China’s doing something smart, learning from past mistakes (and those of others..)
Mechanisms to let equity and bondholders (and not taxpayers) take greater hits in case of a banking crisis..

China’s banking regulator plans to require lenders to set up procedures to allow them to restore their finances in the event of a crisis, a person with knowledge of the matter said.

Banks considered systemically important may have to adopt safeguards including selling debt that can be converted into equity, the person said, declining to be identified because the watchdog’s deliberations are confidential. Regulators will also be given broader powers to supervise those lenders’ decision- making and operations to help discover potential risks early, the person said.

China is seeking to avoid a repeat of its last banking crisis, when the government spent more than $650 billion over a decade to bail out banks after years of state-directed lending. Concerns about lenders’ asset quality resurfaced after credit expansion surged to 96 percent in 2009, prompting the banking regulator to push through more stringent capital requirements.

China’s major banks cut their combined bad-loan ratio to 1.15 percent as of Dec. 31 from 17.2 percent in 2003, when the China Banking Regulatory Commission was created, official data show.

Setting up “self-rescue” mechanisms is part of efforts to make sure equity and bond holders take greater responsibility for salvaging a bank should it encounter financial difficulties, the person said. One possible measure is selling “bail-in” debt, the person said without elaborating.

A CBRC official, who declined to be identified citing agency policy, said in a text message response to questions that the regulator is studying the issue of self-rescue mechanisms.

Law Revisions

The U.S. spent almost $500 billion bailing out its financial institutions during the global financial crisis, according to data compiled by Bloomberg. China holds majority stakes in its four largest publicly traded banks.

Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Agricultural Bank of China Ltd., Bank of China Ltd. and Bank of Communications Co. — the nation’s five largest lenders — are currently designated as systemically important by the Chinese government, the person said. Spokespeople for the banks either declined to comment or weren’t immediately available.

Regulators will have the power to decide when a bank in trouble must activate its self-rescue mechanisms, the person said. The government may seek revisions to China’s Commercial Bank Law to accommodate the new requirements, according to the person.

Global regulators spent the past two years devising ways to ensure taxpayers won’t be on the hook in the event of another banking crisis.

Hybrid Securities

The Basel Committee on Banking Supervision announced last month that hybrid debt securities need to include triggers that force banks to convert them into common stock or write them off, averting government bailouts by providing capital buffers that can fund a “bail-in” by stakeholders if a bank gets into trouble. Hybrid securities blend characteristics of equity and debt.

China’s systemically important banks may also be subject to higher liquidity standards than domestic competitors, and may be required to have lower concentration of loans to a single borrower, the person said.

Should a troubled lender’s own measures fail to revive it, the government would seek to broker an acquisition by a healthy bank to avoid the consequences of a closure, providing support with favorable tax and credit policies if needed, the person said. When public funds become necessary to rescue a bank, management will be held accountable, according to the person.

Capital Ratios

The CBRC may raise the five biggest state-controlled lenders’ capital adequacy requirement to as high as 14 percent, from 11.5 percent currently, if credit growth is deemed excessive, a person familiar with the matter said last month. That includes an additional 1 percent of capital charged on them to reflect their systemic importance, the person then said.

Chinese banks’ weighted average capital adequacy ratio rose 0.8 percentage point last year to 12.2 percent as of Dec. 31, the CBRC said last week on its website.

New loans in China more than doubled from December to 1.04 trillion yuan ($158 billion) in January, the central bank said on Feb. 15. Credit expansion decreased from 1.39 trillion yuan in the year-earlier month. Banks typically expand credit at a faster pace at the start of a year.