Katrina Nicholas is a Bloomberg Gadfly editor. She previously oversaw corporate finance for Bloomberg News in Asia, where she has also been a reporter and editor. She has worked for the Australian Financial Review, Sydney Morning Herald and Nine Network.

China's biggest banks aren't happy about being included in international rules that require them to raise extra capital to protect taxpayers in the event of a renewed bout of financial turmoil. It's hard not to sympathize.

China, after all, wasn't responsible for the global financial crisis. Unlike in the U.S. or Europe, not a single bank collapsed. The country sailed through the upheaval largely unscathed, cushioned by a record $586 billion stimulus plan.

Seven years after the collapse of Lehman, the total loss-absorbing capacity, or TLAC, rule is all about the tender loving care of the general public. The idea is that by making banks sell bonds that are explicitly exposed to losses, a lender that fails can be wound down and recapitalized without the government having to resort to taxpayer-funded bailouts. Here again, China has cause for complaint.

The TLAC rule is designed for a world in which systemically important banks, and the bond investors who funded them, could engage in risky behavior without having to bear the consequences. A world of moral hazard, in other words. Creditors of a bank were implicitly relying on the state to back them up and therefore didn't pay much attention to what the institutions were doing, as Mark Carney, head of the Financial Stability Board, which designed the rule, noted last week. Governments poured hundreds of billions of dollars into banks after the 2008 crisis: Much of that went to rescue bondholders, whose claims were equal to those of depositors.

But China doesn't work like that. All the biggest and most systemically important banks in China are controlled by the state, so the country isn't exposed to the kind of moral hazard that laid waste to public finances in the U.S. and Europe. And Chinese taxpayers will ultimately remain on the hook for anything major that goes wrong with those banks, with or without a TLAC rule. 

The FSB included China's four biggest lenders on its list of the world's too-big-to-fail institutions: Industrial & Commercial Bank of China, Bank of China, China Construction Bank and Agricultural Bank of China. They lobbied hard to be excluded, using various reasons in their submissions, including the fact that customer deposits account for a large proportion of total liabilities, making for a lower liquidity risk than for banks whose focus is primarily on wholesale funding. 

There are practical as well as philosophical objections. To meet the board's requirements, Chinese banks may have to sell as much as 4.4 trillion yuan ($690 billion) of securities, according to ICBC's estimates. That's going to be a challenge, to put it mildly, in a bond market with a total size of about $5.2 trillion.

 China's bond market has been growing, though it remains equal to only about half the size of the country's $10.4 trillion economy. The U.S. bond market, by contrast, is about one and a half times the size of the economy.

Incremental Growth
Size of China's bond market
Source: ChinaBond

What's worse, the biggest players in China's bond market are...Chinese banks. Since lenders aren't allowed to buy each others' bonds for TLAC purposes (for obvious reasons), that means the effective size of the bond market is even smaller. 

That's probably why the Financial Stability Board gave China -- along with other emerging economies -- a nine-year pass on meeting the requirements. The Big Four will have until 2025 to reach total loss-absorbing capacity of 16 percent of risk-weighted assets. That's six years more than their developed-market peers.

That's about all the good news. While moral hazard by private actors may not be such a big issue for China's financial system, risk resides at a much deeper level. The Big Four, despite their recapitalization and IPOs in the decade through 2010, remain tools of state policy rather than profit-maximizing entities.

The effects of this are only beginning to be felt. China's 2008 stimulus saved the economy from falling into a recession, unlike much of the developed world. But unleashing so much credit in such a short time was bound to have side effects. U.S. officials expressed skepticism that the government could possibly allocate so much spending without much of it being wasted.

Going Sour
Bad loan ratio at China's major commercial banks
Source: The People's Bank of China

Now defaults are mounting and banks' nonperforming loans are climbing. Troubled credit swelled to the equivalent of about $628 billion by the end of September, based on data released Thursday by the China Banking Regulatory Commission. Economic growth has slowed to the least in two decades and banks' stock valuations continue to hover near record lows.

Banks, having grown fat from a policy of financial repression that held down funding costs, are facing increasing competition for deposits from shadow banks. Deposit rates have finally been liberalized. China is trying to wean itself from a decades-old industrial model that relied on debt-fueled investments and exports. It's a transition fraught with peril. 

Some time in the next nine years, meeting the TLAC rule is going to seem like the least of Chinese banks' problems.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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Katrina Nicholas in Singapore at

To contact the editor responsible for this story:
Matthew Brooker at