How Basel III will limit Chinese bank financing

Author: Ashley Lee | Published: 6 Nov 2012
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Chinese banks’ Basel III concerns are growing as counsel outline how the China Banking Regulatory Commission’s (CBRC) implementation of Basel III will limit Chinese banks’ financing.

In June the CBRC issued its Regulation Governing Capital of Commercial Banks. The requirements stipulated are much higher than those specified under Basel II and Basel III.

Implementation of the regulation is expected to fundamentally change Chinese banks’ means of financing.

Eversheds’ Kingsley Ong said that due to an ongoing global financial crisis and fears of a slowing economy, Chinese banks had focused more on achieving larger capital buffers than on issuing new loans in the market.

Under the CBRC’s rules, China’s systematically important financial institutions (SIFIs) must maintain a capital adequacy ratio of 11.5% - one percent more than the 10.5% stipulated under Basel III. Other financial institutions must maintain a 10.5% capital requirement.

One Shanghai-based lawyer said Chinese banks had used a lot of subordinate note offerings to satisfy their core capital requirements. But this activity would not qualify under Basel III principles.

The counsel also noted that CBRC regulations previously took account of 100% of loans to SMEs in a bank’s core capital.

“In the new regulations, the percentage has been reduced from 100% to 75% so that Chinese banks will be encouraged to make more loans to small or medium private enterprises, which is in line with the central government’s call to support the economy instead of the real estate or insurance markets,” he said.

Nonetheless, the lawyer conceded the CBRC had also given Chinese banks a 10-year transitional period to close non-qualified capital instruments. “This takes a lot of pressure off the PRC banks,” he said.

The CBRC may also allow Chinese banks to issue preferred shares in the future. This would be a new instrument in China.

Ong believed that, on paper, most Chinese banks already meet Basel III standards, both for the core Tier 1 capital requirement of 4.5 and overall capital requirement of 10.5%.

Indeed, local market participants did not expect any drastic banking reforms, such as the proposed rules in Europe and the UK, to be introduced.

China bank reform: what to expect

China’s securities and commercial banking laws stipulate that commercial banking must be segregated from investment banking, which is similar to the former US Glass-Steagall Act. Chinese banks are therefore generally well-capitalised, with no major political pressure for local regulators to separate proprietary trading (as in the Volcker rule) or conduct any major structural reform of the banking industry. Domestic lawyers predicted that Chinese regulators are likely to observe how international reforms develop before implementing any policy.

Even so, as Chinese banks increasingly operate in a globalised market, it will be hard to avoid being affected by US, EU and UK regulations. Overlapping extra-territorial rules will only increase costs and administrative burden on banks, which will make them uncompetitive, or make the markets in which they operate in uncompetitive.

Financial services professionals have observed a trend of Chinese banks moving their operations from London to Luxembourg to escape regulations and perhaps downsizing their presence in New York to circumvent Dodd-Frank.

But lawyers doubt that Chinese banks will leave the US, UK or EU completely.

Ong did not believe that EU, UK and US bank reforms would deter Chinese banks’ interest in international expansion. “Like any other business decision, they will balance the costs of more stringent regulatory compliance burdens against business opportunities,” he said.

Roy Zhang, partner at King & Wood Mallesons, said that Chinese banks needed to expand their coverage. “Chinese banks must go abroad to finance their big clients looking abroad and familiarise themselves with the international environment,” he said.

But the Shanghai lawyer warned that Chinese banks may readjust their operations in the US as a result of Dodd-Frank and other post-crash legislation.

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