2016/10/3 Contents Chinese financial markets Commercial banks and Basel accord Part 2: The Chinese Banking System Current Banking System in China Banking System Reform in China Shadow Banking and Internet Finance in China Sept. Dec 2016 By Zhang Xiaorong Commercial Banks Commercial banks are the financial institutions that 2.1 Commercial Banks and basel provide services, such as accepting deposits, giving Accord business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. Other services include bank and credit cards, private banking, custody and guarantees, cash management and settlement as well as trade finance ommercial bank performance is very much linked to Balance sheet of a commercial bank Capital Requirements for Banks Liabilities Commercial banks are high leveraged institutions 95 where equity accounts for a small percentage in the total assets Government bonds 15 Equity Mortgage loans result if depositors decide to withdraw Derivatives trading brings contingent and off-balance Other assets sheet obligations for banks. That's why the Basel Committee sets risk-based Total liabilities capital requirements for commercial banks 1
2016/10/3 1 Chinese Financial Markets Part 2: The Chinese Banking System Sept.-Dec.2016 By Zhang Xiaorong Fudan University, Shanghai, China 2-1 Contents • Commercial Banks and Basel Accord • Current Banking System in China • Banking System Reform in China • Shadow Banking and Internet Finance in China2-2 2.1 Commercial Banks and Basel Accord 2-3 Commercial Banks • Commercial banks are the financial institutions that provide services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. • Other services include bank and credit cards, private banking, custody and guarantees, cash management and settlement as well as trade finance. • Commercial bank performance is very much linked to economic growth. 2-4 Balance Sheet of a Commercial Bank 2-5 Assets Liabilities Cash 10 Deposit 95 Government bonds 15 Equity 5 Mortgage loans 20 Other loans 50 Other assets 5 Total assets 100 Total liabilities 100 Capital Requirements for Banks • Commercial banks are high leveraged institutions where equity accounts for a small percentage in the total assets. • Insolvency (the disability in paying the debt) may result if depositors decide to withdraw. • Derivatives trading brings contingent and off-balance sheet obligations for banks. • That’s why the Basel Committee sets risk-based capital requirements for commercial banks. 2-6
2016/10/3 Basel Accord Basel Accord il · Basel i framework · Basel! Framework Capital Accord in 1988 established minimum The new capital accord released in June 2004 capital standard designed to protect against credit Formalized in 2006 The 1996 Amendment broadened the scope to Three"pillars"in Basel ll include market risk in calculating capital In 1998 the Committee discussed the importance Supervisory review of capital adequacy of operational risk as a substantial financial factor In 2001 guidelines on managing operational risk Market discipline through public disclosure Capital Requirements Capital Requirements Risk-Based Capital Guidelines Assets are classified in 4 types according to their risk Capital (asset)requirement provides buffer for ach is allocated a credit risk weigh commercial banks when market reverses afe assets do not require buffer in the market Safe assets preserve value in the downturn, while risky assets lose value and faster Risky assets depreciate more and need more buffer, Risk-based capital means the average value that and should be applied higher weights can be lost in severe market reverses The weighted average is the risk-based capital (or required to deal with the value loss Capital Requirements Capital Requirements Example of Assets Included U.S. Treasur Capital required is defined as Tier I and Tier ll capital. cked securities issued by the Goernment National Tier 1(Core Capital)includes common stock, certain preferred stock, and minority interest. Mortgage Corporal on or the Federal National Mortgage Tier 2(Supplementary Capital )includes loan-loss eserve, certain preferred stock, perpetual debt hybrid capital instruments, and subordinated debt. 0% mortgages Minimum requirements are established as 4% for Tier Do you need 100% cover of the risk-based capital?
2016/10/3 2 Basel Accord I • Basel I Framework – Capital Accord in 1988 established minimum capital standard designed to protect against credit risk – The 1996 Amendment broadened the scope to include market risk in calculating capital – In 1998 the Committee discussed the importance of operational risk as a substantial financial factor – In 2001 guidelines on managing operational risk published 2-7 Basel Accord II • Basel II Framework – The new capital accord released in June 2004 – Formalized in 2006 • Three “pillars” in Basel II – Minimum risk-based capital requirements – Supervisory review of capital adequacy – Market discipline through public disclosure 2-8 Capital Requirements • Risk-Based Capital Guidelines – Capital (asset) requirement provides buffer for commercial banks when market reverses. – Safe assets preserve value in the downturn, while risky assets lose value more and faster – Risk-based capital means the average value that can be lost in severe market reverses. – A certainty amount of safe assets should be required to deal with the value loss. 2-9 Capital Requirements • Assets are classified in 4 types according to their risk. • Each is allocated a credit risk weight. • Safe assets do not require buffer in the market downturn as they depreciate little. • Risky assets depreciate more and need more buffer, and should be applied higher weights. • The weighted average is the risk-based capital (or risk-weighted assets). 2-10 Capital Requirements Do you need 100% cover of the risk-based capital? 2-11 Capital Requirements • Capital required is defined as Tier I and Tier II capital. • Tier 1 (Core Capital) includes common stock, certain preferred stock, and minority interest. • Tier 2 (Supplementary Capital) includes loan-loss reserve, certain preferred stock, perpetual debt, hybrid capital instruments, and subordinated debt. • Minimum requirements are established as 4% for Tier I and 8% for total (Tier I and Tier II). 2-12
2016/10/3 Capital Requirements Capital Requirements Capital Adequacy Ratio(CAr) Example: calculating CAR a measure of the amount of a bank's core capit Cash expressed as a percentage of its risk-weighted asset Government bonds 15*0%=0 Tier 1 capital Tier 2 capital Mortgage loans 20 50%6=10 assets 50*100%=50 According to Basel Il, a commercial bank should Other assets 5*100%=5 keep its Car no lower than 8% for risk Risk-weighted as management purposes. car=- Equity value 7.69% Risk-weighted assets 6 Base| AccordⅢl Basel accordⅢ Basel Ill was developed in response to the In july 2013, the Fed announced that the minimum deficiencies in financial regulation revealed by the leverage ratio would be 6% for 8 systemically late-2000s financial crisis portant financial institution(SIFl)banks and 5% for quires banks to hold 4. 5% of common equity and their bank holding companies. 6% of Tier I capital of risk-weighted assets. In June 2012, CBRC set a minimum CAR for top banks Banks should maintain a leverage ratio--Tier1 of 9.5%(small banks 8.5%)by the end of 2013 capital over the banks average total consolidated CBRC also provided a 6-year grace period for banks assets--no lower than 3% of"systemic importance"to reach a minimum CAr of Banks should also maintain sufficient liquid assets to 11. 5%(smaller banks 10.5%)by the end of 2018 cover total net cash outflows over 30 days or amount over a 1-year period of extended stress. CAR in Chinese Banks Bank loan classification Normal otential weaknesses that deserve managements close attention. CAR in 2015 Mention the repayment prospects for Foreign Banks ected by the current nd paying capacity Rural Commercial Banks Standard ied must have a well-defined weakness, or weaknesses Com mercial Banks dize the liquidation of the Joint-stock Commercial Banks as ban kable 0%高%4%邰%%10%1%14%16%18%20% salvage value, but rather that it is g off this basically worthless asset
2016/10/3 3 Capital Requirements • Capital Adequacy Ratio (CAR) – a measure of the amount of a bank's core capital expressed as a percentage of its risk-weighted asset. – According to Basel II, a commercial bank should keep its CAR no lower than 8% for risk management purposes. 2-13 Capital Requirements 2-14 Cash 10*0%=0 Government bonds 15*0%=0 Mortgage loans 20*50%=10 Other loans 50*100%=50 Other assets 5*100%=5 Risk-weighted assets 65 Basel Accord III • Basel III was developed in response to the deficiencies in financial regulation revealed by the late-2000s financial crisis. • It requires banks to hold 4.5% of common equity and 6% of Tier I capital of risk-weighted assets. • Banks should maintain a leverage ratio——Tier1 capital over the bank's average total consolidated assets——no lower than 3%. • Banks should also maintain sufficient liquid assets to cover total net cash outflows over 30 days or amount over a 1-year period of extended stress. 2-15 Basel Accord III • In July 2013, the Fed announced that the minimum leverage ratio would be 6% for 8 systemically important financial institution (SIFI) banks and 5% for their bank holding companies. • In June 2012, CBRC set a minimum CAR for top banks of 9.5% (small banks 8.5%) by the end of 2013. • CBRC also provided a 6-year grace period for banks of "systemic importance" to reach a minimum CAR of 11.5% (smaller banks 10.5%) by the end of 2018. 2-16 CAR in Chinese Banks14.50% 11.60% 12.59% 13.14% 18.48% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Large Commercial Banks Joint-stock Commercial Banks City Commercial Banks Rural Commercial Banks Foreign Banks CAR in 2015 2-17 Bank Loan Classification Normal Special Mention has potential weaknesses that deserve managements close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Standard is inadequately protected by the current sound worth and paying capacity of the obligator of the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. Doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future Non Performing Loans 2-18
2016/10/3 NPL (Non Performing Loans) Total NPL Calculation A non-performing loan is a loan that is in default or The total amount of the loan, not just the outstanding close to being in default loan balance when the loan was considered (By IMF)A loan is nonperforming when nonperforming, counts toward the nPl total 1) payments of interest and principal are past due Example: a borrower had a $100, 000 loan but repaid 40,000 on time, and went 90 days behind on hi by 90 days or more, ayments with $60,000 still due, the entire $100,000 2)or at least 90 days of interest payments have would be classified as a nonperforming loan delayed by If the borrower starts repaying the loan again after it agreement has been classified as nonperforming the loan is removed from the npl list there are other good reasons to doubt that payments will be made in full If the bank sells the loan to another agency fes l total collection the loan is also removed from the np NPL Ratio NPL Ratio NPL ratio is the NPl to total amount of outstanding perce Example: Bank xXX has a total loan portfolio of $200 illion with S5 million in NPL. The NPl rati 50000005200,000000)=(5/200)=0025,or Financial analysts frequently use the NPl ratio to compare the quality of loan portfolios among banks NPL LoSS Provision NPL Provision Coverage ratio For commercial banks unrecoverable npls are a The loan loss provision coverage ratio is an indicator major source of asset impairment. of how protected a bank is against future losses eet a Provision coverage ratio =(pretax income loan loss that represents a bank's best estimate of future loan amount of the loan that will never be rep Example: a bank extends a $500,000 5-year loan,one If the bank reported pretax income of $2, 500,000 year later the borrower runs into financial problems and a loan loss provision of $800,000 and net charge- If the bank believes the client will only repay 60% of offs of s500, 000, the loan loss provision coverage the borrowed amount the bank will record a loan atio=66(5250000+5800,000)/S500000,or loss provision of s200000=(100%-60%×S500,000
2016/10/3 4 NPL (Non Performing Loans) • A non-performing loan is a loan that is in default or close to being in default. • (By IMF) A loan is nonperforming when: – 1) payments of interest and principal are past due by 90 days or more, – 2)or at least 90 days of interest payments have been capitalized, refinanced or delayed by agreement, – 3)or payments are less than 90 days overdue, but there are other good reasons to doubt that payments will be made in full 2-19 Total NPL Calculation • The total amount of the loan, not just the outstanding loan balance when the loan was considered nonperforming, counts toward the NPL total. • Example: a borrower had a $100,000 loan but repaid $40,000 on time, and went 90 days behind on his payments with $60,000 still due, the entire $100,000 would be classified as a nonperforming loan. • If the borrower starts repaying the loan again after it has been classified as nonperforming, the loan is removed from the NPL list. • If the bank sells the loan to another agency for collection, the loan is also removed from the NPL total. 2-20 NPL Ratio • NPL ratio is the NPL to total amount of outstanding loans in the bank's portfolio, usually expressed as a percentage. • Example: Bank XXX has a total loan portfolio of $200 million, with $5 million in NPL. The NPL ratio is: ($5,000,000/$200,000,000) = (5/200) = 0.025, or 2.5%. • Financial analysts frequently use the NPL ratio to compare the quality of loan portfolios among banks. 2-21 NPL Ratio 2-22 NPL Loss Provision • For commercial banks, unrecoverable NPLs are a major source of asset impairment. • The loan loss provision is a balance sheet account that represents a bank's best estimate of future loan losses. • Example: a bank extends a $500,000 5-year loan, one year later the borrower runs into financial problems. If the bank believes the client will only repay 60% of the borrowed amount, the bank will record a loan loss provision of $200,000= (100% – 60%) x $500,0002-23 NPL Provision Coverage Ratio • The loan loss provision coverage ratio is an indicator of how protected a bank is against future losses. • Provision coverage ratio =(pretax income + loan loss provision) / net charge-offs. A net charge-off is the amount of the loan that will never be repaid. • If the bank reported pretax income of $2,500,000 and a loan loss provision of $800,000 and net chargeoffs of $500,000, the loan loss provision coverage ratio = 6.6 (($2,500,000 + $800,000) / $500,000), or 660%. 2-24
2016/10/3 NPL Ratio Loan to Deposit Ratio(LTD) NPL ratio and provisioning in incorporated financial institutions in China Loan to deposit ratio is the ratio between a banks otal loans and total deposits. a high ratio indicates high operating efficiency, but also high risks because the bank might not have nough liquidity to cover any unforeseen funding requirements or economic crises. If the ratio is greater than 1, the bank is borrowing oney that is re- loaned at higher rates, rather than relying entirely on its own deposits On June 25, 2015, the 75 percent loan-to-deposit 98%198.39%190 ratio in China was removed Abbreviations PBoC: Peoples Bank of China 2.2 Current Banking System in China ·BoC: Bank of china ICBC: Industrial and Commercial Bank of china CCB: China Construction Bank ABC: Agricultural Bank of China BoCom: Bank of Communication PSBC: Postal Savings Bank of China SOCB: State-owned Commercial Banks JSCB: Joint-stock Commercial Banks Abbreviations Current Banking System AMC: Asset Central bank People's Bank of SAFE: State Administration of Foreign Exchange Chin CBRC: China Banking Regulatory Committee CIRC: China Insurance Regulatory Committee Banking Institution CSRC: China Security Regulatory Committee MOF: Ministry of Finance institution CBRC Huijin: China Huijin Investment Co. CIC: China Investment Co .SOE:State-owned Enterprises NPL: Non-performing Loans China Banking institution
2016/10/3 5 NPL Ratio 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 Normal 95.08% 94.87% 94.64% 94.54% 94.25% 94.22% Special Mention 3.52% 3.64% 3.77% 3.79% 4.01% 4.03% NPL 1.39% 1.50% 1.59% 1.67% 1.75% 1.75% Standard 0.68% 0.73% 0.75% 0.78% 0.82% 0.77% Doubtful 0.56% 0.60% 0.65% 0.69% 0.73% 0.76% Loss 0.16% 0.17% 0.19% 0.20% 0.20% 0.21% Provision Coverage Ratio 211.98% 198.39% 190.79% 181.18% 175.03% 175.96% NPL ratio and provisioning in incorporated financial institutions in China 2-25 Loan to Deposit Ratio (LTD) • Loan to deposit ratio is the ratio between a bank’s total loans and total deposits. • A high ratio indicates high operating efficiency, but also high risks because the bank might not have enough liquidity to cover any unforeseen funding requirements or economic crises. • If the ratio is greater than 1, the bank is borrowing money that is re-loaned at higher rates, rather than relying entirely on its own deposits. • On June 25, 2015, the 75 percent loan-to-deposit ratio in China was removed 2-26 2.2 Current Banking System in China2-27 2-28 Abbreviations • PBoC: People’s Bank of China • BOC: Bank of China • ICBC: Industrial and Commercial Bank of China • CCB: China Construction Bank • ABC: Agricultural Bank of China • BoCom: Bank of Communication • PSBC: Postal Savings Bank of China • SOCB: State-owned Commercial Banks • JSCB: Joint-stock Commercial Banks 2-29 Abbreviations • AMC: Asset Management Company • SAFE: State Administration of Foreign Exchange • CBRC: China Banking Regulatory Committee • CIRC: China Insurance Regulatory Committee • CSRC: China Security Regulatory Committee • MOF: Ministry of Finance • Huijin: China Huijin Investment Co. • CIC: China Investment Co. • SOE: State-owned Enterprises • NPL: Non-performing Loans Current Banking System 2-30 Central bank People’s Bank of China Regulatory institution CBRC China Banking Association Self-discipline institution Banking Institutions Non-banking Institutions