Demand for corporate bond issues pressures China banks
China's companies need the ability to issue bonds, yet the development of the country's corporate debt market is glacially slow. Critics blame stick-in-the-mud regulators, but the real reason may be more complex.
Bonds are an essential instrument in the toolkit of any company looking to raise money. Until now, however, few Chinese companies have been granted permission to issue them.
The problem, say critics, is the reluctance of China's state planning authority, the National Development and Reform Commission (NDRC), to sanction new corporate debt issuance.
Last year, the NDRC approved corporate bond issues worth just 65 billion yuan. In contrast, China's banks extended new loans worth more than 2.3 trillion yuan. If the NDRC is unwilling to allow bond issuance on a larger scale, it has its reasons. The commission is anxious to avoid a repeat of the corporate debt splurge of the mid-1990s and its subsequent embarrassing series of defaults.
But the NDRC is not the only regulator involved. The People's Bank of China also has a crucial role and while the central bank is keen to support the development of a corporate bond market in the long run, it has good grounds to restrict debt issuance in the near term.
Among the central jobs of the PBOC is maintaining the stability of the financial system. As China's banks struggle to dispose of mountains of bad loans, the central bank is helping them to rebuild their balance sheets by making sure they earn fat profits on their lending.
At the moment the central bank sets the standard deposit rate at just 2.25 per cent, and the best long-term lending rate at 6.12 per cent. With commercial banks forbidden to lend at less than nine-tenths of the best lending rate, the central bank ensures that they can earn a spread of more than three percentage points between the interest rate they pay on their deposits and what they charge on their loans.
That is great for the banks, but it is less healthy for corporate borrowers. Five-year Chinese government bonds yield 2.32 per cent. So a company that could raise money in the corporate bond market at a two percentage point spread above the equivalent government debt yield would still be paying interest at only 4.32 per cent; more than one full percentage point cheaper than it could borrow from the banks. Clearly if more companies were allowed to issue corporate bonds, they would rush to do so.
The central bank could make bond issuance easier if it wanted to. Last year the PBOC passed regulations allowing companies to issue short-term commercial paper over maturities up to one year without special approval from the NDRC. So far, however, it has shied away from sanctioning widespread longer-term debt issuance.
If the PBOC did allow companies to issue bonds, China's commercial banks would lose their best clients - the country's strongest corporations - to the debt market. That would leave the banks servicing weaker enterprises. In a few years, that may not be much of a problem but for the time being China's banks lack the expertise accurately to assess and price credit risk.
Since late 2004, Chinese banks have been allowed to set higher interest rates on loans to less creditworthy borrowers but few have taken advantage of the freedom. Almost all loans continue to be made at the minimum interest rate to the most reputable borrowers. Until the banks can put in place adequate credit risk management procedures, they will remain unwilling to lend to any but the highest quality borrowers.
Opening up the corporate bond market in the meantime would be a serious blow for China's banks. Until they can manage credit risk better - and earn more of their profits from fee-based rather than interest income - the PBOC and its fellow regulators are likely to make sure corporate bond issues remain the exception rather than the norm.