MNI China Money Week: Lower Provisions Not Bond Market Boon

     BEIJING (MNI) - The China Banking Regulatory Commission's new rule to lower

provision coverage ratio was seen as a positive for the bond market this week,

although closer inspection of the move seems less bullish.

     The CBRC certainly surprised the market with its move Tuesday to lower

banks' provision coverage ratio and provision ratio for bad loans to from 150%

and 2.5%, to 120% - 150% and 1.5% - 2.5%, depending on different banks'

conditions.

     The move pushed the 10-year China Government Bonds and China Development

Bank yields down 2 and 3.5 basis points to 3.8253% and 4.8106% respectively,

data from Chinabonds showed.

     The logic behind the move is a lower provision coverage ratio will allow

banks to have more funds to allocate, leading to increased bond purchases.

However, the logic appears flawed.

     The CBRC's move did not cause banks' cash holdings to rise. Reserves are a

balance sheet accounting item and there is no increase in real term cash

holdings and the move does not directly grant banks increased funds to be freely

invested.

     --NET CAPITAL BOOST

     However, the move will increase net capital by boosting banks' profit

levels. As banks are not allowed to use the increased profits from the new CBRC

rules to pay bonuses or dividends, the retained earnings will grow and lead to

higher capital adequacy ratio.

     This higher capital adequacy ratio, theoretically, will allow banks

allocate more to investments, mainly loans and bonds. However, any benefit will

be impacted by the authorities crackdown on off-balance-sheet lending, mainly

non-standard assets.

     The process of converting non-standard assets into loans will put pressure

on capital adequacy ratios, and lowering the provision ratio can be seen as an

effort to support banks during the process. This will leave little room left for

increased bond holdings.

     --NPL WRITE OFFS

     The rule also encouraged banks to write-off their non-performing loans. The

lower provision coverage ratio and the provision ratio for bad loans together

have resulted in the optimum non-performing loan ratio for banks, satisfying

requirements of both figures without pushing one higher than regulators'

demands, to go down. So banks will be motivated to write off NCDs in order to

lower their NCD ratio.

     The effect on writing-off NPLs is complicated, probably leading to an

increase in "zombie companies" cut off from bank funding. In the past, banks

have rolled over loans to zombie companies to prevent their NPL ratio

increasing.

     Writing off NPLs will instantly lead to a fall in funding demand, which

will be helpful to the bond market, although the overall scale is unclear, as

some enterprises previously crowded out of the loan market will likely turn now

to banks.

     Overall, the new CBRC regulation should be viewed as another part of the

deleveraging campaign, further proving the government's determination. This is

certainly not a boon for the bond market.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

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