China''s Latest Bank Regs May Support Debt Resolution


Friday, March 09, 2018  11:47 AM   /  Fitch Ratings

Chinese authorities' reported plans to relax provisioning requirements and broaden the scope of eligible capital instruments provide greater scope for banks to migrate non-loan and off-balance-sheet assets into loans, says Fitch Ratings. The lower provision requirement would also allow banks to accelerate loan impairment recognition.

Tight regulations on shadow and interbank activities are pushing credit back onto banks' balance sheets, which is consuming bank capital and dragging on profitability. The asset migration scale could be highly significant for some banks over the coming years, and may limit their ability to lend. The latest measures appear to be aimed at providing some relief.

Local reports suggest the provision coverage ratio is set to be lowered to 120%-150% of NPLs, from 150%, and the loan loss reserve ratio to 1.5%-2.5% of loans, from 2.5%. The new requirement will be based on three key criteria: the ratio of NPLs to loans overdue for more than 90 days, NPL write-offs or disposals relative to new NPL formation, and capital adequacy levels. This move would signify a differentiated regulatory approach that emphasises specific targets for individual banks based on their willingness to recognise and resolve NPLs.

Quantitative guidelines on provisioning could lead to greater confidence over reported asset quality. Banks' annual NPL write-offs or disposals will need to be as large as the previous year to qualify them for a reduced requirement. This implies banks would need to actively resolve legacy NPLs and recognise new NPLs each year to stay compliant. Retained earnings resulting from a reduced requirement cannot be distributed as bonuses or used to increase dividends, to ensure banks retain these earnings to preserve capital.

Active debt resolution and improved loss absorption capacity, if sustained, could be credit positive to banks' viability ratings. The PBOC also temporarily released a notice last week encouraging banks to broaden the types of capital instruments they issue, particularly to include new instruments with stronger loss-absorption features. Its list of potential innovative instruments included capital replenishment bonds and Tier 2 (T2) instruments that can be either written down or converted into equity upon point of non-viability (PONV).

External capital replenishment by Chinese banks currently tends to take the form of T2 instruments (written off in full upon PONV) or Additional Tier 1 (AT1) instruments (converted in part or in full into equity upon PONV). Chinese banks have issued around USD220 billion in T2 and USD88 billion in AT1 instruments since 2014, compared with USD22 billion in equity. It is unclear how the alternative capital instruments would differ from existing T2 or AT1 instruments in terms of loss-severity and non-performance risk.

Chinese banks face pressure to build up capital levels over the medium term. In particular, the four global systemically important banks (G-SIBs) - ICBC, CCB, BOC and ABC - face large issuance volumes to meet international total loss-absorbing capacity (TLAC) requirements. We expect BOCOM to also become a G-SIB within two years. We estimate around USD160 billion of extra capital would be required to bring these five banks' ratios up to the TLAC minimums based on September 2017 static figures.

China's G-SIBs are exempt from initial TLAC compliance until 2025, and Fitch does not expect any acceleration in this timeframe. We believe their internal capital generation is just adequate to keep pace with balance-sheet expansion. Domestic loans grew 13% yoy in February. It will therefore be challenging for them to increase their capital ratios to comply with TLAC and other buffer requirements without external capital replenishment, while common equity issuance is made difficult by below-book market valuations. New instruments could increase their options, while also supporting business expansion.

Proshare Nigeria Pvt. Ltd.

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