China on path to requiring current asset-level disclosure by banks

The Wall Street Journal carried an article on China's bank regulator taking steps to establish a leverage ratio as part of its efforts to curb credit risk in its banking system.  This is the next step along the path that will ultimately lead to requiring the banks to provide current asset level disclosure.

As discussed in an earlier post in which the Economist Magazine called for a new model of bank supervision, requiring current asset level disclosure is necessary to overcome the shortcomings of what China's bank regulator calls inadequate traditional bank supervision.

In addition, once market participants can see the quality of a bank's current on- and off-balance sheet assets, they can adjust both the price and amount of their exposure to the bank so they are properly compensated for risk.  This market discipline acts as a constraint on the riskiness of the bank's asset portfolio.

China's banking regulator has proposed that banks have a 4% minimum leverage ratio to curb credit risk, and analysts said the nation's banks are likely to take the requirement in stride. 

But some analysts said that tighter regulation and looming risk could point to slower growth in the medium term. 

The China Banking Regulatory Commission said late Friday in a statement that it is seeking public opinion on the proposed regulation, which requires that the leverage ratio for commercial banks, including both on and off-balance sheet assets, shall not be lower than 4%. The leverage ratio is generally calculated as core capital as a proportion of total adjusted assets. 

"It is now widely agreed that we should introduce a simple, transparent and non risk-sensitive leverage ratio tool -- in addition to the current capital adequacy tool -- to effectively control the degree of leverage in the banking system," the CBRC said in a statement. 

It went on to say that the financial crisis showed that traditional supervision is inadequate because some Western commercial banks were over-leveraged despite having high capital adequacy ratios. 

The leverage ratio is an additional tool to complement minimum capital adequacy requirements, and thereby reduce the risk of excessive leverage building up in individual banks and in the financial system as a whole. 

"The new regulation is likely to create pressure for some banks to replenish capital, but most listed commercial banks will basically meet the requirements," said Li Shanshan, a banking analyst at Bocom International in Beijing. 

"Some banks will meet the requirements after they complete capital-raising exercises by the end of this year," she said. 

Four commercial banks--the China Merchants Bank, Everbright Bank, Shenzhen Development Bank and Huaxia Bank--do not meet the requirement now, but are likely to meet the requirement after their refinancing plans are completed later this year, she said. 

The CBRC issued new regulations early this month to bring management of the country's banking system in line with new global banking requirements that are known as the Basel III rules. 

It stated that systemically important financial institutions will have to comply with a minimum capital adequacy ratio of 11.5%, while non-systemically important financial institutions will face a capital adequacy ratio of 10.5%. 

The regulations will start to apply in 2012 and banks will be expected to meet all requirements by 2016, two years ahead of the Basel III schedule, the CBRC said at that time. 

China's banking authority has repeatedly raised the minimum capital adequacy ratio for banks to slow loan growth and rein in credit risks amid a lending binge of around CNY18 trillion over the past two years. 

However, analysts have been warning that massive loans to local government financing vehicles and the property sector may hold risks for China's banking sector in the coming years despite its current bumper earnings. 

Lu Lei, vice president of Guangdong University of Finance, warned in an article in the Century Weekly magazine Monday that China's banking sector is facing a downturn. 

He estimated that Chinese banks may need to raise as much as CNY4 trillion over the next four years to boost capital if their assets double and if the government doesn't change the current requirement on capital adequacy. 

"A downturn is unavoidable if under credit tightening there is a fall in asset quality, the banking system could become a 'black hole' for capital," he said. 

Banks will also be required to have a loan-provision ratio of at least 2.5%, meaning that percentage of the total loan book must be set aside to guard against losses. The provision coverage ratio, or the amount of non-performing loans that are already covered by provision, will be at least 150%.