China's financial regulatory authorities recently took new steps to facilitate capital replenishing for commercial banks. There are strong signals that alleviating lenders' liquidity pressure and smoothening the mechanism for the transmission of the monetary policy has become a priority for the financial sector's efforts to serve the real economy.

The People's Bank of China, the central bank, conducted the first central bank bill swap (CBS) operation of the year on February 20. Valued at 1.5 billion yuan ($223.55 million) and to be due in one year, the CBS will support the issuance of perpetual bonds by commercial banks to replenish capital.

Many recent policies are about commercial banks' capital supplement. To increase liquidity of perpetual bonds, the PBC created the CBS and has included banks' perpetual bonds with ratings of AA or above as collateral for medium-term lending facility, targeted medium-term lending facility, standing lending facility and re-lending.

The China Banking and Insurance Regulatory Commission (CBIRC) announced in January that it would allow insurance firms to invest in banks' tier-2 capital bonds as well as capital bonds without fixed terms.

A recent executive meeting of the State Council, China's cabinet, also formulated detailed measures to facilitate capital replenishing for commercial banks. For instance, the meeting decided to fast-track the approval of perpetual bond issuance and lower the threshold for preferred stocks and convertible bonds. Wealth management subsidiaries of commercial banks are encouraged to invest in bank bonds issued for capital supplement, and foreign-funded financial institutions are encouraged to participate in bond market transactions.

Commercial banks' capital issue has become an important focus of financial policies for several reasons.

First, while commercial banks' capital adequacy ratios have met regulatory requirement, they still face pressure in the long term. According to CBIRC figures, by the end of 2018, Chinese banks' capital adequacy ratio was 14.02 percent and their tier-1 capital adequacy ratio was 11.58 percent.

However, they need more capital to adapt to the new asset management policy issued last year. In addition, since the capital adequacy ratios of international leading banks stand between 15 and 20 percent, Chinese banks still have space for improvement.

Second, the tools available for banks to replenish capital are still not enough. Commercial banks can rely on internal channels for capital supplement, such as retaining earnings, but they are facing a serious problem of the growth of profits slowing down. Comparatively, capital supplement from external channels are more immediate and effective, but such channels are still short of demand.

For instance, before the launch of perpetual bonds, Chinese commercial banks mainly relied on stock issuance, preferred stocks, convertible bonds and tier-2 capital bonds to replenish capital. In many other countries, however, perpetual bonds are widely used.

Third, alleviating the capital pressure of commercial banks is important to ensure a smooth transmission of the monetary policy, which will make the policy more effective and better serve the real economy. The Chinese financial system mainly relies on indirect financing where commercial banks play a major role. After the central bank releases liquidity, if commercial banks fail to transfer the liquidity into credit granted to the real economy, the monetary policy would not be as effective as desired.

The central bank has repeatedly emphasized that a smooth transmission of the monetary policy is crucial in tackling the difficulty and high cost of financing. Capital inadequacy restricts the ability of commercial banks to give loans. So targeted solutions are important to ensure that the monetary policy runs smoothly.

According to a policy briefing of the State Council on February 19, the PBC will improve regulations, clarify the conditions for issuing capital supplement bonds and the related loss absorption mechanism, and explore the issuance of perpetual bonds and tier-2 capital bonds with debt-for-equity conditions. The taxation authority will soon issue policies concerning perpetual bonds.

As more related policies are being put into play, China will have an increasingly sound mechanism to supplement commercial banks' capital, and the banking industry will become abler to support the real economy.

This is an edited excerpt of an article by financial commentator Zhang Mo published in Economic Information Daily

Copyedited by Sudeshna Sarkar

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