China told banks, which have lent at least $1.2 trillion to local governments, to recalculate capital levels by March 31 to account for higher risk weightings on such loans, two people with knowledge of the matter said.
Assigning risk weightings that are as much as triple existing ones for loans to local-government financing vehicles not fully backed by cash flow may cut capital ratios at China’s five largest lenders to near the regulatory minimum, the people said, declining to be identified as the deadline hasn’t been publicly announced.
The move may increase pressure on banks that fall below required capital ratios to raise money or reduce lending, the people said. Lenders, including Industrial & Commercial Bank of China Ltd., had at least 7.7 trillion yuan ($1.2 trillion) of loans to local-government financing vehicles as of June 30, with 23 percent of the debt not backed by cash flows, a person with knowledge of data collected by the bank regulator said in July.
“If the actual impact on banks’ capital adequacy levels turns out to be alarming, I don’t think the CBRC will be able to implement it as planned,” said Li Shanshan, a Beijing-based analyst at BoCom International Co., referring to the China Banking Regulatory Commission. “The last thing the market wants now is another round of capital-raising by banks.”
Chinese banks raised about $72 billion from sales of stock and convertible bonds last year. The country boasts four of the world’s 10 largest banks by market value.
China cracked down on lending to the funding arms of local governments last year after a surge in such loans fueled concern that a wave of defaults could hurt financial stability. Local governments use financing vehicles to get around regulations that bar them from borrowing directly from banks.
Restrictions on local-government lending are part of a wider campaign to slow credit expansion and keep inflation and property prices in check. China has raised interest rates, forced lenders to lodge more reserves with the central bank, and ordered them to take back off-balance sheet credits onto their books since new loans almost doubled in 2009.
“To truly and completely reflect the risks and impact of LGFV loans, the CBRC has recently issued notices regarding assigning appropriate risk weightings to such loans based on cash flow coverage,” the regulator said in a text message sent to Bloomberg News. “Loans to LGFV did carry certain risks, but as CBRC started to tackle the issues early, the overall risks are controllable.”
The Hang Seng Finance index, which includes Hong Kong-traded shares of four of China’s five largest banks, fell 2.3 percent, the biggest drop since Nov. 23.
Standard & Poor’s warned in July that it’s “highly likely” that some local-government debts will turn bad. Loans to such entities account for 18 percent to 20 percent of total lending, S&P said at the time.
The China Banking Regulatory Commission is restricting lending to local government financing vehicles this year to the construction of affordable housing, an area the government is supporting as it tries to avert a property bubble, a person with knowledge of the matter said in January.
Under guidelines introduced in December, banks must assign 100 percent risk weightings to local-government loans fully covered by cash flows from projects they fund. Credits that are less than 30 percent backed by cash flows were assigned the highest risk weighting, at 300 percent, implying that banks will have to triple the amount of capital supporting each loan.
The new risk weightings will cut capital adequacy ratios at eight Hong Kong-traded Chinese banks by 0.42 to 1.23 percentage points and their Tier 1 core capital ratios by 0.33 to 0.95 percentage point, Nomura International Hong Kong Ltd. analysts estimated in January. Agricultural Bank of China Ltd. will be hurt the most while China Merchants Bank Co. is the least affected, the analysts said.
ICBC, China Construction Bank Corp., Agricultural Bank, Bank of China Ltd. and Bank of Communications Co., the nation’s five largest lenders, had an average capital adequacy ratio of 11.8 percent as of Sept. 30, above the 11.5 percent regulatory minimum. The banks raised a combined $56 billion in equity and convertible bond sales in 2010 to prepare for stricter rules.
The CBRC may order the biggest lenders to raise capital adequacy ratios to as high as 14 percent when credit growth is judged excessive, a person familiar with the matter said Jan. 28.