CHINA has delayed the start date for implementing new capital-adequacy rules under the Basel III framework, but the nation's banks are under orders to use the reprieve to push ahead with reforms in the sector.

The government said earlier this month that the new rules will come into effect next January 1. The Basel Committee on Banking Supervision developed Basel III to address financial regulation deficiencies arising from the 2008-09 global financial crisis. The new rules essentially require banks to hold more capital as risk cushion against bad times.

China circulated draft rules for implementation last August. At that time, the start-up date was set at the start of 2012. The delay has been blamed on a slowdown in the nation's economy and concern about how the European debt crisis will play out in international financial circles.

In the first quarter, China's economy grew 8.1 percent to notch its slowest performance in two years. The government believes that ample credit supply is essential for growth to pick up.

Capital targets

"The rules aim to set reasonable schedules for banks to meet capital targets in a way that helps maintain appropriate credit growth," the State Council, China's Cabinet, said in a statement on June 6.

The new draft rules require large banks to maintain capital adequacy ratios at 11.5 percent, while the remainder of lenders must keep 10.5 percent as the minimum. The banks must meet the targets before 2019, three years later than originally expected.

In the first quarter, the weighted average capital adequacy of Chinese banks was 12.7 percent, according to the China Banking Regulatory Commission. Shang Fulin, the CBRC chairman, told the People's Daily newspaper last week the ratio will fall about 1 percentage point after the implementation of revised rules. By that time a few banks may fall below the target, while the majority will be safe.

China is trying to reform its banking sector to make it conform more closely with international standards on risk management, loan losses and prudent lending. In other words, it wants to make the financial industry to make more efficient use of money.

"The fundamental purpose is to guide commercial banks to establish long-term mechanisms of prudent operation, to strengthen the mechanism that restrains capital expansion and to shift the scale and speed-driven mode of development," Shang said.

Banks' easy profits

Premier Wen Jiabao has criticized the "easy profits" of the big lenders, saying they are taking advantage of their dominant position. The banks have long relied on interest income from feeding loans to giant state-owned companies. At the same time, some have provided financial services to ineligible property development projects to keep their profits.

The National Audit Office said earlier this month in a statement that subsidiaries of the Industrial and Commercial Bank of China, China Citic Bank and China Merchants Bank violated banking rules between 2004 and 2010 by issuing 18.9 billion yuan (US$3 billion) of loans to property developers and local government financing vehicles.

"One of the critical considerations when developing the draft was to strengthen the services to support the real economy," Shang said. "At the moment, lenders still favor large enterprises over small and medium-size enterprises that are cash strapped."

The draft rules lower the risk buffer for lending to small business and individuals so that costs for lenders will be lower.

JP Morgan wrote in a report published after the announcement of the revised rules that the draft sweetens the incentive for banks to lend to the two groups of borrowers.

Eying other businesses

In addition, banks are being encouraged to develop businesses with lower capital deployment, such as trade financing, investment banking, wealth management and retail banking, analysts said.

On the same day as the State Council announced its decision to postpone Basel III implementation, the International Financing Review said local lenders will be allowed to securitize up to 50 billion yuan of assets.

A source at Guotai Junan Securities confirmed that his brokerage has been mandated to issue loan-backed bonds for the Bank of Communications, the nation's fifth-biggest lender, and China Development Bank, one of the three policy banks.

China is finally reviving loan securitization after halting a pilot project in 2008 during the global financial crisis. Lenders are now allowed to issue securities that are backed by a pool of payments from bank loans, which removes the loans from their balance sheets.

Shang said the CBRC will work with the central bank and the securities regulator to promote the development of asset-back securities and to expand financing channels for the commercial banks.

Medium-sized lenders said they won't be seriously affected by the tougher rules. Shanghai Pudong Development Bank said last week it can reach the regulatory requirement of capital adequacy by the end of 2014, without external financing.

"The revised rules, together with the capital needed to fund growth, could push Chinese banks to shore up capital," Ryan Tsang, an analyst at ratings agency Standard & Poor's, wrote in a report last week.

"The rated major state-owned systemic banks, which face a higher requirement, may have to retain more profits to build up their capital in the next few years," Tsang said.

Establishment of a unified and supportive regulatory system of capital adequacy.
Details
Systemically important banks are required to maintain their capital adequacy ratios at 11.5 percent, while the rest must adhere to 10.5 percent.
Difference/Impact
It's consistent with the current supervision standards.

Provision of strict and explicit definition of capital.
Details
The criteria of all asset classes are classified in the new rules. Capital tools like subordinate bonds are granted with higher loss-absorbing capacity. Commercial banks are allowed to count excess loan-loss provisions toward capital, and are given a 10-year grace period to phase out securities they've issued that don't qualify as capital under the revised rules.
Difference/Impact
It's tighter than the current rules.

Expansion of capital for risk coverage.
Details
Operational risk is added to the regulatory framework in addition to credit risk and market risk. Regulatory rules are introduced for complex trading like asset securitization and over-the-counter derivatives, guiding the banks to carry out prudent financial innovation.
Difference/Impact
It's tighter than the current rules.

Revised risk weighting for different asset classes in accordance with the principle of prudence.
Details
Risk weighting of small business loans and individual loans is reduced to support the real economy. Commercial banks are encouraged to extend loans to small companies and individuals. The risk weighting of public sector entities is lowered while that for interbank exposures is lifted.
Difference/Impact
It will boost lending to SMEs.