China broadens capital tools for banks and lightens provisions for non-performing loans

Tighter regulation of shadow banking credit instruments is hoped to move lending back to banks' balance sheets, but could at the same time weaken banking sector profitability and erode capital buffers. Therefore, the China Banking Regulatory Commission (CBRC), the PBoC and three other regulators released a guidance on increasing bank capital and encouraging the increased use of "innovative" debt instruments for this purpose.

The IMF warned in December that China's banking sector needed to increase capital to bolster financial stability. International credit rating agency Fitch also warned that capital levels in big Chinese banks fail to meet international standards. Even with a nominal 9 % increase in bank total assets last year, the credit stock increased even more (by 13 %). Agricultural Bank of China recently announced it would increase its capital base by selling 100 billion yuan ($16 billion) in shares to government-connected investors.

The CBRC also eased provisions that banks need to set aside for non-performing loans (NPLs). Banks were earlier required to set aside 150 % of their NPL aggregate and 2.5 % of the bank's total loan stock. Now these buffers can be applied on a bank-by-bank basis. The loan-loss provisions can be decreased to 120 % of the NPLs and to 1.5 % of total loans. Officials say this is intended to encourage banks to be more frank in declaring NPLs and should encourage them to write down NPLs faster. Banks currently have considerable leeway in determining which loans are reported as non-performing.

While the 120 % requirement is still high by international standards, it is widely believed that Chinese banks extensively under-report their NPLs. Official figures show the NPL ratio for the banking sector overall is below 2 % (and just over 5 % including the "special mention" loans that are likely to be non-performing). In contrast, the IMF estimates that 13 % of Chinese bank loans at end-2016 were likely non-performing. The CBRC has recently tightened banking supervision and imposed fines on several banks for NPL concealment.

While the new measures are hoped to promote bank lending to support growth, smaller NPL buffers and novel debt instruments will increase banking sector risk exposures.