Why China’s asset securitisation pilot is set to fail

Author: | Published: 15 Mar 2012
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China’s new asset securitisation pilot programme cannot succeed without the resolution of regulatory conflicts-of-interest and more buy-in from domestic banks, according to market participants.

The People’s Bank of China (PBOC) last week announced Chinese banks were participating in a pilot scheme to securitise credit assets, and confirmed its intentions to gradually promote asset securitisation within China’s domestic banking sector.

It is understood those involved in the scheme will initially be limited to the Bank of China, China Construction Bank, Industrial and Commercial Bank of China, Agricultural Bank of China and China Development Bank. The pilot is expected to include only simple structures to start, such as collaterised loan obligations (CLOs).

But one Beijing-based law firm partner told IFLR the PBOC’s enthusiasm for the scheme was largely driven by its responsibility for the development of China’s interbank bond market and a desire to prove to China’s State Council that this market was both sophisticated and progressing rapidly.

The China Banking Regulatory Commission (CBRC) had been much more conservative in its reaction to the pilot, he said, because it was more concerned with the need to protect domestic financial institutions from unnecessary risk.

“The PBOC is not really shouldering its responsibilities on this,” said the lawyer. “It is leaving it up to the CBRC to deal with the potential risks posed by the pilot to the financial institutions under it supervision and the possible reputation damage that could occur if anything were to go wrong.”

“The CBRC and PBOC need to reach some middle ground on this,” he said.

But attaining the CBRC’s buy-in would be difficult. “Put simply there are fundamental problems with the asset-backed securitisation (ABS) structure,” he said.

As with previous ABS pilots, the programme is limited to the interbank bond market which means the majority of investors are banks.

“The associated risk of securitising credit assets thereby remains within the domestic banking system,” said the lawyer. “The CBRC is understandably uncomfortable with that.”

Others also questioned participating banks’ enthusiasm, and readiness, for involvement in the scheme.

A Shanghai-based in-house counsel said there was currently little incentive for banks to securitise creditworthy assets. There is a danger, therefore, that this will prompt banks to package bad assets together with those assets that meet regulators' requirements, and thereby bypass credit regulations.

“Until the PBOC introduces a more market-orientated interest rate system in which banks are able to freely decide lending rate and saving deposit rate ceilings and floors, domestic banks will have little incentive to get rid of good loans on their books,” he said.

“A more market-based interest rate system would encourage banks to compete with each other and thereby ensure there is more of a need for ABS programmes,” he said.

In more competitive conditions, banks would be much more open to a scheme which enables them to securitise loans and thereby acquire more regulatory capital to make more loans,” he said. “But right now conditions are not ripe for this to succeed.”
Many banks were also unprepared to issue ABS, he said. “Many of my clients are still waiting for further instruction on this as to how they should prepare task forces internally,” he said.

China launched a securitisation programme in 2005, backed by high-quality bank assets, such as loans to state companies and mortgage loans. But the Chinese government slowed down the process of financial innovation in the wake of the US subprime mortgage crisis.