Chinese banks:Liquidity Risk Management Guideline

Wholesale-funded banks with high shadow banking exposure under pressure.

    The CBRC released today The Guideline on Liquidity Risks of CommercialBanks, matching the Basel III standards of liquidity management (e.g. LCR andNSFR) and introducing new measures. We view it as a continuation of financialdeleveraging, as we expect this regulation to lower banks’ duration mismatch,cut off wholesale funding and reduce investment in shadow banking assets. Assuch we see a net positive over the longer run as it reduces systemic liquidityrisks. However, near term, the banks that are wholesale-funded and shadowbanking-centric are likely subject to NIM pressure. Among the banks we cover,joint-stock banks are more affected while big banks should benefit.

    What prompted regulators to issue such a regulation.

    The leverage in China’s financial sector has increased notably in past years,characterized by rising duration mismatch and proliferation of shadow banking.

    Liquidity risks in the system trended up accordingly and only recently havestarted to moderate given the ongoing financial deleveraging campaign. Tofurther contain liquidity risks, it is necessary to strengthen banks’ liquiditymanagement, especially for joint-stock banks and smaller city/rural banks.

    What are the regulatory changes.

    The key change is that the regulators introduced three liquidity risk indicators:1) Net Stable Funding Ratio (NSFR), which measures banks’ ability to supportmedium-to-long-term funding needs; 2) Liquidity Matching Ratio (LMR), whichmeasures the degree of duration mismatch; and 3) High Quality Liquid Asset(HQLA) Adequacy Ratio, which is a simplified version of Liquidity CoverageRatio (LCR) and is applied to banks with assets below Rmb200bn. Togetherwith LCR and Liquidity Ratio introduced in the past, the CBRC has establisheda comprehensive liquidity risk monitoring system (Fig 3).

    What are the implications for the entire financial system.

    Judging by the details, China’s regulators are inclined to suppress interbankbusinesses with speculative purposes and to contain banks’ shadow bankingexposure, while encouraging traditional loans/bond investments and thedevelopment of retail and SME banking. For example, the NSFR calculationassumes a much higher stability rate of 90-95% for retail deposits than 0-50%for corporate and interbank deposits. Also, for LMR the discounting rate forinterbank deposits less than 3 months was only 0%, vs. 70% for deposits. Thisregulation is a follow-up to The Asset Management Guideline issued on 17 Nov2017 (see our report), suggesting that the financial deleveraging campaign isnot over yet. We expect China’s shadow banking to shrink with risingtransparency while the growth of loan and bond market should stay resilient.

    What are the implications for individual banks.

    We believe the regulation should favor banks with stronger deposit franchises,higher CASA ratio, less duration mismatch and better asset quality. Indeed, ourdetailed calculation (Fig 4) shows that deposit-funded banks i.e. big-four banks,are delivering higher LCR, LMR and Liquidity Ratio than other banks. Amongthe banks we cover, CMB, CNCB and MSB were reporting LCR lower thanregulatory requirement, and many JSBs were showing lower LMR. We expectthese banks to be subject to NIM pressure in the near run, as they may beforced to switch to lower-yield assets and/or to lengthen liability duration.