An ailing Chinese bond market could drive the profits of Beijing’s massive policy banks into negative territory.
China’s bond market has been in free fall of late, with the 10-year sovereign bond yield leaping to its highest level in three years in mid-November, breaching the 4% threshold.
Debt issued by the country’s policy banks have been even worse affected, with yields on China Development Bank’s 10-year bonds rising past 5% on Wednesday for a total increase of 70 basis points this quarter.
The spread between CDB debt and sovereign bonds of equivalent maturity has expanded to nearly 1 percentage point, which is unusual given its status as a state-owned bank that operates at the behest of central government policy.
China’s two other policy banks – the Agricultural Development Bank of China and the Export-Import bank of China, aren’t faring much better, with the latter’s 10-year yield leaping to 5.1% this week, prompting the delay of a 10 billion yuan bond auction.
Given that rises in lending rates tends increases in bond yields, a prolonged debt market slump could severely hamper the profitability of the policy banks, and even necessitate recapitalisation measures by Beijing.
“If this goes on — for instance one or two more years — they’ll definitely lose money,” said Shilei, chairman of Shanghai-based Attractor Adviser Ltd., to Bloomberg.
“If they see large losses they’ll need the Ministry of Finance to replenish capital.”
The rise in yields adds further to existing pressure on policy banks, with Beijing recently unveiling tighter regulation due to risk concerns.
The China Banking Regulatory Commission has just launched new measures to contain risk exposure for the policy banks, mandating that they strengthen their governance systems and establish capital constraints based on capital adequacy ratios from the start of 2018.
Any Ill-health amongst the policy banks could have wider repercussions given their immense size and influence, with CDB holding assets of 14.3 trillion yuan at the end of last year.
According to Nomura Holdings analysts CDB has recently emerged as “the main financial force behind quasi-fiscal stimulus and local government in infrastructure construction in recent years,” while the tighter regulation of policy bank recently flagged by Beijing could “[result] in slower monetary base and infrastructure growth.”