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Regulators to Conduct Stress Tests on China's Banks
Summary:

Cover, Issue 443, Nov 9
Translated by Tang Xiangyang
Original Article: [Chinese]

Local banking regulators and commercial banks in China have begun to carry out stress tests in an attempt to quantify the risks associated with the huge amount of new loans issued over the past year.

The tests, which will focus on debt obligations over the next three years, aim to quantify the level of risk posed to the stability of China's banking system by loans made to projects in over-heated industries and other high risk sectors.

The tests were begun after a recent government decision to restrict investment in, or approval of, any new projects in a variety of industrial sectors plagued by overcapacity.

Stress Tests

The tests will be targeted at loan risks in specific over-heated industrial sectors, a source within a state-owned bank revealed to EO.

According to the result of the tests, the CBRC may require commercial banks to adjust their operating strategy - for instance, requiring them to supplement capital or strengthen their risk management systems.

According to an anonymous source at a local bank, the tests will be imposed on all the Chinese commercial banks and will be supervised by both the China Banking Regulatory Commission (CBRC) and the National Development Reform Commission (NDRC).

Stress tests are an internationally-accepted risk management tool used by commercial banks around the world to estimate risk.

On October 29, the CBRC formally released a policy document titled Liquidity Risk Management Guidelines for Commercial Banks, which requires domestic commercial banks to conduct stress test at least once a quarter and to conduct specialized stress tests any time when market behaviour is erratic or as required by the CBRC.

An anonymous source at the CBRC revealed that the regulator was worried that some businesses wouldn't be able to repay their loans and might even go bankrupt as the Chinese government attempted to eliminate overcapacity in certain sectors.

"Under these circumstances, the CBRC has required commercial banks to conduct stress tests on the potential bad loans. Given the new requirements announced by the NDRC, we want to be clear how many enterprises will be able to update their technology and how many might be forced to close, and in this manner determine how many loan defaults are likely" he said.

The specific factors that will be used to calculate the tests are still unsettled. It's a complicated task as the situation is radically different from region to region. For example, the default rate on housing loans are widely divergent when you compare large cities to medium and small-cities.

"It's not really suitable for me to reveal the details of the test, but regulators will consider imposing strict standard, and account for the possibility of extreme circumstances," he said.

It's said that the preliminary results of the stress tests will be available by earlier next year.

Adjusting Credit Policy

The NDRC program aims to eliminate overcapacity in a number of problem sectors over the coming three years. As credit adjustment often lags behind changes to industrial policy, the banking regulator is aware of the need to pay attention to the risk of a spike in bad loans.

Since the financial crisis broke out last year, the CBRC has repeatedly warned commercial banks of the risks of lending to industries which are experiencing overcapacity along with high energy consuming, heavy polluting and resource-intensive industries.

Requesting that they gradually withdraw from lending to these sectors.

A source close to the CBRC commented that the big commercial banks along with local banks on the eastern seaboard were doing a better job of gradually easing their exposure to these problem industries.

The amount of loans that Bank of China lent to industries experiencing overcapacity in the first half of the year, dropped by 3.41 percent in terms of the banks total lending. According to the latest commercial bank report covering third quarter lending, China Construction Bank has managed to reduce the amount of loans that it's extended to such problem companies by 55.8 billion yuan in the first three quarters of 2009.

In the first half of 2009, when total new lending was up 23%, 56 Shanghai-based banks, including both Chinese banks and the local branches of foreign-invested banks, decreased their lending in the risky industries mentioned above by 12.98 billion yuan. The industries effected included steel, electricity, coal coking and cement.

However, a source with a local banking watchdog said, given the large scale shift that is taking place in a variety of industries, the potential for a sizable amount of bad loans to emerge is still very real.

This year, in a situation where authorities were determined to achieve a GDP growth rate of 8 percent, projects that utilised outdated industrial facilities managed to obtain funds and rear their head once more.

Under pressure to meet lending targets but lacking any real lending alternative, some middle and small-sized banks had no choice but to team up with local governments and provide loans to such projects.

Some emerging sectors, such as the production of crystal silicon (used in solar power devices) and the production of parts used to produce wind power turbines, have experienced rapid development over the past few years, but now are suffering from overcapacity too.

Banks that already have much long-term exposure in the industry, face even more risks unless producers are able to keep up with technical developments in both industries.

However, the above source also noted that the timing of any major adjustment to credit policy would depend on the annual revisions to the NDRC's Guiding Catalogue for the Adjustment of Industrial Structure, a document released at the end of each year that sets investment policy for the coming 12 months, and also the results of the stress tests due to come out early next year.

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