China Begins Major Bank Bailout To Combat Crippling Economy

China Begins Major Bank Bailout To Combat Crippling Economy

After the credit crunch of the last decade, Chinese banks are suffering. They are over-indebted, under capitalized and so cluttered with unproductive loans that they struggle to lend. Now the People’s Bank of China (PBC) has decided to solve them. The PBC managed to announce the bailout on January 25th without revealing that it was actually a bailout. In order to improve the liquidity of the perpetual bonds of the banks (including the non-term capital bonds) and to encourage the banks to rebuild their capital by issuing bonds in perpetuity, the People’s Bank of China (PBC) decided to launch the Central Bank Swap Bills (CBS).

Major traders in open market transactions can exchange perpetual bonds issued by qualified banks for central bank bonds with PBC. And the perpetual bonds of banks rated at least AA will be included as eligible collateral for a Medium-Term Loan Facility (MLF), a Medium-Term Targeted Loan Facility (TMLF), permanent loan and loans to the central bank. It’s about recapitalizing the banks and not just providing liquidity support.

What Caused The Bailout

The reason for this is a bailout, and not just prompting banks to recapitalize, is hidden in the dense central bank that talks about the remaining phrases in the press release. According to the PBC, the banks must have sufficient capital to guarantee sustainable financial support to the real economy, and an important way to rebuild their Tier 1 capital is to issue bonds with an indefinite term. The Central Bank Bills Swap (CBS) allows financial institutions holding perpetual bonds to have more high-quality collateral, improves the liquidity of these bonds in the market and increases the market’s willingness to buy them, thereby encouraging banks to rebuild their own funds by issuing perpetual bonds, creating favorable conditions for increased financial support to the real economy.

This is not entirely clear either, because perpetual bonds do not have to be repaid, they are treated more like equity in bank balance sheets. Like preferred shares and convertible bonds, they can be part of additional Tier 1 or 2 capital. Banks can recapitalize by issuing perpetual bonds. The PBC wants Chinese banks struggling to build their capital by issuing perpetuals, which they had not done before.

Investors Wary

But although Chinese banks seem to want to issue perpetual bonds, investors are cautious. So, the PBC provides a backstop. It does it in two ways – banks and financial institutions can exchange assets in perpetual bonds for very liquid credit, which they can then use as collateral to obtain financing and banks can pledge perpetual assets (of sufficient quality) to the PBC in exchange for financing. Of course, it would only be collections of perpetual documents. Banks should always find buyers for new perpetual bond issues.

By a remarkable coincidence, the same day the PBC announced its plan, the China Banking and Insurance Regulatory Commission (CBIRC) announced that it would allow insurance companies to invest in perpetual bonds issued by banks. This completes the loop. Banks can issue perpetual bonds and insurance companies can buy them, knowing that they can exchange them with the PBC for liquid and safe invoices. At first glance, this looks remarkably like other mechanisms designed by central banks to obtain loans from banks.

The purpose of this scheme is recapitalization, not just funding. And one way or another, a lot of perpetual links will end up being featured in the PBC books. So, in fact, the PBC is recapitalizing banks under arm’s length conditions. The reason for the big bailout of Chinese banks is clear. China’s economy is weakening and its banks are not in a position to support it. As the head of the PBC says, banks in the recapitalization phase should release them to lend more to the real economy, provided that the demand exists.

About Varun Seepathi 40 Articles
With an experience of over 3 years, Varun Seepathi has aided more than 50 medium to small and large firms for foraying into new markets, by increasing footprint in the existing bracket and understanding the ins and outs of these beasts. These beasts are the companies which have been exclusively engaged in materials, chemicals or packaging activities, and have encountered restraints either in the maintenance of P&L or in beating their competitors. He has also authored more than 300 research papers relating to the industry which consist of crucial information such as addressable serviceable market, strategies of players, growth of the market, market size, forecast, market share estimations and winning strategies along with opinions on the same. The “three slope distributor/off-taker evaluation model” currently in use by a lot of multinational companies has also been pioneered by him. A mood driven writer, a professional consultant, and a born explorer, Varun Seepathi is currently working as a full-time consultant. Healthcare, wealth management and information technology are some of the verticals of the industry where he has demonstrated his skills.