Chinese banks to have larger capital needs due to weaker organic growth and tougher regulations

This is the third report of the China Banking Series 2021. 

While the capital adequacy of Chinese banks seems to be relatively unaffected by the pandemic, this note warns of a worrisome trend stemming from rapid deleveraging and tougher regulations. In the third note of NATIXIS China Banking Series 2021, we analyze the drivers behind the potential capital needs for Chinese banks. 

On the surface, capital ratios of Chinese banks are above regulatory limits. But the pressure is now more apparent with lower profitability. First, core Tier-1 capital ratio has been falling for two consecutive years, which is the costliest type of capital to be funded externally. Second, regulatory changes, such as the pursuit of “interest concession”, have compressed net interest margin and profitability, even for large banks. Third, the deleveraging campaign is hampering asset growth and amplifying the gap between big and small banks.

For large banks, the biggest test comes from the total loss-absorbing capacity (TLAC). After many years of delay in implementation due to China’s emerging economy status, the big-4 banks eventually need to meet the requirement. Our estimate shows the capital gap will be at least RMB 3.5 trillion by 2028, assuming the big 4 banks can still generate enough organic capital growth to meet their asset expansion. But the final capital gap can widely fluctuate based on the growth of risk-weighted assets (RWAs) and profit generation.  

The dilemma is different for small banks. In previous years, small banks have been involving in riskier businesses as perceived by regulators, which has led to their growth in risk-weighted assets outpacing total assets. With the clampdown on shadow banking, small banks also feel the pressure to bring off-balance sheet items back to their books, which means higher capital need and limitation of further asset growth. Whether it is before or after the deleveraging campaign, small banks have been struggling to generate organic capital growth. Their difficulties to raise capital have forced local governments to issue bonds to support banks in their provinces, of which the issuance has almost doubled from RMB 27 bn in H2 2020 to RMB 42 bn in H1 2021.

Therefore, both large and small Chinese banks are going to face higher capital needs but for different reasons. Tougher regulations are at the core of capital needs for large banks, especially from the looming TLAC requirement. For small banks, deleveraging is painful and will bring higher pressure on capital demand. Local governments are helping but they will also need to step up bond issuance to seek funding. This means that the capital needs for banks will grow in 2021 and onwards.

Full report available for NATIXIS clients.