China announced its plans for recapitalizing the largest of its commercial banks, a move that will help it address financial concerns. This is a first in more than a decade.
This initiative aims to boost a struggling banking industry that is suffering from record low margins, declining profits and growing bad loans.
In a rare Tuesday press conference, Chinese regulators laid out a number of steps to help the six largest commercial banks in China, such as increasing their core Tier 1 capital.
The first time since 2008 that the authorities have recapitalized these banks, it is the first capital infusion since their public company status.
Six major banks receive a boost in core capital
Li Yunze announced recapitalization plans. He stated that different banks will receive capital at different times. However, he did not provide any further details.
Li’s goal is to improve capital management and the operations of banks so that they can support China’s economy better.
Li explained that the recapitalization will be a mix of both internal and external channels for raising capital.
This move is part of an overall strategy designed to maintain stability in China’s financial sector. The banking industry plays a crucial role in managing risks and driving economic growth.
Six banks are targeted for capitalization: Industrial & Commercial Bank of China Ltd.
State-owned commercial banks have relied traditionally on retained profit to boost their capital base, but fee cuts and declining margins are putting pressure on balance sheets.
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This recapitalization is taking place at a moment when profitability in China’s banking industry has been severely impacted.
The combined profits of the commercial banks in the United States increased only by 0.4% during the first six months of 2023. This is the lowest growth rate since 2020.
The slowing growth was exacerbated due to the falling net interest margins. These dropped down to an all-time low of just 1.54% at the end of the month of June, well below the threshold of 1.8% that is considered essential for maintaining a sustainable profit.
At the end of last month, core Tier 1 capital ratios of six of the largest banks, which is a key indicator of financial stability, were on average 11.77%.
This figure is still above the minimum 8.5% requirement set by China for its systemically significant banks. However, the trend has been downwards, raising concerns about further decreases that could threaten the stability of China’s financial system.
Li Yunze’s remarks echoed this concern, noting how the banks may struggle to offer the same amount of assistance to China’s economic growth without more capital.
This recapitalization plan aims to reduce these risks, by making sure that banks are adequately capitalized to absorb losses while supporting lending.
Economic measures that support the recovery
This recapitalization was announced as part of an broader stimulus package that Chinese authorities unveiled to stabilize the real estate and boost economic growth.
One of the most important measures included a general reduction in mortgage rates. This is expected to reduce annual interest costs by about 21 billion dollars or 150 billion yuan.
The mortgage rate reduction also puts pressure on banks, as it reduces their loan income.
In order to counteract the effect of mortgage rate reductions, regulators announced a reduction in the required amount of reserves that banks must hold as well as the lowering of the main policy rate.
The adjustments will help offset the loss of revenue due to mortgage rate reductions.
Pan Gongsheng, Governor of People’s Bank of China addressed concerns regarding the impact of interest rate changes on the profitability of banks. He stated that these adjustments would have a positive effect.
By reducing the interest rates on loans, the bank’s profits will be protected.
Banks are looking to improve their performance amid difficult conditions
Some of China’s largest banks experienced a positive stock market reaction following the announcement.
Bank of China shares rose 4.2%, while ICBC’s, China’s largest commercial bank, saw their stock rise by 5.2%.
Analysts believe that this recapitalization is a sign of the Chinese government’s intention to stabilize its banking system and to send a message positive to the markets.
Analyst Liao Zhiming at Huayuan Securities Co. said: “This recapitalization program shows regulators taking action in order to deal with the pressures on banks, and make sure they are a reliable source of service for the real economy.”
However, challenges remain. China’s banking sector is also facing a growing number of non-performing (NPL) loans, particularly within the real estate industry.
In recent years the financial health of developers has declined, leading to an increase in bad loans.
The banks have been forced to increase their provisions for losses on loans, reducing profits further.
The process of recapitalization could last several years
The commercial banking sector in China is still under pressure as it prepares for a possible recapitalization that may take several years.
China’s banking sector is expected to remain cautious as it navigates an ever-changing financial landscape, due in part to the combination of falling profitability, increasing bad debt and economic uncertainties.
The recapitalization program also highlights the important role played by China’s commercial state banks in its economy.
Injecting new capital into these financial institutions signals the regulators’ commitment to maintain stability within the system even though broader risks are continuing to rise.
As new information becomes available, this post China recapitalizes major banks after profits fall and bad debt increases may change.
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