PBOC Perpetual Bond Support Seen as Banking System Bailout

China’s recent moves to help banks replenish capital through perpetual bond issuances are seen as a bailout of the banking system. But what happens in another crisis?

Last week, the PBOC (People’s Bank of China) announced plans to set up a CBS (central bank bill swap) facility to help improve the liquidity of perpetual bonds, a new no-maturity fundraising debt instrument for banks, allowing them to be exchanged for highly-liquid central bank bills and to be used as collateral for central bank lending.

According to a Forbes op-ed, the purpose of the scheme – which it calls “the Great Chinese Bank Bailout” – is not just funding, but recapitalisation, where the perpetual bonds will ultimately end up on the PBOC’s books. This is likened to the European Central Bank’s LTRO (Long-Term Refinancing Operation) scheme, which in 2011 amid the eurozone debt crisis encouraged governments to issue debt for banks to buy and then pledge at the ECB for cheap funding.

As for finding buyers for new perpetual bond issues, the article notes that on the same day as the PBOC announcement, the CBIRC (China Banking and Insurance Regulatory Commission) said it would allow insurance companies to invest in perpetual bonds issued by banks.

“This completes the loop. Banks can issue perpetual bonds and insurance companies can buy them, knowing that they will be able to exchange them at the PBOC for safe liquid bills,” the op-ed says. “One way or another, lots of the perpetual bonds will end up on the PBOC’s books. So, in effect, the PBOC is recapitalising banks at arm’s length.”

“The reason for the Great Chinese Bank Bailout is clear. China’s economy is weakening, and its banks are in no shape to support it.”

According to the PBOC, recapitalising banks will allow them to lend more to the real economy. As a Bloomberg article notes, Chinese banks have already been lending well in excess of deposit and GDP growth.

“Since the beginning of 2016, as loans outstanding grew 41 percent, deposits rose just 29 percent. That put balance sheets under increasing strain. Officially, capital adequacy ratios improved to 13.8 percent in 2018 from 13.4 percent two years earlier. In reality, this was only achieved with an accounting sleight of hand,” it says.

But banks “don’t have the ability to continue lending as much as they do without additional capital”, thus the PBOC plan to help banks raise funds.

On Friday (25 January), Bank of China became the first bank to issue perpetual bonds, with more than 140 investors participating in its CNY 40 billion (USD 5.9 billion) issuance. And more issuances are expected, given UBS estimates that Chinese banks need to raise between CNY 1 to 3 trillion, depending on the targeted capital-adequacy level.

But this does not include the additional funding China’s four G-SIBs (global systemically important banks) need to meet TLAC (total loss-absorbing capacity) by 2025, an implementation timeline that may be accelerated if credit bonds to GDP exceeds the 55 percent trigger set by the FSB (Financial Stability Board). Nor does it include a plan to designate more domestic institutions as systemically important, which will require even more fundraising from newly-designated institutions.

Post-crisis reforms such as loss-absorbing bank capital are intended to prevent  governments from having to bail out failing banks, and instead allow the market to absorb losses, so it is natural for the PBOC’s perpetual bond “liquidity support” to be questioned.

“In China, where banks need to recapitalise to continue lending and supporting growth, the implication seems to be that the market wouldn’t be buying these perpetual bonds without some kind of support. Why might that be?” asks an FT contributor.

The new policies will indeed create more “favorable capital-raising conditions” for banks, improve liquidity and support lending, says S&P Global. But even the ratings agency, which recently won approval to operate in China, sees the PBOC plan as “a type of government support to Chinese banks,” according to analyst Liang Yu.

Meanwhile, policymakers have been pushing to open up the domestic bond market to foreign investors, who like insurance companies are seen as likely buyers of Chinese bank-issued perpetual bonds and could encourage even more issuances of this new fundraising instrument.

But, following China’s crackdown on shadow banking in an effort to deleverage the financial system, one has to wonder whether the latest moves will result in even larger banks, funded by even more leverage, with even more (potentially non-performing) loans on their books.

With China’s financial system already worth almost USD 40 trillion, how will this all unravel in the event of another (most would say inevitable) crisis?

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