Sticks and carrots from NPC to Chinese banks: Forced lending to the private sector in exchange for more capital

During the opening session of the 13th National People's Congress (NPC), Chinese Premier Li Keqiang presented the government work report. While the market read the new growth target ( 6-6.5% ) rather negatively, Li Keqiang was very transparent about the difficulties in reaching this target and the fiscal and monetary measures. He also made direct reference to the much needed support from banks to increase their lending to the private sector. More specifically, Li Keqiang’s expectations for banks were made very clear in three main directions: a) lower funding costs for small-and-micro enterprises (SMEs); b) 30% growth in state-owned commercial banks ’ lending to SME s from negative growth in 2018; and c) extend the maturity of loans, especially for manufacturing firms . While the sticks are crystal clear , more carrots are being waved around. This is definitely necessary as banks know there is a price to be paid for stretching the balance sheets, especially for the private sector. In fact, the ratio of problem loans is more than double for SME s than the rest. And the carrots come in different forms. First, banks are going to be allowed to issue perpetual bonds to improve their solvency ratios. Second, the PBoC is ready to accept them as collateral for a new liquidity refinancing facility and, most importantly, to buy and hold such perpetual for as long as three years in exchange for PBoC bills. The long – and caring – shadow of the PBoC can already been seen in the relatively low pricing for the recent perpetual bond issuance by Bank of China. When comparing Bank of China with other banks’ issuance with the same international rating, the coupon of Bank of China stands out as the lowest both in absolute and relative terms to their respective sovereign benchmarks. Despite a higher benchmark rate in China than the US and Europe, the CNY denominated perpetual bond issued by Bank of China was still able to offer the lowest yield of 4.5% among all recent issuance of banks’ perpetual bonds at A rating. In the same vein, the spread of 136bps against 10-yea r Chinese Treasury yield remained the narrowest compared to global peers. Based on the very low cost of funding for the perpetual bond issued by the Bank of China, it seems clear that the carrot is big for Chinese banks to help the leadership with the stimulus, no matter whether the additional credit to the private sector may worsen asset quality down the road.