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China Test Shows Bad Loan Surge Would Hurt Banks’ Capital

China’s systemically important banks may see their capital adequacy ratio fall to 10.5 percent in the event bad loans surge fivefold, according to a stress test by the nation’s central bank.

The average capital adequacy ratio of the 17 banks, which account for 61 percent of China’s banking assets, may fall to 10.5 percent from the end-2013 level of 11.98 percent should nonperforming loans increase 400 percent in the worst-case scenario, the People’s Bank of China said in its annual financial stability report yesterday.

China introduced stricter capital requirements for banks in January 2013, posing a challenge for an industry facing slower loan growth and rising bad debts amid more competition and interest-rate deregulation. Industrial & Commercial Bank of China Ltd. and its three closest rivals will face a capital shortfall of $87 billion under the new rules by 2019, according to an estimate by Mizuho Securities Asia.

The government is requiring the biggest Chinese banks to have a minimum common equity Tier-1 ratio of 8.5 percent and total buffer of 11.5 percent by the end of 2018. Banks’ bad loans increased for a ninth straight quarter as of December to the highest level since 2008, data from the China Banking Regulatory Commission show.

The stress test also examined the effect of changes in economic growth, bond yields and foreign exchange rate. The results show that “Chinese banks’ asset quality and capital adequacy level are relatively high,” the central bank said in the report. “The banking system, as represented by the 17 banks, has relatively strong absorbent capacity.”

The banking system’s capital adequacy ratio will fall 0.19 percentage point in the event of a parallel increase of 250 basis points in lending and deposit rates, according to the central bank.

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