More banks, and other state firms, are expected to enter the market with the hybrid securities that were introduced by mainland regulators in April.
For the banks, the goal of issuing the shares is to boost capital adequacy to match the third round of international banking standards known as the Basel accords. During the interim reporting season in August, mainland banks stressed their progress in meeting Basel III deadlines, in 2018 and 2019.
Basel III was instituted in the wake of the global financial crisis with the hope of stemming the next systemic meltdown.
But experts are asking why China is being drawn into a scheme that is explicitly meant to counteract systemic risk in the global financial arena.
Mainland banks are big - by assets, the biggest in the world. They are also connected through their off-balance-sheet lending practices to great levels of systemic risk. But the banks' risks are not global.
Mainland banking risk is concentrated in commercial and retail capital, says Bradley Ziff, a senior risk adviser at financial software firm Misys.
That is a stark contrast to the huge capital markets, rates and derivatives businesses that global banks such as Bank of America, HSBC or JP Morgan are running across the globe, the primary targets of Basel.
"It's a question of, do the banks in China need to meet Basel from a governance perspective, or is there really a requirement to post that capital because they pose a series of globally systemic risks? The answer to the latter question is probably no," Ziff said.
The real role for Basel in China is at home. And that is revealing some major contradictions in government financial planning.
Basel became relevant in China when it launched a 4 trillion yuan stimulus package in 2009 in response to the global financial crisis.
For mainland regulators, the increased capital adequacy ratios are a means of counteracting the growth-spurring wave of spending that followed that stimulus package, says Standard Chartered bank analyst Dorris Chen. Banks will have to think twice about lending to risky projects that drain capital with little promise of return.
Basel also introduced a cost-sharing function for the risks associated with this massive expansion of the banking sector. That is where the preferred shares come in. In order to meet the levels of capital adequacy, banks are going to the market for recapitalisation, a sign that the central government is unwilling to back major bailouts alone.
The assets of mainland commercial banks ballooned from 48 trillion yuan in 2007 to 122 trillion yuan in 2012, according to data from CLSA, almost four times the size of the assets in all other mainland financial institutions combined.
"We're coming from a time when the government bails out everything," Chen said. "There are other things the government will need to spend on in the future and they don't want to have to bail out the banks. They want the market to get involved in this."
Ultimately, Basel III on the mainland reflects one of the government's greatest contradictions: its desire to slow investment-driven growth while still striving to meet high gross domestic product targets.
In part, Chen said, the book-constraining function of Basel III had helped give rise to banks' creative off-the-book lending business – the shadow banking industry that Moody’s estimates was worth 37.7 trillion yuan at the end of last year – as a means to circumvent tougher capital requirements.
As bank lending to loss-making projects slows, shadow banking soared to 66 per cent of mainland GDP at the end of last year, according to Moody's Investors Service, playing no small role in hitting the growth targets the government cannot bear to part with yet.
