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China's New Capital Rules Will Ease Strain On Banks Ahead Of TLAC Rollout


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China's New Capital Rules Will Ease Strain On Banks Ahead Of TLAC Rollout

HONG KONG (S&P Global Ratings) Nov. 10, 2023--China's new bank capital rules will be less onerous than the draft measures proposed in February. The recent changes will likely mitigate strains on Chinese banks' capital buffers amid declining profitability, and help them address their TLAC gap (see "China's Major Banks Still Have An RMB3.7 Trillion Shortfall On TLAC Requirement," Jan. 18, 2023).

The National Administration of Financial Regulation introduced the rules on Nov. 1 to more accurately reflect banks' lending risks. The measures will also bring the country's banking system broadly in line with Basel 3 standards.

The final version allowed a handful of meaningful relaxations. It reduces banks' regulatory capital charges on certain residential mortgages and equity holdings. "China's new capital rules may channel bank resources to policy-supported initiatives," said S&P Global Ratings credit analyst Michael Huang.

We expect the new capital rules will continue to address emerging strains in the Chinese banking industry (see "China's Tightening Capital Rules To Hit Aggressive Banks," Feb. 22, 2023).


The regulators have reduced the risk weights of residential mortgages that meet prudential requirements, from the draft measures for tier-one banks. Among other steps, the rules stipulate that:

  • Risk weights are lowered to 20%-50% from 40%-75%, for residential mortgages not relying on rental income, when the loan-to-value ratio (LTV) is below 100%; and
  • Risk weights are lowered to 30%-75% from 50%-105% for residential mortgages relying on rental income, when the LTV is below 100%.

Significantly, the final rules are not just a relaxation from the February draft proposal, they are somewhat less strict than the existing standards. Most banks' residential mortgage LTVs are below 80%, which will subject them to below 50% risk weights under the new rules. This is compared with a uniform 50% risk charge under existing capital rules.

"We believe the Chinese regulators want to balance the need for robust risk controls without placing excessive burden on the banks, given they play an instrumental role in supporting the economy," said Mr. Huang. "The eased capital charges do not make it easier for developers to borrow from banks, but it does reduce some burden for banks as they charge lower interest rates on homebuyers seeking a mortgage."

We believe the changes will be generally favorable to Chinese banks. Those lenders with prudent underwriting standards and lower LTVs will likely enjoy incremental capital savings.

The new rules also loosen the capital charges on certain equity holdings in nonfinancial corporates to 250% from 400%. Some of the holdings are policy-oriented or associated with resolving asset risks (such as debt-to-equity swaps).

The new rules raise charges on subordinated claims of financial institutions to 150%, in line with Basel 3 requirements. But officials maintained the regulatory risk weighting for the subordinated debt of policy banks at 100%.

"The risk weighting supports policy banks' fundraising to facilitate government initiatives, while still meeting the regulators' aim to reduce contagion risk among commercial banks," said S&P Global Ratings credit analyst Ming Tan.


We assume that China's global systemically important banks (G-SIBs) need to raise Chinese renminbi (RMB) 2.4 trillion in total loss-absorbing capital (TLAC) before January 2025, to satisfy regulatory requirements. China's G-SIBs are Industrial and Commercial Bank of China Ltd., China Construction Bank Corp., Agricultural Bank of China Ltd., and Bank of China Ltd. The lenders are also known as China's 'Big Four' banks.


A combination of proactive issuance of regulatory capital instruments and a pivot to less capital-intensive exposure could help the G-SIBs bridge their TLAC gaps.

We nonetheless expect the TLAC capital gap to grow, mainly driven by Chinese G-SIBs' fast risk-weighted asset (RWA) growth and weak profitability amid a lackluster economic recovery.

But the new capital rules help reduce RWA growth by lowering risk weightings. The new rules also allow incremental capital savings under the internal rating-based approach, under which the RWA output floor will be lowered to 72.5% of RWA versus 80% under the standardized approach.

We test the TLAC funding pressure in different scenarios and focus on the annual RWA growth rate and return on average assets (ROAA) of the Chinese G-SIBs.

TLAC gap sensitivity analysis
Big Four banks' combined TLAC gap (Tril. RMB)* for different ROAA and RWA scenarios
Average annual RWA growth rate§
7.5% 9.0% 10.5% 12.0% 13.5%
Average ROAA§ 0.6% 1.86 2.34 2.84 3.34 3.84
0.7% 1.65 2.14 2.63 3.13 3.63
0.8% 1.45 1.93 2.42 2.91 3.42
0.9% 1.25 1.73 2.21 2.70 3.20
1.0% 1.05 1.52 2.00 2.49 2.99
*TLAC gap refers to the volume of TLAC capital these banks need to raise by January 2025. §Average for 2023 and 2024. RWA--Risk-weighted assets. ROAA--Return on average assets. RMB--Renminbi. Source: S&P Global Ratings.

We expect the major banks to expedite the issuance of TLAC-eligible instruments to plug their funding gap, as TLAC implementation begins in about a year. Senior nonpreferred debt could play an increasing role in TLAC conformance for Chinse G-SIBs, given their cheaper funding costs. It is also a likely substitute for some mature senior unsecured debt without adding much to debt leverage.

Traditional Tier-2 and additional Tier-1 (AT1) instruments will continue to be key to replenishing immediate shortfalls. The Big Four banks collectively have unused Tier-2 and AT1 quota of about RMB1 trillion as of end-September 2023, by our estimates.

The regulators allow a two-year phase-in period for Chinese banks to beef up their reserves for nonloan exposure, and a five-year period for pillar three disclosure (a framework that promotes market discipline and transparency via public disclosure) when the rules become effective on Jan. 1, 2024.

Editor: Jasper Moiseiwitsch

Related Research

This report does not constitute a rating action.

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Primary Credit Analysts:Michael Huang, Hong Kong + 852 25333541;
Ming Tan, CFA, Singapore + 65 6216 1095;
Secondary Contact:Ryan Tsang, CFA, Hong Kong + 852 2533 3532;
Research Assistant:Birao Fan, HANGZHOU

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