Beijing's reserve-ratio cut will do little for investors

SHANGHAI • China's latest monetary policy move, due to take effect next Thursday, will not do much for investors seeking respite from a falling stock market or a slumping yuan.

Some 500 billion yuan (S$103 billion) out of 700 billion yuan freed up by a cut in reserve-ratios announced on Sunday is intended to assist banks in funding debt-to-equity swaps - a key plank of the nation's effort to reduce risks in the financial sector that until now has seen disappointing take up.

Use of the funds will be slow as banks have to carefully choose company targets, according to Ms Iris Pang, Greater China economist at ING Bank. That suggests that much of the newly released money will remain unused for a long time, she said.

The initiative works by converting soured loans into equity stakes, meaning that companies in theory can lower their leverage and reduce interest expenses, while banks can improve their asset quality. China's five biggest banks had agreed on swap programmes worth 1.6 trillion yuan by the end of last year, but only around 20 per cent of these were executed, according to China International Capital Corporation.

A debt-equity swap means that the bank or investor takes on more risk. Compared with loans, banks face substantially higher capital requirements if they own a share of a commercial entity. A normal loan has a risk weighting of 100 per cent, and non-performing loans are weighted at 250 per cent. By comparison, for the first two years that a bank holds equity, the risk weighting is 400 per cent, and this jumps to 1,250 per cent from the third year.

If China's lenders were to use the whole 500 billion yuan for swaps, their risk-weighted assets would increase by 2 trillion yuan in the first two years and 6.25 trillion yuan from then on, according to analysts at Shenwan Hongyuan Group.

The 2016 plan tries to make sure the swaps are market-oriented, requires the involvement of public investors and also demands that banks set up an asset management subsidiary to arrange the swap on their behalf. Establishing more asset managers "would consume banks' capital and cannot be solved directly by the liquidity release from an RRR (reserve requirement ratios) cut," chief China economist at UBS Group Wang Tao wrote in a report.

"It's unclear if commercial banks have enough knowledge, skills and the human resources" to select qualified companies, calculate swap ratios and take part in corporate governance as a board member, said chief China economist at Nomura International Lu Ting.

Part of the reason for the slow take-up may be bad memories of the last time this tactic was tried.

Swaps are a "painful" process that should only be used when there is no other choice, according to adviser to China's banking and insurance regulator Yang Kaisheng, who led China's first round of swaps in the late 1990s to write-off bad debts.

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A version of this article appeared in the print edition of The Straits Times on June 28, 2018, with the headline 'Beijing's reserve-ratio cut will do little for investors'. Print Edition | Subscribe