Can China’s new Basel-based capital rules prevent a Silicon Valley Bank-style incident?

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China has just seen the release of new capital adequacy rules for commercial banks, prompting speculation from domestic economists as to the likely impacts on the financial system. 

On 1 November, China’s National Administration of Financial Regulation (NAFR) released the “Commerical Bank Capital Management Measures” (商业银行资本管理办法), as part of efforts to bring capital adequacy requirements for Chinese banks more in line with the Basel III standards set by the Bank for International Settlements (BIS). 

The move comes following the release of a draft version of the Measures on 18 February for the solicitation of opinions from the public. Differences between the official Measures and the draft version have since prompted much commentary from domestic observers. 

Capital requirements differ based on banks

Zeng Gang (曾刚), chair of the Shanghai Institution for Finance & Development, said the release of the Measures was part and parcel of increased efforts by Beijing to achieve “comprehensive regulation” of the financial sector. 

“The implementation of the new capital regulations is an important measure for fulfilling the call of the Central Financial Work Conference to comprehensively strengthen financial supervision,” Zeng wrote

“It is also an important starting point to guide the banking industry to better serve the high-quality development of the economy.”

While based on Basel III requirements, Zeng points out that the new Measures apply differentiated requirements to the Chinese banking sector depending on the nature of various financial institutions. 

“The new capital regulations are based on the outcomes of international regulatory reforms (Basel III) in tandem with China’s actual national conditions, in order to comprehensively improve capital regulation,” Zeng writes. 

“First-tier banks fully benchmark the international standards of the Basel Agreement, strictly implement high standards, and fully apply the second and third pillars,” Zeng writes. 

“The capital measurement rules for second-tier banks have been partially simplified to be more in line with the reality of small and medium-sized lenders.

“A third tier of banks includes most smaller rural commercial banks and rural lenders. The new Measures have significantly reduced the capital requirements for banks in this tier, greatly simplifying their compliance costs and guiding them to focus on county-level markets and small and micro businesses.”

Despite the differentiated nature of Basel III requirements as applied by Chinese authorities, Zeng highlighted their determination to use the regulations as a tool for preventing banking crises even in China’s regional markets. 

“The bottom line of risk that financial institutions must guard cannot be relaxed…the new measures apply consistent capital quality standards to all banks,” Zeng wrote. 

“Third-tier banks implement simplified risk assessment, capital planning, stress testing and monitoring reporting procedures, which fundamentally prevent the possibility of cases like Silicon Valley Bank from occurring in China.”

Guosen Securities foresees only modest impact on Chinese banking

Wang Jian (王剑), chief financial sector analyst at Guosen Securities, says the official version of the Measures differ only moderately from the draft version, and will not have a drastic impact on banking sector operations. 

“Compared with the previously issued draft version, overall the Measures are slightly relaxed,” Wang wrote. 

“We believe that after the implementation of the new capital regulations, the capital adequacy level of the banking industry is expected to be stable overall and this will have little impact on the sector.”

Wang nonetheless highlights a number of changes from the draft, particularly in relation to the weighting of home loans and equity holdings.  

  1. The risk weighting of personal housing loans has been significantly reduced for first-tier banks. Where the loan-to-value ratio is 50% or less, the risk weighting in official Measures is now 20%, as compared to 40% in the draft. Similar reductions are applied to other loan-to-value ratios. 
  2. The risk weighting for industrial and commercial enterprise equity investment has been reduced from 400% to 250%. The same reduction applies to equity eld in industrial and commercial enterprises following market-based debt-equity swaps, as well as “equity investment that is subject to major state subsidies and subject to government oversight.” 
  3. The credit conversion factor for domestic letters of credit for trade in services has been reduced from 100% to 50%.