Banks ordered to raise loan loss reserves

Chinese financial institutions have been required by authorities to turn in more provisions to cover possible rises in loan impairment amid a slowdown in the world's second-largest economy.

In a move to tighten the banking sector's risk prevention and control, the Ministry of Finance (MOF) ordered financial enterprises to keep 1.5 percent of their gross loans as general provisions beginning in July this year, up from the existing 1 percent.

The new "dynamic provision" rules will apply to policy banks, commercial banks, financial companies, urban and rural credit cooperatives, lease financing companies and financial asset management firms, as well as smaller town- and village-based banks.

To ensure a smooth transition, financial enterprises will be given a grace period of five years to meet the new regulatory standard.

Under the existing rules, financial asset management firms and small town- and village-based banks are not subject to the regulation in this regard.

The new rules aim to "boost the banking sector's ability to guard against risks" and make financial enterprises' reserves for loan losses "more predictable" and better reflect changes in the economy, the MOF said in a statement on its website.

In calculating potential risky asset value, the MOF also raised the weighting of sub-prime loans from 25 percent to 30 percent, while setting the weighting for suspicious loans at 60 percent and losses at 100 percent.

China categorizes bank loans into five-levels -- normal, monitored, sub-prime, suspicious loans and losses. Sub-prime, suspicious loans and losses are usually considered to be bad loans.

The new rules came following public criticism of the huge profits Chinese banks secured last year, as the banks pulled in large amounts of money despite a slowdown in the country's economy.

China's banking sector reported a combined net profit of 1.0412 trillion yuan (165.3 billion U.S. dollars) in 2011, 15.8 percent greater than a year ago, according to the China Banking Regulatory Commission (CBRC).

The gross domestic product grew by just 8.1 percent in China in the first quarter of this year, slowing from 8.9 percent in the fourth quarter of last year and marking the slowest quarterly expansion since the second quarter of 2009.

Many small- and medium-sized enterprises have complained that it is difficult for them to get loans from banks because of high financing costs, which have added to their misery amid the economic slowdown.

Zhao Qingming, a senior researcher with the China Construction Bank (CCB), said it was rare for the MOF to raise provision standards for financial enterprises in the past over concerns that such an adjustment would reduce fiscal revenues and dividends allocated to the state for state-owned stakes in those companies.

Higher provisions may dim banks' balance sheets with fewer net profits for shareholders, as lenders will have to set aside more profits in reserve to cover loan losses.

"As China faces a complicated economic situation with more uncertainties at home and abroad, the loan quality of banks is somehow declining, reflected by higher non-performing loan ratios," Zhao said, "Therefore, the adjustment [of the provisions] is designed to ensure the smooth operation of the banking industry."

Zong Liang, deputy general manager of the strategic development department of the Bank of China, said the MOF hopes to reduce the scale of risky assets by lowering its tolerance for risks with higher provision standards.

"The new rules will definitely reduce banks' profits," Zong said.

But Zhao Qingming, the economist from CCB, argued that the adjustment in provision standards will have a limited impact on major banks' dividend levels, as large lenders have already allocated more provisions to cover possible losses.

All 16 listed commercial banks have met the 1.5-percent new regulatory provision requirement, according to their annual reports.

Share prices of banks posted strong rallies in China's stock markets on Wednesday, lifting benchmark indexes to some of their best single-day gains in months.