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This morning’s Shanghai Daily featured a piece regarding the increase in bond issuance from Chinese banks. As state-owned banks have come under fire in recent years for their licentious lending to state-owned enterprises and putative non-performing loans (NPL’s), they have become subject to increased government consternation. In an effort to avoid perilous financial troubles, the People’s Bank of China (PBoC) has taken precautionary measures, increasing the rate of interest paid to depositors, curbing lending quotas, and most notably, increasing capital requirements. For China’s state-owned banking sector, long accustomed to the ‘more is better’ lending mentality, this has resulted in the employment of a number of new capital-raising strategies.

Chief among these strategies has been the issuance of bonds. For financial institutions with strong government backing, this means liquidity at relatively low interest rates. Although most issue subordinated debt, cooperation with the China Banking Regulatory Commission has insured that rates are not prohibitive. This strategy has already been employed this year by China Construction Bank, Agricultural Bank of China, and Pudong Development Bank. Although much of the issuance has taken place domestically, it has coincided with greater internationalization of the RMB: on September 7^th, the Bank of China announced that it would issue up to RMB 5 billion in RMB-denominated bonds for sale in Hong Kong. China Merchants Bank and China Citic Bank have also joined the fray, issuing theirown ‘dim sum’ bonds. Bond issuance from banks trebled in the first half of 2011 and looks to be employed extensively as the government seeks to wean companies off their reliance on banks.

Issuance of new shares has also been employed by a number of Chinese financial institutions. Citic Securities, China’s largest brokerage, recently completed a HK$13.2 billion ($1.7 billion) share issuance in Hong Kong. Although the shares sold at the low end of the potential price range, the issuance provided the brokerage with a solid infusion of outside capital otherwise unavailable. China Everbright Bank, in an effort to satisfy capital requirements, recently received approval to hold a $7 billion IPO in Hong Kong. However, the issuance was delayed indefinitely after the desired share price was found unattainable. Overall, Chinese enterprises have seen a slowdown in IPO interest given tepid external demand. Thus, the strategy will probably have limited efficacy.

Capital infusions and mergers have also been favored solutions, as banks have sought to alleviate pressure from NPL’s. The aforementioned Pudong Development Bank was recently the recipient of China Mobile’s patronage. With some $51 billion in cash, the world’s largest mobile operator is capable of acting strategically. Last year, it acquired a 20 percent stake in Pudong Development Bank, providing the lender with a much needed infusion of capital, sans an increased debt burden. For smaller lenders, mergers and acquisitions have been the preferred method for mitigating excessive debt burdens. Both the Bank of Hangzhou and the Bank of Nanjing have made acquisitions of smaller and weaker rivals in recent months. For many smaller local lenders, such infusions have been essential in navigating the peril of NPL’s from local government financing vehicles (LGFV’s).

Although the transition away from the debt-fueled investment model should be the subject of approbation, the new strategies applied banks are not without risk. As the Wall Street Journal reported this morning, the dim sum bonds are subject to global market vagaries. Any sellout related to the European debt turmoil could result in dramatically increased borrowing costs for Chinese enterprises. As Gensheng Shen has argued, the information asymmetry that exists with Chinese enterprises, many of which are a legacy of the planned economy, will continue to be a deterrent for outside investors. Although many foreign financial institutions have taken strategic stakes in Chinese banks, the banks continue to serve some policy functions. Nonetheless, the recent policy changes by the PboC and CBRC are clearly steps in the right direction.

As Michael Pettis has argued vociferously, China will need to transition from investment and export-led growth to a more sustainable consumption-based path. Paramount in making this transition will be reducing excessive debt-fueled investment from state-owned enterprises. Increased capital requirements, reduced lending quotas, and higher rates paid to depositors will greatly facilitate the process. Perhaps inadvertently, this will also accelerate the internationalization of the Renminbi, as the recent RMB-denominated bond issuances in Hong Kong have evidenced. This should serve to mitigate the much-maligned global imbalances that have proliferated in recent years. Although numerous problems will continue to exist for China’s banks, including weak corporate governance and lax lending practices, the recent developments should be quite auspicious.

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