BOFIT Viikkokatsaus / BOFIT Weekly 2019/06

The central bank and The China Banking and Insurance Regulatory Commission (CBIRC) gave the green light last month to the issuance of “perpetual bonds” by commercial banks. The first issue of perpetual bonds by the Bank of China on January 25 was valued at 40 billion yuan (USD 6 billion).

The issuance of perpetual bonds should help recapitalise banks (additional Tier 1), and thereby help them increase lending. The government’s main motivation is concern over banking sector stability as particularly some smaller Chinese banks are barely able to meet their minimum reserve requirements. The reduction in the use of off-balance sheet shadow banking sector instruments has boosted traditional bank balance sheets, which also necessitate further reinforcement of capital buffers. In its latest financial stability review, the IMF urged China to increase capitalisation of its banking sector.

Like many other bonds with good credit ratings, commercial banks can use perpetual loans as collateral with the central bank. To boost demand, the CBIRC will also allow insurance companies to invest in perpetual bonds issued by banks. Further, the People’s Bank of China has introduced a new policy instrument that allows financial companies to swap perpetual loans issued by solid banks for PBoC bonds for up to three years at a time. The central bank bonds acquired in such swaps cannot be traded, but can be used as collateral for PBoC credit facilities.

The purpose of promoting this complicated swap arrangement is ultimately to support recapitalisation of banks. Swap operations are not a reflection of an easing of the monetary stance. The PBoC will not purchase the perpetual bonds of commercial banks, but only swaps them temporarily for its own bonds which are, at least for the time being, believed to be more attractive to investors than initial perpetual bonds.

In the recent public discussion of China’s economic predicament, the inability of loose monetary policy to promote high growth has been one of the topical issues. According to media reports, the PBoC recently directed commercial banks to maintain their leading growth and volume of new lending at least at the same level as in the same period last year. While the PBoC has offered the banking sector substantial liquidity, the economic slowdown has depressed corporate borrowing demand and the willingness of banks to lend to riskier corporate borrowers. In such case, excess liquidity tends to flow elsewhere than the real economy.