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China Regulators Said to Draft Plan for Bank Failure Risk

China’s government is drafting rules to help manage the fallout of any bank failure, two people with knowledge of the matter said, as lenders in the country face rising loan defaults and increased competition.

The People’s Bank of China and the China Banking Regulatory Commission are working on a plan to ensure the safety of deposits and an orderly repayment of financial firms’ liabilities during a crisis, the people said, asking not to be identified because the draft rules haven’t been made public. Under the rules, financial institutions deemed to have failed will be allowed to cease operations rather than be propped up.

In the wake of the global credit crisis, regulators around the world have sought to impose tighter rules to minimize the economic impact of bank failures. In China, soured loans have climbed to the highest level since September 2008 as a slowing economy and a government crackdown on shadow financing make it harder for borrowers to repay debt.

A system to manage bank deposits during periods of crisis may accelerate the introduction of deposit insurance, which the government pledged in March to start this year as leaders push the most sweeping liberalization policies since the 1970s. For the banking industry, those changes also include allowing lenders more freedom to set interest rates.

Build Buffers

Facing slower profit growth and interest-rate deregulation, Chinese banks have struggled to build buffers to cover loan losses. The last major bank failure occurred in 1998, when the PBOC shut Hainan Development Bank for failing to repay debt.

“I do not deny that there is some risk,” Jin Zhongxia, director general of the PBOC’s Financial Research Institute, said on the sidelines of a financial forum in Beijing yesterday, when asked about threats to the banking sector. “We have to pay attention to that and take some action to control, to improve, but the entire risk level is controllable.”

Press officers for the PBOC and CBRC didn’t immediately respond to faxed questions yesterday seeking comment on the draft rules.

The regulators plan to require banks to have a contingency plan in place so that they can recover financial strength when faced with difficulties and continue to operate, the people said. Financial firms may be classified based on their systemic importance and subject to different regulatory and exit standards, the people said.

Adequacy Ratio

The country’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 last month. More borrowers are struggling to make repayments in an economy that grew 7.4 percent in the first quarter, the slowest in 18 months.

One or two small banks may fail as they get about 80 percent of their funding from interbank markets and higher-cost deposits in savings vehicles known as wealth-management products, Fang Xinghai, a bureau director at the Office of the Central Leading Group for Financial and Economic Affairs, said in November. The group is the highest-level agency within the Communist Party for financial and economic policies.

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