The Big Four Chinese state-owned banks will soon have to issue billions of dollars of offshore bonds, out of an urgent need to meet an international financial standard, the Total Loss Absorbing Capacity (TLAC). The People’s Bank of China (PBOC) recently said that the Big Four banks probably need to implement TLAC ahead of schedule, because China’s corporate debt has risen to perilously high levels. This massive offshore fundraising will boost the non-bank institutional investor base of China’s domestic bond market.
The Big Four state-owned banks comprise Bank of China (BOC), Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China (ABC) and China Construction Bank (CCB).
“The PBOC signalled potential acceleration to conform with TLAC requirements, which would likely require greater near-term offshore issuance [by the Big Four Chinese banks],” said a Fitch ratings report on November 7.
Fitch expects more offshore capital issuance from Chinese banks in the near future. Capital raising by Chinese banks in recent years has mostly been done domestically, the ratings agency noted.
The PBOC will support the Big Four banks in issuing TLAC bonds overseas, and will push financial liberalization, in order to meet the TLAC standard, said the central bank’s financial stability report published on November 2.
“Our country faces challenges in meeting the TLAC standard,” the PBOC admitted.
TLAC requirements are a standard of the Financial Stability Board (FSB), an international body that monitors and makes recommendations for the global financial system. It aims to ensure that global systemically important banks (G-SIBs) have enough equity and bail-in debt to pass losses on to investors, and to minimize the risk of a government bailout. After the painful lessons of the global financial crisis in 2008, the aim of the TLAC standards is to prevent banks from “becoming too big to fail”.
The PBOC will probably speed up the implementation of TLAC requirements for Chinese G-SIBs, it said. China’s G-SIBs include the Big Four state-owned Banks.
TLAC standards require that G-SIBs in developing countries - which includes China - meet a minimum threshold of 16% of their risk-weighted assets by January 1, 2025. For the first time, in its financial stability report, the PBOC admitted that the country’s outstanding financial and non-financial corporate bonds are close to 50% of GDP and might soon reach the FSB’s 55% trigger for an accelerated implementation of TLAC requirements. A number of bankers already believe that China is close to the 55% limit, FinanceAsia reported on September 11.
“The People's Bank of China's (PBOC) 2018 Financial Stability Report underlined that capital positions across much of the banking sector would be vulnerable under stress, which reinforces our view that bank capital would act as a significant constraint against more aggressive policy easing,” the Fitch report said.
This implies that China’s Big Four banks could face implementation of TLAC requirements ahead of the January 1, 2025 timeline, said Fitch. “Chinese G-SIBs will have difficulty meeting minimum TLAC requirements amid the obstacles to large-scale domestic TLAC issuance.”
The PBOC’s report admitted as much itself when it said there is “a rather significant TLAC gap” among the Big Four banks and that they “face great pressure in meeting TLAC requirements”. The PBOC and ratings agencies have not given an explicit number for this TLAC shortfall because of political sensitivities.
A Moody’s report on November 8 has estimated, however, that the Big Four banks’ risk-weighted assets totaled Rmb57.6 trillion ($8.2 trillion) at the end of the third quarter. The four banks themselves disclosed they hold a total of Rmb6.4 trillion of capital beyond capital buffers as at the end of that period. Using these data, a simple calculation suggests the Big Four banks fall short of TLAC requirements by Rmb2.8 trillion ($402 billion).
“In the near future as soon as possible, the G-SIBs must top up their capital, reduce business growth, securitize their assets,” said the PBOC report. “They must issue TLAC-standard bonds as soon as possible.”
The Big Four banks are likely to issue TLAC bonds on a scale far greater than previous years. Since 2016, only one Chinese TLAC bond has been issued, which was the BOC’s $3 billion 5.9% perpetual non-call five TLAC bond on September 11, according to Dealogic.
The PBOC said that China’s domestic non-bank investor base of bank-issued bonds needs to expand significantly to enable the country’s total TLAC bond issuance to reach sufficiently large levels. A successful implementation of TLAC standards, it said, would fuel the development of the non-bank institutional investor base for China’s domestic bond market.
Mutual funds are the largest buyers of bonds from Chinese commercial banks. According to Moody’s, at the end of Q3 they took 50.3% of bonds issued by commercial banks.
On a positive note, Moody's argues that the implementation of TLAC is credit positive for these Big Four banks’ depositors and senior debtholders. And TLAC bonds which are issued will not only recapitalize the banks, they will also provide a larger cushion to absorb losses.
