HONG KONG, May 16: China has authorised four small regional lenders to sell the country’s first subordinated bonds that are compliant with new banking rules, testing the waters before weightier capital issuance from the biggest state-owned banks.

China began to enforce Basel III standards on January 1 2013, but there has been no subordinated bond issuance eligible as capital since the regulatory change.

The upcoming deals will provide a template for at least Rmb210bn (USD34bn) of loss-absorbing Tier 1 and Tier 2 instruments that the country’s largest lenders plan to issue by 2015.

Agricultural Bank of China announced earlier this year that it planned to sell up to Rmb90bn of new style Tier 1 and Tier 2 capital before the end of 2015 in onshore or offshore markets.

China Construction Bank and Industrial and Commercial Bank of China also announced similar funding plans for up to Rmb60bn each, while Bank of China has yet to reveal its plans, but is expected to raise in the tens of billions as well.

Small deals, big issues Chinese banks are generally well-capitalised, as they rely on a solid deposit base. According to the China Banking Regulatory Commission (CBRC), the average capital ratio of the banks at the end of March was 12.28 per cent, and core Tier 1 stood at 9.85 per cent. Meanwhile, the CBRC’s new rules require that banks considered systemically important maintain a minimum core Tier 1 ratio of 6.5% and a total capital ratio of 9.5 per cent.

Analysts have said that not only will Chinese banks have to issue additional bonds over time to maintain their core capital levels in line with the new CBRC requirements, but they will also have to raise funds to replace old capital-eligible securities. So the Rmb210bn may be just the beginning.

One analyst said that the smaller banks are the most vulnerable to potential capital shortfalls, so it makes sense from the government’s perspective to test appetites for Basel III compliant debt with issues from regional lenders.

The first out of the box is expected to be Tianjin Binhai Rural Commercial Bank, which may hit the market before the end of next month with a Rmb1.5bn Tier 2 financing. The China Banking Regulatory Commission has already approved the deal.

Chongqing Rural Commercial Bank, meanwhile, is working on a Rmb5bn issue. And Bank of Jinzhou and Jiangnan Rural Commercial Bank are also preparing Tier 2 bonds that will meet all Basel III requirements.

Tianjin Binhai’s bond is now pending final approval from the People’s Bank of China. In keeping with the international standard, the notes will carry a 10-year maturity, and be callable after five years.

In order to comply with the new banking requirements in China, the bonds will be written down to zero if the issuer is no longer deemed viable. Discussions, however, remain ongoing as to the definition of that non-viability point, mirroring concerns in other markets.

“The People’s Bank of China wants more disclosure on what the trigger is. For example, what is ‘no longer viable’? Does that mean bankruptcy? If that means bankruptcy, how should we decide when a bank has gone bankrupt?” a source familiar with the situation said.

The official guidelines issued by the CBRC in December leave some room for ambiguity. The rules require Tier 2 capital instruments to include explicit loss-absorption clauses in the event of a non-viability trigger, either via a write-off or conversion to equity.

The trigger event occurs when the CBRC judges a bank to be no longer viable without the writedown or conversion, or if relevant departments judge the bank to be likely to fail without external financing support.—Reuters