China is stepping up efforts to rein in risks in the financial sector, curbing banks’ use of complex financial products and resisting lobbying to relax the rules governing bad-loan buffers.

China’s banking regulator is pushing back against requests from the country’s largest banks to reduce the 150 percent minimum ratio for bad-loan provisions, a move that is likely to curb their profits, people familiar with the matter said Thursday. Banks whose ratios are already below that level are being urged by the China Banking Regulatory Commission to take steps to restore their buffers, said the people, who asked not to be named discussing private information.

It follows hard on the heels of a separate move by the CBRC to clamp down on risks in China’s shadow banking sector, a key area of concern in the country’s highly-leveraged financial system. The regulator has drawn up tougher rules for the nation’s $3.5 trillion market for wealth-management products, which have been used by some banks to extend loans to risky borrowers and to evade capital requirements, a person with knowledge of the matter said on Wednesday.

"Tightening WMP is something we want to see and will reduce risks in the banking system," said Sophie Jiang, a Hong Kong-based analyst at Nomura International (HK) Ltd. "Understandably, the regulator is doing this out of prudence and maintaining financial stability," she added.

Credit Explosion

A growing number of analysts has issued warnings on the build-up of risks in China’s financial system, and urged the government to take action. The banks are grappling with a growing pile of bad loans after flooding the financial system with cheap credit for years to prop up economic growth. Credit has roughly doubled as a proportion of gross domestic product over the past eight years to stand at 243 percent by the end of 2015, according to Fitch Ratings.

Nine of 15 respondents in a Bloomberg survey at the end of last month, including Standard Chartered Plc and Commonwealth Bank of Australia, predicted the government will be forced into a recapitalization of the banks within two years, as bad loans surge. Many of the analysts put the cost at more than $500 billion.

The CBRC’s stance means banks may need to sacrifice profitability to restore buffers for soured lending that Industrial & Commercial Bank of China Ltd. and Bank of China Ltd. breached in the first quarter. Some of the biggest lenders, which are due to report earnings next month, had been publicly arguing that the 150 percent ratio should be lowered.

"Higher provision means lower profit, and lower profit means even lower valuation -- and that’s bad news to equity investors," said He Xuanlai, a Singapore-based analyst at Commerzbank AG. "But apparently CBRC believes the stability of the financial system matters most."

Wealth Products

The CBRC’s new draft rules on wealth-management products are designed to reduce risks in the sector by limiting the involvement of smaller banks and of mass-market investors, according to the person familiar with the situation, who asked not to be identified discussing private information. Smaller banks and the less wealthy investors would no longer be permitted to get involved in WMPs that invest in riskier assets such as equities, the person said.

The products are a key reason behind the growth of China’s shadow-banking industry, which Moody’s Investors Service estimates is worth more than 50 trillion yuan ($7.5 trillion). As well as being used to side-step lending restrictions and capital requirements, because they exist largely off the banks’ balance sheets, there are fears that lenders could face a liquidity crunch if investors suddenly turn cold on the products.

More than a decade of profit growth at Chinese banks is threatened by slowing growth and an accompanying rise in nonperforming loans, hurting their ability to return money to shareholders. That prompted the nation’s largest lenders to urge the regulator to cut provisioning requirements earlier this year. A bad-loan coverage ratio of about 120 percent to 130 percent would be "reasonable" and "possible," the chairman of China Construction Bank Corp. Wang Hongzhang said in April.

Banks which fail to meet the required ratio won’t be immediately penalized by the CBRC, the people familiar said Thursday. Even so, the regulator is pushing them to accelerate bad-loan write-offs, the people said -- a move that would boost the coverage ratio while hitting profits.

Bank Profits

Some lenders whose bad-debt coverage ratios slipped below the regulatory minimum in the first quarter have since lifted the buffers back above the threshold, one of the people said, without naming the banks.

The CBRC hasn’t made a final decision about whether to keep the ratio unchanged and could lower it in the future, the people said. The regulator didn’t reply to faxes seeking comments.

Combined profits at the top five banks may drop 3.4 percent in 2016, the first decline since 2004, according to analysts surveyed by Bloomberg.

Source:
courtesy of BLOOMBERG

by Bloomberg News

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