China’s banking regulators should bring in new rules for the planned debt-equity swap programme to save banks from capital strains, says audit giant EY. Under the current rules of the China Banking Regulatory Commission, if a loan is converted into equity, the amount of risk-weighted assets (RWA) is enlarged four times for equities held for two years by the bank and 12.5 times if held longer, said Jack Chan, EY’s managing partner of financial services, Greater China, yesterday. Premier Li Keqiang said at the National People’s Congress in March that the government may use “market forces” to implement the debt-equity swaps – converting corporate loans into equities that will be held by banks – to ease the debt burden of banks and enterprises. China’s plan for trillion-yuan debt-to-equity swap could backfire, IMF report warns “Banks will face great pressure to maintain the capital adequacy ratio if there are no new policies, such as relaxing the regulations on RWA, along with the swap scheme. The scheme cannot be implemented on a large scale either.” According to EY, Chinese banks will possibly see more bad debts and narrower interest margin this year, after 26 listed banks posted on average a net profit growth of 2.56 per cent last year – slowing down for five straight years. The average non-performing loan ratio will continue to soar, after climbing 0.41 percentage points to 1.62 per cent in 2015, rising for three consecutive years, EY said. “We still can’t see when the NPL ratio will peak out,” said Kelvin Leung, EY’s banking and capital markets leader of financial services, Greater China, adding that the balance of “special mention” loans – which borrowers are experiencing difficulties to repay and may turn into bad loans in the future — also continued to rise. Manufacturing and wholesale sectors will see more soured debts this year amid the overcapacity problem in an economic slowdown, Leung said. Chinese banks swap transparency for debt Domestic banks are also facing risks of sliding net profit as the net interest margin is expected to narrow further. “Some banks have not fully adjusted their lending rates after China cut interest rates five times,” Leung said. “The effect of rate cuts will gradually be felt this year and will keep up the pressure on the net interest margin.” Leung said he would not discount the possibility of further dividend cuts by listed banks this year and added that some small and medium-sized banks may seek initial public offerings in Hong Kong to replenish their capital. Chinese banks are unlikely to see their net profit grow a lot in the short term but in the long term, they may find opportunities as a result of China’s financial reforms and the “One Belt One Road” initiative, Chan said.