[HONG KONG] Chinese officials are rushing to introduce a new form of bail-in debt as early as this year as the country's biggest banks face a capital shortage that could run close to US$1 trillion.
Bankers say China's four largest lenders are under pressure to begin boosting their total loss-absorbing capacity (TLAC) in months, rather than years, as faster credit growth and rising bad loans have added to the amount of capital they need to comply with international standards for systemically important banks.
Chinese banks have until 2025 to meet the first TLAC hurdle, but this newfound urgency has raised expectations that the first senior bonds that count towards the requirements may arrive as early as the end of this year.
"I think what has happened is that they have looked at how much capital needs to be raised, and realised that they need to start moving," said a Hong Kong-based debt capital markets banker specialising in financial institutions.
"Each time I'm in China the regulators are always asking how we should do this, and it's clear that they are working hard to get something set up soon."
Global banking regulators estimated the TLAC shortfall of China's four global systemically-important banks at US$387 billion last November, when they extended the requirement to build up a bigger capital buffer to Agricultural Bank of China, Bank of China, China Construction Bank and Industrial and Commercial Bank of China.
A few weeks later, Moody's came out with its own estimate of US$584 billion, far larger than a US$115 billion funding gap for US banks and a US$201 billion requirement for European banks.
Nevertheless, bankers still said at the time that China's G-SIBs were in no rush and expected that it would be years before any new TLAC-eligible bonds emerged, since the Chinese banks had until 2025 to raise their TLAC buffer to 16 per cent of risk-weighed assets and until 2028 to hit the final ratio of 18 per cent - six years longer than major banks elsewhere.
Bankers now say that earlier forecasts had not sufficiently accounted for the expected growth of Chinese banks' balance sheets over the next decade. Factor that in, they say, and the TLAC bill could be as high as US$1 trillion.
"The 2025 TLAC deadline may seem a way away, but the sheer volume of capital required means Chinese G-SIB banks needed to start raising yesterday," said Brian Weintraub, head of financial institutions capital markets for Asia at Deutsche Bank. "With forecast asset growth, organic capital generation and TLAC requirements, there's a growing realisation that banks need to start planning now because of the sheer volume of capital required over the next nine years," he said.
The first challenge for Chinese regulators is to decide how they want the system to work.
While China's banks have been issuing Additional Tier 1 and Tier 2 securities since 2013, current laws make no allowance for writedowns of senior bondholders.
Their options include creating bank holding companies to make senior creditors structurally subordinated, as has been done in the UK, Switzerland and US, or amending insolvency laws so that all senior bank debt can be bailed in.
Another option is the creation of a Tier 3 system, where a new class of bonds could absorb losses after junior debt but before any other senior liability. Variations of this are on the table in peripheral European countries. Chinese regulators, however, are said to have shown little interest in Tier 3.
Bankers seem to agree that amending the insolvency law to rank all senior bondholders below depositors, similar to the approach Germany took, is the most likely route for China. While the holdco structure is also considered a possibility, it would require much more time to implement, as nothing of the sort currently exists in China.
Should China follow the German model, existing senior bonds would qualify as TLAC, alleviating some of the pressure on banks to issue more capital. However, the level of cross holdings between the big banks (which must deduct TLAC investments from their own ratios) would still leave them with a large hole to fill.
In theory at least, China could decide to ignore the global rules set by the Financial Stability Board and the Basel Committee on Banking Supervision, which have no legal force unless they are incorporated into domestic rulebooks. However, the sense of urgency reported by China bankers shows that the mainland's officials are taking the challenge seriously.