Banks ordered to raise liquidity coverage ratios

Chinese commercial banks' liquidity coverage ratios must reach 100 percent by 2018 to strengthen them against the risks of credit crunches, the China Banking Regulatory Commission said on Wednesday in a new liquidity management regulation.

The target ratio is set at 60 percent this year, rising by 10 percentage points annually until 2018, the same transitional period specified in the Basel III accord.

The CBRC's regulation will take effect on March 1.

The liquidity coverage ratio measures banks' ability to guard against liquidity risks when they cannot obtain adequate assets at reasonable costs to pay due debts, make other payments and maintain normal operations.

"Some banks have shown decreasing stability in capital resources and low liquidity," said the news release on the CBRC's website.

"As interdependence among financial institutions grows, problems stemming from individual banks or certain regions tend to cause tight liquidity in the entire banking system."

Last June, domestic banks were hit by a severe credit crunch. The Shanghai Interbank Offered Rate surged to 8.3 percent in early June from 2 to 3 percent in May.

The People's Bank of China did not inject capital to ease liquidity. Instead, the central bank called on other banks to tap into their existing capital.

The CBRC has also specified that banks' loan-to-deposit ratios can't exceed 75 percent. The liquidity ratio must be at least 25 percent.

The regulation is applicable to all Chinese commercial banks, including foreign and Chinese-foreign joint stock banks, with more than 200 billion yuan ($33 billion) in assets.

"The calculation of the LCR is very complicated. Small banks may not even have the statistics needed," said Li Wenhong, deputy director of the policy department of the CBRC.

"Even large banks have to improve their accounting systems to generate all the statistics for the calculation.

"Banks should rely less on the PBOC in times of risk," said Li. "The LCR requirement can help banks to forecast turbulent situations and conduct business with higher risk awareness. On the other hand, banks can also make their risk prevention systems more suitable to their own conditions."

The liquidity coverage ratio gauges banks' overall risk management of all activities, including wealth management products and interbank business, Li added.

The ratio is calculated by dividing a bank's net cash outflow in the coming 30 days by quality liquidity assets.

Quality liquidity assets are those that can be liquidated with little or no loss under the stress conditions specified by the CBRC. They should have high stability and low risk and be in strong demand.

Those assets can include cash, reserves at the PBOC and securities issued by sovereign entities or multilateral financial institutions such as the International Monetary Fund.

Stress conditions can include systemic risks that influence the whole market, such as significant losses in retail deposits, credit rating downgrades by one to three notches and reductions in mortgage value caused by market turbulence.

"The LCR is borrowed from global rules and is quite new in China. It is a better measure of banks' resiliency than the loan-to-deposit and liquidity ratios, which the Chinese banking system has been using for risk assessment," said Zeng Gang, a financial professor in Chinese Academy of Social Sciences.

"The introduction of LCR requirements will cause banks to evaluate risk more carefully. Therefore, banks may take measures to reduce risk prevention costs, making the whole system more secure."