China softens rules on bank lending to local govts: Sources

SHANGHAI (REUTERS) - New rules from China's banking regulator aimed at restricting local government borrowing are weaker than a draft version circulated last month, according to a copy of the rules provided to Reuters by two industry sources.

The adjustment in the final set of restrictions reflects the challenge policymakers face in striking a balance between supporting economic growth and the need to prevent excessive debt buildup through special-purpose vehicles known as local-government financing vehicles (LGFV).

Compared to the draft version released in March, the final rules relax the hard cap on the total amount of LGFV loans banks are allowed to hold.

The draft version required banks to keep their overall exposure to LGFVs at the same level as end-2011. The final version simply says that banks "must not increase the volume of LGFV loans" without specifying the baseline against which increases will be calculated.

A provision mandating that banks hold the share of their overall loan portfolio devoted to LGFV loans at or below the end-2012 level has also been removed from the final version.

The China Banking Regulatory Commission (CBRC) released a final version of the rules on Monday, the sources said.

Chinese officials and external analysts began warning about the risks of local government debt as early as 2010, but infrastructure spending financed by local borrowing remains an important pillar of China's macro-economy.

The draft version capped at 15 per cent the portion of a bank's total LGFV loans that may be invested in LGFVs whose asset-liability ratio exceeds 80 per cent.

The current version softens that provision to state simply that the ratio of LGFV loans given to such LGFVs should not increase compared to last year, regardless of what the ratio is in percentage terms.

Finally, the final rules emphasise that banks and regulators should implement a "differentiated credit policy" by continuing to support projects that further national policy priorities.

The priorities singled out for credit support are affordable housing, highways, and water treatment.

The rules come as data released on Monday showed that GDP growth, industrial production, and fixed asset investment all fell short of expectations.

Beyond short-term economic management, the new administration of President Xi Jinping has established urbanisation as a key goal.

That means local governments will have to keep spending on urban infrastructure to accommodate new urban residents, as well as better integration of migrant workers who already live in cities but lack access to housing, education, and other benefits.

Banking industry sources said the new rules will hit small cities and towns the hardest, while larger cities should continue to enjoy access to credit to support the government's urbanisation drive.

At the same time, the restrictions on bank lending would continue to push LGFVs away from bank borrowing and towards the bond market. As banks pulled back on lending, bond issuance by local governments soared 148 per cent year-on-year in 2012 to 637 billion yuan (S$127 billion), according to figures from China's main bond clearinghouse.

The new rules from CBRC also instruct banks to be cautious about purchasing LGIV bonds.

Outstanding loans to local governments totaled 9.7 trillion yuan by end-2012, CBRC chairman Shang Fulin recently stated.

Ratings agency Fitch estimates that total local government debt, including bonds and loans, totaled 24 per cent of China's GDP by end-2012.

Localities accumulated much of their debt during China's credit-fueled economic stimulus, launched in the depths of the global financial crisis in 2008.

Debt issuance stabilised in 2011 but picked up again last year, as policymakers launched a new wave of infrastructure spending to stabilise the world's No. 2 economy its slowest full-year growth in 13 years in 2012.