Analysis: Debt-laden China's local governments scramble to rescue small banks with $21 bln in special bonds

Shengjing Bank Co

28/11/2023 23:00

By Ziyi Tang and Ryan Woo
       BEIJING, Nov 29 (Reuters) - Local governments in China
have sold record amounts of so-called special bonds this year to
inject capital into struggling smaller banks, as authorities
seek to contain spillover risks from a deepening property crisis
and a sputtering economy.
    Special-purpose bonds are a form of off-budget debt
financing used by local governments in China, with the proceeds
raised typically earmarked for specific policy goals, such as
spending on infrastructure projects.
    Local governments plan to use the proceeds of the latest
bond sales to purchase equity or convertible bonds from smaller
banks, most of them state-owned, effectively recapitalising
them, according to the deal prospectuses.
    The governments have raised 152.3 billion yuan ($21.05
billion) via such bonds so far in 2023 to replenish the capital
of small and medium-sized banks, according to data from the
official China Electronic Local Government Bond Market Access.
    But total funds raised so far are modest compared to the
banks' needs, analysts say. 
    China's small, regional banks would need to address a
capital shortfall of an estimated 2.2 trillion yuan based on a
scenario where up to 20% of regional lenders face capital
inadequacy, according to an October report by S&P Global
Ratings.
    Highlighting Beijing's push to avoid a financial crisis like
the one in 2008, the value of special-purpose bonds issued this
year is already more than double the 63 billion yuan issued in
2022, and is the highest on record since such instruments were
introduced in 2020 to help smaller lenders impacted by the
COVID-19 pandemic.
    The trend highlights how more and more of the country's
smaller banks are being propped up with government support, amid
a deepening crisis in the property market, which accounts for
about a quarter of the economy.
    Authorities have been ramping up measures to support real
estate, including relaxing home purchase restrictions and
lowering borrowing costs, although these have failed to shore up
a meaningful recovery.
    The People's Bank of China (PBOC) and the National Financial
Regulatory Administration (NFRA) did not respond to Reuters
request for comment.           
    
    DEEPER IN DEBT
    The intensified efforts to support smaller banks also come
amid growing worries about the impact of ballooning local
government debt on the economy. 
    Local government debt reached 92 trillion yuan ($12.6
trillion), or 76% of China's economic output in 2022, up from
62.2% in 2019, according to the latest data from the
International Monetary Fund.
    While policymakers are highly concerned over rising debt
levels, Beijing has little option but to support smaller banks
to contain spillover risks, analysts said.
    "It is important to avoid any failures of even the smallest
institutions, as a single failure could generate knock-on
effects and spread financial contagion to other financial
institutions," said Gavekal Dragonomics researcher Zhang Xiaoxi.
    It was not immediately clear if the central authorities had
given any guidance to the local governments on recapitalising
smaller banks, and who were the buyers of these special-purpose
bonds.
    Some provinces are accelerating plans to reform and defuse
risks at local, high-risk small and medium-sized banks and to
replenish capital via multiple channels, central bank governor
Pan Gongsheng said in Beijing earlier this month.
    
    CONTAGION RISK  
    Local governments and banks are fundamental to China's
economy, with Beijing tasking provincial and city officials with
meeting ambitious growth targets. 
    But after years of over-investment in infrastructure,
plummeting returns from land sales, and soaring COVID costs,
economists say debt-laden municipalities now represent a major
risk to the world's second-largest economy.
    The issuance of fresh debt by the local governments to
recapitalise banks, coming at a time when their own liabilities
are growing rapidly, could make the financial balancing act for
municipalities even more precarious.
    On top of $21 billion raised so far this year, the Henan
provincial government last week announced a plan to issue 28.2
billion yuan worth of special purpose bonds to recapitalise 26
local banks, according to the government website.
    
    WEAK LINKS
    Smaller regional banks are the weak links in China's $61
trillion financial sector, due to their industrial, sectoral and
geographical concentration, opaque governance, and lack of
stringent regulatory oversight.
    As of end-September, China's rural commercial banks reported
a 3.18% non-performing loan ratio with city commercial banks at
1.91%, data from the NFRA showed, higher than the average of
1.61% in the banking sector. 
        Many analysts believe the real amount of soured loans is
far higher.
    Smaller Chinese banks face greater challenges in raising
funds to replenish their balance sheets compared with their
large peers, because of their lower creditworthiness, limited
operating scope and risk profiles.
    Among the top issuers of the special bonds this year are
debt-laden provincial governments in Liaoning, Yunnan and the
government in Inner Mongolia region, which aim to use the
proceeds to recapitalise local banks.
    Regional banks operating primarily in weaker regions heavily
exposed to indebted local government financing vehicles bear
higher credit risks than their peers in wealthy regions, S&P
analysts said in last month's research note. 
    "Local governments are a likely the first line of defense
whenever regional banks become stressed," they said.
"Nevertheless, we expect local-government support to strained
lenders will be selective."

 (Reporting by Ziyi Tang and Ryan Woo; Editing by Sumeet
Chatterjee and Kim Coghill)
 ((Ziyi.Tang@thomsonreuters.com;))