Within China’s labyrinthine banking system, nothing is ever quite as it seems. Rarely does Beijing ever simply do what it says it will: new, long-awaited regulations and market transactions are often just smoke and mirrors.
Take Central Huijin Investment’s announcement in August that it would raise Rmb40 billion ($5.9 billion) from the interbank market. The domestic arm of China Investment Corporation, Beijing’s $200 billion sovereign wealth fund, was keen to recapitalize the nation’s leading banks, each of which had its balance sheet stretched to breaking point by China’s crisis-busting $600 billion fiscal stimulus plan.
Huijin was keen to boost liquidity levels at Bank of China (BOC), China Construction Bank, and Industrial and Commercial Bank of China, the latter the world’s largest lender by market capitalization. It also wanted to pump billions of renminbi into two policy lenders: Export-Import Bank of China and China Export and Credit Insurance Corp. The sale consisted of Rmb20 billion in seven-year bonds and an equal value of 20-year notes.
The issue was step one, Huijin said, in a protracted de facto bailout of China’s banking system, with Huijin seeking to raise up to Rmb187.5 billion from bond sales, with the capital set to be handed to the likes of ICBC.
CIRCULAR FUNDING
The sale caught the eye for other reasons though. China’s leading banks were expected to benefit directly from a cash injection by Huijin following the bond sales. Yet, curiously, more than 80% of the notes were bought by the very banks touted to benefit from the sale, leaving analysts to point out that leading Chinese lenders were, essentially, funding themselves.
“It’s a very strange state of affairs,” says one Chinese economist. ‘”It’s almost as though Huijin is using the banks to make itself wealthier.” Some analysts believe the underlying reason was to allow Huijin – which owns a majority stake in most leading Chinese banks – to refinance a portion of the vast quantity of failed or failing loans it keeps on its books.
Global rating agency Moody’s took an uncharacteristically dim view of the events. It noted that Huijin’s actions purported to increase the value of both assets and equity within the banking system but, in reality, the gains were “artificial and without real economic substance”.
Moody’s also cast doubt on claims by Chinese lenders that Huijin’s capital-raising exercises would keep their balance sheets well stocked for at least another three years. “These announcements suggest the new capital likely won’t last long... pain lies ahead if China’s economic growth slows and the banking business model cannot adjust accordingly in time.”
China’s biggest banks are entering a new and exacting stage in life. They are now listed vehicles – parts of vast and opaque Communist Party-owned vehicles to be sure, but solid members of leading index tracker funds nonetheless. Announcements involving mainland banks and banking laws can genuinely move global markets.
Yet Beijing’s prized lenders have had a testing start to a listed life. After raising record amounts of capital following initial stock sales in 2005 and 2006, all ran into the mother of all headwinds.
China’s response to the global financial crisis was decisive. Its stimulus package forced state banks to lend crazily. In 2009 alone, mainland banks disbursed a record $1.4 trillion in new loans. The spree continued into 2010, with much of the new capital being channelled into provincial investment bodies, which in turn directed cheap capital into local infrastructure projects.
Doubts have been raised about the quality of much of this new lending, and the ability of many banks to deal with rising non-performing loan ratios further down the line. China’s response this year has been to cajole its banks into issuing a mixture of fresh debt and equity: $45 billion in new capital has been raised in 2010 to reinvigorate depleted balance sheets, including a $6 billion rights issue by BOC and a $22 billion Hong Kong-Shanghai initial public offering by Agricultural Bank of China.
Can Beijing balance the books? Will the nation’s lenders become better and more risk-averse corporate citizens? Some experts think so. “We don’t expect loan growth to be as high as what we saw in 2009,” says Lucy Feng, regional head of bank research at Nomura in Hong Kong.
“But for sure the banks will be encouraged to have more stable growth in terms of their credit balance. Last year, we saw sector loan growth at a record high, so regulators will now be more prudent in terms of regulating loan growth.”
SAFER BANKING
Other challenges face the country’s banks in the months to come. Regulators at the China Banking Regulatory Commission (CBRC) are considering plans that could force banks to boost their provisioning levels to 2.5% of total reserves, from 1.5%, with a decision expected by the end of the year.
Analysts are dubious this will happen, however. Kevin Chan, head of Hong Kong and China banking research at CLSA, says such a move would likely force banks to “stop making short-term loans, or to raise loan pricing significantly. This will have a major undesirable negative impact on the China economy.”
Chan believes the rumoured policy ultimately “does not seem likely”. Yet leading banks will probably need to continue raising capital forwarding the future. They remain tools of the state, and China, the great modern nation-state builder, needs them to continue sucking in capital and spewing out loans.
On September 15, CBRC vice-chairman Wang Huaqing said the “rapid growth of the domestic economy will continue to create robust loan demand. Therefore, for the boards of Chinese banks, replenishing capital will be an important task over the next decade.”
For Wang – and others within Beijing – Chinese banks continue to fulfil one role: helping to build out the world’s fastest growing major economy. That bodes well for China but ill for the capital-constrained partially listed banks that, through times of plenty and times of crisis, have helped fuel China’s rapid ascent.