China Tightens Bank Liquidity Rules, but Risks Remain

China Tightens Bank Liquidity Rules, but Risks Remain

The FINANCIAL -- Fitch Ratings-Hong Kong/Singapore - The China Banking Regulatory Commission's (CBRC) recent measures signal a strengthening of liquidity management in line with Basel III norms, but the credit benefits will take time, says Fitch Ratings.


It is unclear if the regulations will sufficiently address liquidity issues arising from the banks' growing off-balance sheet activities, or will deal with current concerns about the impact of rising bad debt exposure. Moreover, the targets are progressive (in line with Basel), and full compliance is not expected before 2018, according to Fitch Ratings.

For the first time, the authorities issued guidelines around banks' liquidity cover ratio (LCR) - the amount of liquid assets to cover for cash outflows in a stressed situation. Chinese banks do not currently disclose LCR, but the CBRC regulations will require this to be shored up to 100% of cash outflows by 2018. The new regulations also require commercial banks' liquidity ratio - which is the proportion of liquid assets (to total assets) - not to fall below 25%, while they are already obliged not to exceed a loan/deposit ratio of 75%.

However, we think it is too early to conclude whether strengthened liquidity regulations will address the ongoing mismatches evident among off-balance sheet exposures and obligations (explicit and contingent). The regulations do not specifically target off-balance sheet items per se, and it is unclear how the new rules in themselves will significantly reduce such activity. The loan/deposit cap has already encouraged risk-taking in areas that are often out of the regulatory purview. Additional administrative measures - or regulatory controls - may therefore be necessary.

Moreover, the CBRC's latest measures remain unaccompanied by steps to quicken the pace of NPL recognition, and which are one of the sources of strain on domestic liquidity. As previously highlighted in our research, the ever-greening of older, unpaid loans has weighed on banks' ability to extend new credit; and this has become a growing contributor to the periods of liquidity tightness that certain banks may experience. Meanwhile, reclassification of exposures (such as interbank) can make it difficult to assess the true extent of liquidity risk. Any further pressure on profitability will also drive liquidity strains, although this is a less pressing credit concern.

The introduction of tougher liquidity regulations could still prove to be credit supportive in so far as it ultimately instills greater discipline in credit exposure decisions, enhances their liquidity profile and boosts system-wide stability. Moreover, better asset/liability management will eventually address liquidity stresses. Nonetheless, to be successful, regulations also need to target the key credit issues (such as the banks' wealth management product activities) but which also remain challenging - given the scope of reliance by the banks on such activity, and the limited transparency.

As a backstop, the central bank holds a large pile of bank reserve deposits. Aside from open market operations to limit excessive strains, any reduction in the required reserve ratios could also have the potential to inject considerable liquidity into the system, according to Fitch Ratings.