China Changes Bank Loan-to-Deposit Calculation for Growth

Chinese regulators increased banks’ capacity to lend money and bolster the slowing economy by changing the way loan-to-deposit ratios are devised.

Banks from today can include in the calculation negotiable certificates of deposit sold to companies or individuals, the China Banking Regulatory Commission said in a statement yesterday. They can also exclude loans advanced to small enterprises and the rural sector that are backed by bonds, the CBRC said. Bank lending is capped at no more than 75 percent of deposits to prevent an overextension of credit.

The changes in calculation may allow lenders such as Bank of Communications Co., which was approaching its limit under the previous methodology, to lower its ratio and advance more loans. Premier Li Keqiang is seeking to cut funding costs and feed credit into the world’s second-largest economy, which is forecast to expand in 2014 at the weakest pace in 24 years.

Easing the loan-to-deposit requirements “will help amplify lending, especially for banks that focus on small and medium-sized enterprises,” Richard Cao, a Shenzhen-based analyst at Guotai Junan Securities Co., said by phone. “This is an extension of the latest round of targeted easing.”

Bank share performance was mixed today as the change fell short of market expectations for the inclusion of some interbank deposits in the calculation, according to analysts at HSBC Holdings Plc and China International Capital Corp.

Rural Lending

Bank of China Ltd. shares gained 0.4 percent to 2.56 yuan at 11:13 a.m. in Shanghai, while Bank of Communications fell 0.3 percent. Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp., the nation’s two largest lenders, were unchanged.

Banks can also exclude from the ratio calculation some loans backed by bonds with at least one year of maturity, and credit backed by funding from international financial organizations and foreign governments, the CBRC said.

Rural banks can take out loans funded by their largest shareholder that were offered to farmers and smaller companies. Locally incorporated foreign banks can include among their deposits funding put in place by their parents for more than a year, according to the statement.

The calculation change -- flagged by CBRC Vice Chairman Wang Zhaoxing on June 6 -- is the latest government measure to support growth without unleashing a broad stimulus program. The central bank cut last month the amount some banks are required to hold in reserve.

‘Targeted Stimulus’

“This is another ‘targeted stimulus’ policy conducted by the Chinese authorities to help the economy regain momentum,” Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Group Ltd., wrote in an e-mail yesterday. “The new loans extended by the Chinese commercial banks in the next few months will be significantly bigger compared with the same period of last year.”

Zhou estimates total lending in China will exceed 10 trillion yuan ($1.6 trillion) in 2014, more than last year’s 8.9 trillion yuan.

While the loan-to-deposit ratio for China’s banking industry was nine percentage points below the cap as of March at 66 percent, the requirement has become a constraint for some publicly traded lenders. Bank of Communications’s ratio was 74 percent at the time, while Bank of China’s was 72.5 percent as of Dec. 31, according to their earnings reports.

Market Distortions

Critics of the ratio have said it exacerbates the volatility of deposits. Wu Xiaoling, a former deputy governor of the central bank, said in September that the ratio and China’s lending quota severely undermined the authority of banks in managing their owns assets and liabilities, and led to distortions in the market as some banks use illegal means to obtain deposits.

A cash demand by banks to meet regulatory requirements such as the loan-to-deposit ratio and a crackdown on off-balance-sheet lending combined to push interbank lending rates to a record in June last year.

The ratio can be replaced by more thorough liquidity indicators under new rules set by the Basel Committee on Banking Supervision, according to Lu Zhengwei, Industrial Bank Co.’s chief economist. Liquidity risks won’t get out of control and the complete removal of the loan-to-deposit ratio can lower the economy’s borrowing costs by 138 basis points, Lu wrote in a report yesterday.

Basel III

New rules under the so-called Basel III regulatory regime require banks to comply with a liquidity coverage ratio, which measures the amount of easy-to sell assets they must keep to meet expected cash outflows in times of stress. Chinese banks’ liquidity coverage ratios should be at least 60 percent by the end of this year and reach 100 percent at the end of 2018, the banking regulator said in February.

The loan-to-deposit ratio, which was written into China’s commercial banking law in 1995, could be scrapped when the People’s Congress convenes next year to consider amendments, Bank of America Corp. economists Xiaojia Zhi and Ting Lu wrote in a note yesterday. They estimated that about 1 trillion yuan of existing loans may be excluded when calculating the ratios following this week’s change, while the impact on the deposit base is likely to be negligible as China has yet to allow the sale of negotiable CDs to companies and individuals.

China’s economic slowdown has hurt borrowers’ ability to repay debt, driving up banks’ bad loans. Sour debt at Chinese lenders increased to 646.1 billion yuan as of March 31, the highest level since September 2008, according to CBRC data.

“If the downward pressure on the economy intensifies in the second half of the year, the government may take other easing measures,” said Guotai Junan’s Cao. “Maybe another round of targeted cuts in reserve requirement ratios.”

— With assistance by Jun Luo

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