The "Interlinking Policy" on Credit Controls

The staggering amount of credit issued in the first week of 2010 coupled with the steady recovery of the macro economy, particularly the export sector, have caused China's regulatory authorities to finally put the brakes on new credit issuance.

Beginning January 10, the China Banking Regulatory Commission (CBRC) convened three meetings over the span of the week.

On Monday of last week, the CBRC issued a statement aimed at the credit blowout of major banks during the first week of 2010.

A three day long annual working conference then convened on Friday. During the conference, the CBRC stressed the urgent need for financial institutions in the banking industry to balance issuance of credit, match up with the restructuring of the national industry structure, supervise the intended use of loans and strictly control the flow of capital.

At the same time, the CBRC called together high level officials from China's major commercial banks to convene the Q4 economics and finance workshop and discuss detailed regulatory requirements.

On the evening of January 12, the People's Bank of China (PBC) made a surprising announcement that effective immediately the deposit reserve ratio would be raised by half a point to 16 percent. An insider at the central bank told Caixin that the momentum building for a world economic recovery is already an undisputable fact.

The move by the central bank signifies that last year's radical strategy of allowing banks to issue 10 trillion yuan in new loans to stimulate economic growth would be revised in 2010.

At the CBRC's annual working conference, officials formulated a principle of "don't say, just do" towards the amendment. A regulatory official explained the purpose of this action: "just do" refers to strengthening banks' execution of credit control measures while "don't say" refers to preventing banks from claiming local government pressure as an excuse to stall. At the same time, how regulatory institutions will go about helping financial institutions in the banking industry realize sustainable development while simultaneously supporting economic development became another focal point of discussions.  

History Repeats Itself?

Authoritative data shows that within the week from January 4 to January 8, five large state-owned commercial banks including the Industrial and Commercial Bank of China, the Agricultural Bank of China, Bank of China, China Construction Bank and Bank of Communications loaned out over 280 billion yuan. Furthermore, newly increased loans in the entire banking industry for the week reached 600 billion yuan.

If this pace keeps up, there is potential for the banking industry to surpass the total of 1.62 trillion yuan in new credit issued last year in January, a fact that is raising concern among the central bank and regulatory authorities.  

After the statistics on credit for the first week of 2010 were disclosed, the central bank's moves to increase the deposit-reserve ratio and recent actions by regulatory authorities have begun to resemble the situation that occurred two years ago. 

In early 2006, acting to prevent the domestic economy from overheating, the central bank and the CBRC successively adopted a series of temporary control measures. In addition to repeatedly raising the deposit-reserve ratios for financial institutions, authorities also put into effect proportional quarterly controls on the pace of commercial bank lending.

However, a source from the central bank stated that the situation is different when compared to two years ago and the current goal is not to prevent the economy from overheating. Instead, because it is predicted that there will be numerous fluctuations in the economy in 2010, the goals for macro economic policy are simply to smooth out these fluctuations and balance the issuance of credit.

The above source added that from a policy perspective, the inertia of investment and loan issuance in Q1 tends to be the strongest, and during this period the central bank should increase supervision and form measures to counteract the market, otherwise subsequent policy measures will be at risk of becoming passive. But from a historical perspective, no matter if regulators are adjusting reserve requirements or regulatory controls, there has always been the notion that the measures are "paper tigers" that will not markedly influence bank loaning practices.

The source close to the central bank stated that some officials have suggested implementing separate deposit reserve ratio requirements to control credit issuance, or in other words notifying banks in advance that if in a short time loan issuances increase rapidly or conflict with CAR, bank reserve ratios will automatically increase.

A source close to the CBRC stated that regulators can also use other measures including evaluating the non-performing rate of bank loans and looking at CAR indicators to regulate the expansion rate of the risky assets of banks. These measures can also help to control loan risk and other off-balance sheet risk. 

Increased Pressure on Capital Controls

In response to the credit "blowout," on the evening of January 13 the CBRC publicly issued new requirements for banks' CAR. Even though the notification had already been distributed to commercial banks some time ago, the January 13 announcement serves to drive home the point. At the end of 2009, the CBRC required large banks' CAR be no lower than 10 percent and core CAR be no lower seven percent. Not long ago, the CBRC had already issued a CAR information guide to banks aimed at facilitating the use of standardized procedures and promoting cautious management.

A high-level official from a large commercial bank said that the new CAR requirements would force banks to re-assess risk and would have the deepest influence on operational risk, ultimately leading to increased financial pressure on large commercial banks in the future.

A high-level official from a share-owned commercial bank with an urgent need to replenish capital stated that if the bank couldn't complete financing as soon as possible, its day-to-day operations and business development would face serious pressure. At present a number of branch organizations are dealing with the situation of having project backlogs but at the same time not daring to lend. This is because as soon as the bank's CAR approaches the "red line," any business activities bordering on increasing risky assets will be subject to numerous restrictions.

Still, higher CAR requirements don't have to be an arduous challenge for banks. A source close to the shareholding organization of a large state-owned commercial bank said that in terms of the added risk that loan issuance has placed on capital, banks hold the highest proportion. Therefore, if banks can improve the quality of their lending, the positive influence on CAR would be significant.

An Ace in the Hole

Aimed at reducing inherent credit risk, regulatory departments recently brought out yet another "ace in the hole," deciding to test the issuance compliance of fixed asset loans for loans issued in the first half of January and find out whether or not banks have adopted the method of lender entrusted payment. Local banking regulators throughout the country will begin on-site investigations based on the "Tentative Measures for the Administration of Loans for Fixed Assets" that became effective beginning October 2009.

Lender entrusted payment refers to a kind of loan payment method where the lender transfers the loan proceeds directly to the ultimate payee. This method can reduce the risk of the borrower using the loan for a purpose other than what it was originally intended for.   

The above-mentioned regulations clearly stipulate that a fixed asset loan whose amount exceeds the total investment of the project by more than five percent or is over five million yuan is required to utilize the method of entrusted payment. 
    
Both regulatory and bank officials have stated that while these measures have the potential to bring about fundamental change in the industry, because they will challenge certain vested interests, the measures will be met with significant resistance.

Regulatory authorities discovered during a 2009 investigation that many enterprises divert bank loan funds to act as letters of credit or down payments for bank acceptance bills. Furthermore, along with the steady recovery of both the stock market and the real estate market, instances of credit capital violating regulations for use and flowing into real estate and stocks have begun to increase.

A source from a regulatory agency stated that the "Tentative Measures for the Administration of Loans for Fixed Assets" are in fact not a short-term policy action. However, a senior official from a large bank spoke bluntly saying that the implementation of the new regulations would likely cause shocks throughout the industry over the short-term. 

Still, a high level official from a state-owned bank stated that under the loose credit environment some borrowers already have the upper hand during negotiations.  Whether or they can accept this requirement and how to best regulate improper lending practices are the biggest challenges facing the new policy regulations. 

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