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UPDATED: August 8, 2011 NO. 32 AUGUST 11, 2011
Taming Wild Banking Risks
Banking regulator keeps a watchful eye on Chinese banks to fend off threats as their credit ratings come into question

In addition, commercial banks themselves value the quality of loans and have reinforced risk-control efforts over their loans.

Problems remain

Banks must also conform to new supervision standards for China's banking sector announced by the CBRC in May, said Zhou Xiaohe, a researcher with the Hong Kong-based financial news agency ETNet.

CBRC's new supervision standards will have stricter capital adequacy, leverage, liquidity and loan loss reserves requirements, and hence it is considered as China's counterpart to Basel III, or the third of the Basel Accords agreed by members of the Basel Committee on Banking Supervision. Basel III was developed in response to the deficiencies in financial regulation revealed by the global financial turmoil in 2008. Its introduction as a global regulatory standard on bank capital and liquidity marked the beginning of the global reform of banking supervision.

The CBRC will revise and release supplementary rules and standards like that on commercial banks' capital adequacy by the end of 2011 to ensure the new supervision standards be implemented in early 2011. All banks will have to meet the capital adequacy requirements first—no less than 11.5 percent for systematically important banks and no less than 10 percent for non-systematically important ones, said the CBRC guideline.

The stricter requirements will put additional pressures on capital for bank managers. Chinese commercial banks will have to pursue diversified businesses and services in the next five years, but it will still be difficult to find a replacement for loans as their major source of capital, said Zhou Kunping, Deputy Manager of the Development Research Center under the Bank of Communications.

Commercial banks have to raise funds to meet the capital adequacy requirements set in the guideline, particularly because the central bank has raised the deposit reserve requirement ratio several times to a record high of 21.5 percent in the first half of this year, which has made the financial market thirsty for liquidity.

A total of 903.55 billion yuan ($139 billion) was raised in the banking sector last year, making up 27 percent of the total fundraising in the financial market, said a report in Wind Information, a publication on financial data, information technology and software services. Banks raised 62.21 billion yuan ($9.57 billion) in the first half of 2011, or 30.3 percent of the total and 68.85 percent of last year's total, said the publication.

To some extent, it's irrational for banks to grow through ceaseless fundraising, said Zhou. Shareholders' stakes in these banks will be diluted when banks raise too much money through equity financing, he said.

Even if banks raise funds through issuing bonds, this could cause increases in their accounting costs and trim their return on the capital ratio in case of a slowdown in growth, he said.

In addition, while competing for funds with companies in other industries, banks seeking large amounts of capital will hinder the effective capital deployment within the financial market, and make it even more difficult for poorly capitalized small and medium-sized enterprises to survive on direct financing.

Anticipating bad debts

Zuo Xiaolei, chief economist of the Beijing-based China Galaxy Securities Co., advised banks to dispel fears of local government debts turning into bad debts on their balance sheets in order to clear up international doubts about the health of China's banking sector.

"It's imperative to have solutions addressing local government's debts in the short run, and introduce standards and rules for local governments to abide by in issuing local debts, so as to prevent a crisis from breaking out in the long run," Zuo said.

Zuo proposed several solutions: turn local debts into national debts; assess economic and social benefits of infrastructure projects; privatize some local state-owned enterprises (SOEs) to pay back loans; and require a certain ratio of bad debt reserves for local governments' debts as a risk control device.

In principle, increases in Central Government revenues don't necessarily ensure the payment of loans secured by local governments through their fundraising platforms, and that is why loans to local governments have to be classified and treated differently, she said.

Loans have been granted for local governments either to fulfill their functions or to implement public welfare projects. Loans that were part of China's counter-crisis stimulus package should be included as national debts and paid off from the Central Government's coffers, like a certain proportion of increases in annual fiscal revenue, she said.

As most loans to local governments were invested in infrastructure projects, assessing such benefits will help strike a balance between debts and revenues of public finance, she said.

While local governments are advised to sell part of their state-owned assets by privatizing SOEs to pay their debts, banks are advised to have a certain ratio of bad debt reserves for loans to local governments.

In the long term, measures should be taken to contain local governments' impulse to propel GDP growth through launching as many projects as possible, which is the root cause of huge accumulated local government debts, she said.

Zuo also advised banks to have an accountability system and a budget constraint mechanism for granting loans to local governments, as few Chinese banks operate independently from governmental interference, which is especially true with loans.

It will only increase their risks of having more NPLs if banks fail to practice discretion and manage loans to local governments in line with basic principles, she said.

Statistics on China's Commercial Banks

- Non-performing loans:

433.6 billion yuan ($66.7 billion) at the end of 2010

433.3 billion yuan ($66.66 billion) at the end of Q1 2011

- Non-performing loan ratio:

1.13% at the end of 2010

1.1% at the end of Q1 2011

- Capital adequacy ratio:

12.2% at the end of 2010

11.8% at the end of Q1 2011

- Core capital adequacy ratio:

10.1% at the end of 2010

9.8% at the end of Q1 2011

(Source: China Banking Regulatory Commission)

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