Market page 20 issue 397
Translated by Liu Peng
Original Article: [Chinese]

China's massive policy bank, China Development Bank (CDB) officially became a commercial bank on Tuesday December 16.

With the change in the bank's status, its bonds would eventually lose the high credit ratings on par with treasury bills it has long enjoyed, a privilege stemming from its policy bank status.

This change might pose a challenge to guaranteeing its capital adequacy ratio, according to a source from the bank.

Earlier in the month, the bank convened its first shareholders conference, outlining a three-year transitional period.

An official from the Ministry of Finance told to Economic Observer that raising its returns on invested capital is another hurdle for CDB to overcome in its transformation.

Challenge to Guarantee Capital Adequacy Ratio
"Guaranteeing its capital adequacy ratio is the paramount problem for CDB to solve on its road to development," said the above reliable source from CDB.

According to CDB's annual accounting report in 2007, its capital adequacy ratio reached 12.77% after receiving an injection of 20 billion US dollars by Central Huijin Investment Company (now incorporated into China Investment Corporation). That figure declined to some 11% for the first three quarters this year.

"It is hard for CDB to make sure its capital adequacy ratio meet the standard of 8% for commercial bank by its own accumulations," the above source added.

The source calculated that the bank had 2.5 trillion yuan in its credit balance, but its present capital requirement only reached 200 billion yuan, so CDB still had a gap to fill in its capital requirement.

According to a CDB internal calculation, the bank would see a gradual decline in its capital adequacy ratio from 2006 to 2010 on the condition that the state wouldn’t inject capital to it.

Therefore, in order to guarantee the capital requirement, CDB had to successively issue financial bonds worth of RMB 13.6 billion, RMB 47.4 billion, RMB 88.2 billion and RMB 140.9 billion respectively during four years from 2007 to 2010.

In that case, "The problem is that bond financing is the only way for CDB to raise funds, but as CDB converts into a commercial bank, its financial bonds, which enjoy a T-bond credit rating, will turn into corporate bonds bearing high investment risk over the three transitional years," said the above source.

As a result, CDB will lose its high credit rating advantage in 2011 and its costs in bond issuance will increase due to the company bond’s higher yield rate and investment risks.

In addition, the bonds would become less lucrative for its former investors, mainly commercial banks.

On December 3, CDB succeeded in issuing RMB 22 billion in bonds. The EO learned that national commercial banks however had became the third largest group to purchase CDB's bonds, despite that CDB clearly indicated that its bonds still enjoyed the same credit rating as T-bonds.

Before this, those banks were usually the largest buyers of CDB's bonds.

The source said that state-owned companies like in the electric power and petroleum chemical sector had deep interest in CDB's commercial reform and were willing to participate in it as strategic investors.

A source from Central Huijin Investment Company revealed that CDB will follow the model of the Industrial and Commercial Bank (ICBC) did to realize its reform and listing in stock exchanges. Huijin and the Ministry of Finance would each own 50% of CDB's shares at 1 yuan per original share. Later on, strategic investors might see a share price between RMB 1.1 and RMB 1.2 per share.

Pressure to Increase Returns
An official from Ministry of Finance told to EO that compared with the capital adequacy ratio challenge, raising the returns on invested capital was the bigger challenge for CDB's reform.

After reform, though CDB would exceed ICBC in terms of capital requirement, it still fell far behind ICBC in profit margins, the official added.

Public date showed that ICBC's total capital requirement and profits respectively reached RMB 240 billion and over RMB 60 billion in the first half this this year, while the figures for CDB were RMB 300 billion and RMB 20 billion respectively.

"Compared with policy banks, a commercial bank must make profits and pursue the largest capital returns," said the above official, adding that infrastructure construction loans contributed most of CDB's profits, but CDB's advantage in this sector would be weakened as commercial banks competed in it.

The EO learned that at present, CDB's core business still focused on providing loans for domestic infrastructure construction, basic and pillar industries, and after reform, it would still center on the medium-and-long-term loans as well as an expanded investment bank business.

"CDB is actively contacting some investment banks, making ambitious attempts to innovate its commercial operations," said Xiao Yanmin, vice-director of CDB's banking business development.

He said CDB had invested in a dozen of funds and was doing some research on various others involved in equipment manufacturing and agriculture. After the reform, CDB would also explore businesses in asset management and equity investments.

By the end of 2007, CDB had set up six funds with its total assets reaching RMB 3.3 billion. It has also already joined hands with private equity firms to finance small-and-medium-sized companies.

"It can enhance the cooperation with PE to jointly invest in companies," said a source from CDB, adding other commercial banks had yet to expand this business.