Banking & Finance

China banks face instability on shake-up of funding base

Global regulation ropes in Chinese banks for a capital raise of up to US$400 billion

PUBLISHED : Thursday, 12 November, 2015, 7:04pm
UPDATED : Thursday, 12 November, 2015, 9:54pm

In the drive to bailout-proof the banking system for taxpayers, global regulators could usher in new instability to China’s banking sector by pushing them to diversify their funding bases, experts say.

The Financial Stability Board, a global banking oversight body hosted by the Bank for International Settlements, issued its final rules this week for Total Loss Absorbing Capacity, or TLAC. The rules have been called the final step in Basel III regulation and will ask the world’s 30 biggest banks to raise substantial capital buffers to protect taxpayers from paying for a failed bank.

READ MORE: China Construction Bank joins global list of systemically risky banks

Until this week, many industry watchers believed the FSB would initially exclude emerging-market banks from the rules. Instead, that short list of banks, including China’s four biggest lenders, have been given until 2025 to hit the first deadline.

The announcement marks the first time that China has been given a countdown on meeting the requirements. Experts expect that TLAC could force a fundamental shift to the funding base at China’s banks over the next decade, a change that could lead to instability.

“It doesn’t really benefit the system from a financial stability perspective,” said Liao Qiang, senior director of financial institutions at Standard & Poor’s ratings Services in Beijing. “At the end of the day, this is supposed to enhance stability, not take away from it.”

One of the main concerns was the introduction of market sensitivities to the banks’ funding mix.

The structural strength of China’s biggest banks have been their vast deposit franchises, which have provided stable and cheap funding for the lenders.

Bringing in market-driven debt products of up to 10 per cent of the funding base would leave the banks far more sensitive to investor sentiment, Liao said. The funding would also be more expensive than the cost of artificially low deposit rates the banks have appreciated for decades.

The rules apply to what the FSB calls Globally Systemically Important Banks, or GSIBs. The majority hail from developed markets and must post a minimum TLAC level of 16 per cent of their risk-weighted assets starting 2019. The level jumps to 18 per cent in 2022. Emerging-market banks will be required to meet those same requirements in 2025 and 2028.

Asset deterioration at China’s banks will also create a hurdle for implementing TLAC, said Wang Jun, a senior regulatory intelligence expert at Wolters Kluwer Financial Services in Shanghai.

As bad debt rises across the board for Chinese lenders, the risk weighting on assets increases too, and diminishing net profits create a wider gap for the TLAC capital to cover.

“It’s a big challenge to the asset-liability management of the banks,” Wang said. “If they can’t control asset quality then TLAC will be difficult to implement.”

Non-performing loans (NPL) have been on the rise in China over the past two years. Agricultural Bank of China had the lowest regulatory capital level among the national commercial lenders and also the highest NPL ratio, which breached the 2 per cent mark at the end of September.

The rules are expected to push Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China to raise between US$350 billion and US$400 billion in debt over the next decade. China Construction Bank was added to the GSIB list just last week.

The 10-year deadline may seem distant but China was only in the early stages of preparing for the change. The China Banking Regulatory Commission has yet to define which instruments will qualify for TLAC.

Tier-one and tier-two regulatory capital will likely count toward the TLAC buildup, including instruments such as subordinate debt and preferred shares.

The depth of China’s financial markets was another challenge for raising the volume of capital. The domestic bond market, which is underdeveloped compared to other countries where banks raise TLAC capital, will likely have difficulty absorbing that volume of debt over the next decade.

“Chinese GSIBs have been exempted from the initial TLAC deadlines given the still-low levels of demand among Chinese non-bank investors for fixed-income assets, which constrains the extent to which banks can issue substantial volumes of capital and debt instruments,” Moody’s Investors Service said in a note on Thursday.

Ratings agencies have stressed that Chinese government support for its biggest banks underpins strong ratings. In a note this week, Fitch said China’s banks could be downgraded if the implementation of TLAC coincides with the weakening of sovereign support.