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MNI: China Local Gov'ts Face Risks From Bank Recapitalisations

(MNI) Beijing

Regionally-owned small- and mid-sized Chinese banks have filled capital gaps with a jump in local government bond issuance, but a squeeze on net-interest margins and vested shortages in operations of the local banks could make repayment of the debt harder, putting pressure on provincial finances as calls grow for industry consolidation to reduce risk, policy advisors and economists said.

Over six provinces and cities this year have issued more than CNY100 billion of local government special-purpose bonds (LGSB) to recapitalise their regional lenders which are not qualified to issue debt themselves, compared to 2022’s total of CNY63 billion. One CNY34.6 billion injection by Liaoning Province, into a new provincial-level rural commercial bank, was the largest recapitalisation of a single lender via LGSBs so far, according to MNI data.

The capital raising comes amid deteriorating investor sentiment towards regional commercial banks following the bankruptcy of Baoshang Bank in 2019, an advisor to financial regulators told MNI, asking for anonymity. It is difficult to determine the real capital gap of small banks due to a lack of information, the advisor added.


According to China Securities Cooperation, the small- and mid-sized banks’ capital shortfall could reach CNY3.9 trillion in 2022 should city and rural commercial lenders expand their loan books by 15% and 25%. That shortfall could tip CNY5.34 trillion if city-focused loan books increase 20%. China Banking and Insurance Regulatory Commission said in March it had granted LGSB quotas totaling CNY550 billion for over 600 small banks between 2020-2022. But the quota was not completely used yet.

Guo Yixin, senior fixed-income analyst at CIB Research, said CNY340 billion of the quota had been used to date. He explained China’s banking sector needs to recapitalise to fuel economic growth, expand assets and promote energy transition.

CBIRC data showed lenders made net CNY667.9 billion in profits in Q1, up 1.3% y/y. The capital adequacy ratio (CAR) at city and rural commercial banks was 12.6% and 12.4% at the end of 2022, compared to the average 15.2% of China’s wider banking industry, but above the 10.5% minimum requirement.

Yu Wengong, partner at Joius Law Firm and Public-Private Partnership expert at the Ministry of Finance and National Development and Reform Commission, told MNI local governments have two main channels to inject proceeds from LGSBs into small lenders – deposit-to-equity swaps and by indirectly holding shares through local state-owned capital management companies.

So-called “small and mid-sized bank LGSBs” are a variant of LGSBs and, as a form of off-budget government liability, are designed to fund infrastructure projects whose profits repay the debt, Yu explained. But the capacity of small banks to repay the 10-year bonds is highly uncertain, he noted.


According to deposit-to-equity swap agreements unveiled by local media, the deposit turns into equity when the small banks’ core tier-one CAR drops below 5.1%. Yu said, however, there have been cases where the swap failed when triggered, as it would have meant local governments would have taken over the debt when lenders cannot repay. He suggested authorities introduce clear rules and law to regulate the use and issue of “small and mid-sized bank LGSBs” , or the repayment of local government debt will be harder.

In the case of Liaoning Province’s LGSB issue, the local government will receive deposit interest, dividends and equity transfer income to repay the debt with a precondition that the bank’s share price doubles over five years.

Yu said bailout plans must be detailed and reforms should target improvements to small-bank operations besides capital injections, or the bailout is not sustainable.

The adviser agreed that LGSBs will likely exacerbate fiscal risk without better performance by troubled lenders, noting authorities are pushing regional banks to merge to enhance better their capacity to absorb loss.


Liaoning Province announced last November it could establish a provincial-level rural commercial bank by merging 30 small banks in its region – the third province after Zhejiang and Henan to detail such plans for its local banking system.

Wang Jun, chief economist at Huatai Asset Management, said mergers will enable local lenders to expand business, increase competition and prevent spillover risk to the banking sector. The country should reduce the number of small banks via mergers and restructures to about 400 from 4,000, and the central government should support this via the issuance of special treasury bonds, Wang suggested.

China’s coming National Financial Work Conference will likely unveil plans for the overhaul of the financial system, which may detail reform of local financial regulation, Wang predicted.


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