Banking Newsletter. Review and Outlook of China s Banking Industry in April 2018

Transcription

1 Review and Outlook of China s Banking Industry in

2 Editorial Team Editor-in-Chief:Linda Yip Deputy Editor-in-Chief:Jeff Deng Members of the editorial team: Ariel Liu, Luna Liu, David Li, Sophia Shu, Daisy Wu (in alphabetical order of last names) Advisory Board Jimmy Leung, Margarita Ho, Richard Zhu, Michael Hu, Vincent Yao, James Tam, Raymond Poon

3 Preface The, s analysis of China s listed banks and the wider industry, is now in its 34th edition. This analysis covers 34 A-share and/or H-share listed banks that have released their 2017 annual results as of 24. According to their size and business characteristics, those banks are categorized into following three groups: Large Commercial Banks (6) Joint-stock Commercial Banks (8) Rural & City Commercial Banks (20) Industrial and Commercial Bank of China (ICBC) China Construction Bank (CCB) Agricultural Bank of China (ABC) Bank of China (BOC) Bank of Communications (BOCOM) Postal Savings Bank of China (PSBC) China Industrial Bank (CIB) China Merchants Bank (CMB) China Minsheng Bank Corporation (CMBC) China CITIC Bank (CITIC) China Everbright Bank (CEB) Ping An Bank (PAB) Huaxia Bank (HXB) China Zheshang Bank (CZB) Bank of Shanghai (Shanghai) Bank of Jiangsu (Jiangsu) Bank of Ningbo (Ningbo) ShengjingBank (Shengjing) HuishangBank (Huishang) Bank of Jinzhou (Jinzhou) Bank of Tianjin (Tianjin) Harbin Bank (Harbin) Guangzhou Rural Commercial Bank (Guangzhou RCB) Jiutai Rural Commercial Bank (Jiutai RCB) Changshu Rural Commercial Bank (Changshu RCB) Wuxi Rural Commercial Bank (Wuxi RCB) Jiangyin Rural Commercial Bank (Jiangyin RCB) ZhongyuanBank (Zhongyuan) Bank of Zhengzhou (Zhengzhou) Zhangjiagang Rural Commercial Bank (Zhangjiagang RCB) Bank of Chongqing (Chongqing) Bank of Qingdao (Qingdao) Bank of Gansu (Gansu) Chongqing Rural Commercial Bank (Chongqing RCB) The total assets of these banks, as of 31 December 2017, accounted for 78.91% of the total assets of China s commercial banking sector. Unless otherwise stated, all the information in this newsletter comes from publicly available sources. All amounts are in RMB except for ratios. For more information, please talk to your contacts or any of those listed in the Appendix as Banking and Capital Markets Contacts.

4 Table of Contents 1 Macro overview 05 2 Listed Banks Result Analysis Large Commercial Banks Joint-stock Commercial Banks Rural & City Commercial Banks 33 3 Features Banks wealth management business is set to transform under the New AM Regulations 3.2 Addressing shadow banking risks to ensure banks ongoing stability 3.3 Leveraging New Provision Regulations to enhance risk management 3.4 Quantifying the implications of new financial instrument reporting standards (IFRS 9) Appendix 55

5 Macro Overview China recorded higher GDP growth for the first time in 4 years Lower M2 growth indicates improved fund flows in the financial system Tougher regulation to prevent financial risks Overseas direct investment slumped

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7 China recorded higher GDP growth for the first time in 4 years There s synchronized growth across the world in 2017 for the first time since the financial crisis. According to the IMF, global GDP grew 3.70% in 2017, 0.50 percentage points higher than that of Consumer Price Index (CPI) remained stable in 2017, exhibiting 1.60% growth, 0.40 percentage points lower than in Producer Price Index (PPI) rose 6.30%, putting an end to year years consecutive decline. Benefitting from a favourable external environment, China recorded strong GDP growth 6.90% in 2017, 0.20 percentage points higher than in 2016 following a downward growth trend in past three years. Contribution to growth from net export firmed to 9.10%, reversing last two years drop. Consumption has become the main driver of growth, contributing 58.80%. Contribution from investment was 32.10%. Figure 1 Steady GDP growth China real GDP grew by 6.90% in 2017, the first pickup in 4 years 9.50% 7.70% 7.80% 7.30% 6.90% 6.70% 6.90% Source: National Bureau of Statistics 7

8 Lower M2 growth indicates improved fund flows in the financial system Money supply decelerated amid continued deleveraging and tougher financial regulations, with M2 growing 8.20% in 2017, the lowest growth in recent years. However, social financing growth was resilient and stood at around 12.00%, consistent with the full year target. Credit continued to expand rapidly, with RMB loan growing 12.70%. The amount of new loan was trillion, higher than The divergence of M2 and social financing growth in 2017 indicates financing demand from real economy wasn t impacted by the deleveraging. Deceleration of M2 growth reflects an improvement in fund flows - funds that circulated within the financial system with embedded structures were channelled to the real economy, the chains of fund flow were also shorten. Figure 2 Falling M2 growth M2 growth fell to 8.20% in December, significantly lower than social financial growth 14% Social financing growth YOY, , 12.00% 12% 10% 8% 6% Monthly M2 growth YOY, , 8.20% 4% 2% 0% Source: PBoC 8

9 Tougher regulation to prevent financial risks Regulation and risk prevention were among the key words in financial sector in Since Q the CBRC began taking serious measures to tackle irregularities in the banking sector, a series of inspections commonly referred to as three, three, four, ten (three types of violations, three types of arbitrages, four types of improper conducts, and ten types of malpractices), targeting inter-bank activities and wealth management business. China s top decision making meetings in 2017, including the 19th Party Congress, Central Financial Work Conference, Central Economic Work Conference, reiterated the importance of preventing and mitigating financial risks. In 1Q 2018, the merge of banking and insurance regulatory bodies was a step towards closer coordination with the regulatory framework. Under the fine tuned framework, the PBoC will take on the role of regulation drafting and macro prudential regulation, while the merged banking and insurance regulatory body will focus on enforcement. Bond yields, such as government bond yields, rose amid tougher regulation in Figure 3 Interest rates on the rise Government bond yields rose amid tougher regulation, with shorter maturity yields rising more than longer term ones 3.35% 3.04% 2.68% 3.88% 3.84% 3.79% 10-year 5-year 1-year Source: PBoC 9

10 Overseas direct investment slumped To mitigate financial risks and reduce volatility of cross-boarder capital flows, Chinese authorities imposed several measures to contain the private sector s "irrational" overseas investments. As a result, non-financial overseas direct investment (ODI) dropped by 29.40% to USD 120 billion. On the other hand, non-financial FDI increased by 7.90% to USD 131 billion. Expectation on RMB depreciation was high at the beginning of 2017, which turned out to be just expectation. RMB against a basket of currencies remained stable, with China Foreign Exchange Trade System (CFETS) Index rose 0.02% for the whole year. Resilient RMB indicates that the concern on China s economic downturn has eased due to supply side structural reform measures, such as cutting excess capacity, reducing inventories, lowering borrowing costs, deleveraging and tackling weakness. Figure 4 ODI slumped Non-financial ODIs decreased nearly 30% as a result of policy tightening on irrational outbound investment % % 14.11% 14.71% Non-financial ODI (in billions) YOY growth % Source: Ministry of Commerce 10

11 Listed Banks Results Analysis Large Commercial Banks Net profit growth improving, but profitability indicators still under pressure Total assets reached over 100 trillion despite a slower growth Credit asset quality improved Joint-stock Commercial Banks The disparity in net profit growth increases Encouraging signs emerged for credit asset quality Pressure in common equity tier 1 capital Rural & City Commercial Banks Net profit growth slowed, with volatility among individual banks Credit asset quality improved Common equity tier 1 CAR went down

12 Large Commercial Banks in 2017 a snapshot Operating performance Credit asset quality Net Profit Non-performing loans Overdue loans 1, billion YOY 4.10% billion 1, billion 3.93 billion billion Net profit growth in last 5 years NPL in last 5 years billion Overdue loans in last 5 years billion 1, , , Return on total assets Return on equity 1.00% 13.79% NPL ratio Overdue loans ratio ppts ppts 1.51% 1.78% Net interest income Net fee & commission income ppts ppts 2, billion billion NPL ratio vs overdue loans ratio NPL ratio vs 90 day or above overdue loan ratio YOY 9.76% YOY -3.88% NPL ratio Overdue loans ratio NPL ratio 90 day or above overdue loan ratio Net interest spread Net interest margin 1.93% 2.04% ppts ppts Cost-to-income ratio Business & administration expenses 30.71% ppts billion YOY 3.82% Special mention loans 1, billion Special mention loan ratio 3.08% billion ppts Financial position Total assets trillion YOY 7.33% Total liabilities trillion YOY 7.17% Provision coverage ratio % 17.35% Provision ratio 2.67% 0.03 ppts Assets growth in last 5 years Liabilities growth in last 5 years Provision coverage ratio in last 5 years Provision ratio in last 5 years 2.79% 2.78% 2.75% 2.67% 2.64% Note: ppts refers to percentage points

13 2.1 Large Commercial Banks Net profit growth improving, but profitability indicators still under pressure Six large commercial banks covered in this newsletter generated an aggregate net profit of 1.03 trillion in 2017, increased by 4.10%. The growth was higher than that in 2016 (1.92%). Most of those banks saw net profit growth improving in 2017, due to the growth in net interest income. Return on total assets (RoA) Return on equity (RoE) ICBC 1.20% 1.14% 15.24% 14.35% CCB 1.18% 1.13% 15.44% 14.80% ABC 0.99% 0.95% 15.14% 14.57% BOC 1.05% 0.98% 12.58% 12.24% BOCOM 0.87% 0.81% 12.22% 11.40% PSBC 0.51% 0.55% 12.88% 13.07% That said, their profitability indicators, i.e. return on total assets (RoA) and return on equity (RoE), fell in 2017 for most banks, suggesting their profitability pressure is still there. Figure 5 Net profit growth rebounded for most banks Most large commercial banks saw higher net profit growth in 2017 than 2016 (In billions) ICBC % 2.99% CCB ABC BOC % 1.82% 0.51% 2.58% 4.83% 4.93% 2017 vs vs 2015 BOCOM % 4.39% PSBC % 19.94% 13

14 Large Commercial Banks Interest income increased steadily, whereas fee & commission income presented an opposite picture Expansion of interest generating assets, especially loans, drove six large commercial banks net interest income to increase steadily. Aggregate net interest income of those banks increased by 9.76% in 2017 to 2.07 trillion. On the other hand, fee and commission income of those banks presented an opposite picture - the aggregate amount in 2017 decreased by 3.88% to billion. According to those banks, this was due to their avocations to the government s calling of fee waving, as well as the drop in product supply from insurance companies through bank channel as a result of tighter regulation on insurance sector. Figure 6 Fee & commission income under pressure Net interest income for six large commercial banks increased steadily in 2017, whereas fees and commission income presented an opposite picture ICBC -3.69% 10.65% CCB ABC % -0.60% 8.30% 11.01% Net interest income BOC 0.03% 10.57% Fee & commission income BOCOM -5.56% 10.21% PSBC 10.78% 19.37% 14

15 Large Commercial Banks NIS and NIM rebounded slightly As market interest rates rise, net interest spread (NIS) and net interest margin (NIM) for six large commercial banks rebounded slightly, indicating the pressure was eased. This is largely due to their stable and low funding costs on liability side, which maintained cost on interest-paying liabilities at a flat or lower level. NIS ICBC 2.41% 2.46% 2.30% 2.03% 2.10% CCB 2.57% 2.62% 2.47% 2.07% 2.09% ABC 2.64% 2.76% 2.49% 2.11% 2.16% BOC 2.01% 2.13% 1.97% 1.69% 1.70% BOCOM 2.33% 2.17% 2.06% 1.75% 1.44% PSBC 2.66% 2.87% 2.71% 2.34% 2.46% NIM ICBC 2.57% 2.66% 2.47% 2.16% 2.22% CCB 2.74% 2.80% 2.63% 2.20% 2.21% ABC 2.79% 2.92% 2.66% 2.25% 2.28% BOC 2.13% 2.25% 2.12% 1.83% 1.84% BOCOM 2.52% 2.36% 2.22% 1.88% 1.58% PSBC 2.67% 2.92% 2.78% 2.24% 2.40% Figure 7 NIS and NIM rebounded slightly NIS and NIM rebounded slightly, following consecutive drops in 2015 and % 2.65% 2.48% 2.42% 2.49% 2.32% 2.10% 2.11% NIM 1.98% 2.00% NIS

16 Large Commercial Banks Total assets reached over 100 trillion despite a slower growth By the end of 2017, total assets of six large commercial banks reached over 100 trillion for the first time, at trillion, 7.33% more than that at the end of The growth was slower than in 2016 (11.01%). All six banks saw slower assets growth. Figure 8 Asset growth slowed across the board All six banks saw slower assets growth in 2017 than in 2016 (In trillions) ICBC % 8.68% CCB % 14.25% ABC BOC BOCOM % 7.27% 7.93% 7.56% 10.00% 2017 vs vs % PSBC % 13.28% 16

17 Large Commercial Banks Loans and financial investments continued to grow, whereas interbank assets showed a mix picture Among various components of the assets of six large commercial banks, loans and financial investments continued to grow in 2017, whereas interbank assets showed a mixed picture. Those banks continued to adjusted their loan mix in 2017, by increasing medium to long term loans and reducing discounted bills. By customer groups, retail loans grew fast than corporate loans in their portfolio. As for financial investment portfolio, most banks financial assets measured at fair value through profit and loss, and held-to-maturity assets recorded faster growth. Figure 9 Credit continued to expand Six large commercial banks loans and financial investments continued to grow in 2017, while interbank assets growth varied ICBC 8.82% 5.03% 18.10% CCB ABC % % 9.45% 2.23% 10.70% 15.36% Loans and advances Financial investments Interbank assets BOC -9.86% 9.33% 14.65% BOCOM 8.62% 9.24% 9.32% PSBC -8.57% 20.49% 70.68% 17

18 Large Commercial Banks Credit asset quality improved Credit asset quality of six large commercial banks improved in 2017, with non-performing loans (NPLs) growing slightly by 0.46% to billion. Not only NPL ratio continued to fell, other indicators such as special mention loans ratio, overdue loan ratio and past-due-but-not-impaired loan ratio of those banks all went down. NPL Ratio ICBC 0.94% 1.13% 1.50% 1.62% 1.55% CCB 0.99% 1.19% 1.58% 1.52% 1.49% ABC 1.22% 1.54% 2.39% 2.37% 1.81% BOC 0.96% 1.18% 1.43% 1.46% 1.45% BOCOM 1.05% 1.25% 1.51% 1.52% 1.50% PSBC 0.51% 0.64% 0.80% 0.87% 0.75% Overdue loan ratio ICBC 1.35% 1.91% 2.79% 2.65% 2.01% CCB 1.01% 1.41% 1.65% 1.51% 1.29% ABC 1.39% 2.06% 3.14% 2.83% 2.09% BOC 1.16% 1.48% 1.96% 2.15% 1.86% BOCOM 1.41% 2.37% 3.04% 2.64% 2.22% PSBC 0.60% 0.82% 0.99% 0.96% 0.97% Figure 10 Credit asset quality pressure eased Past-due-but-notimpaired loan ratio ICBC 0.44% 0.79% 1.29% 1.06% 0.56% CCB 0.17% 0.34% 0.30% 0.27% 0.24% ABC 0.34% 0.61% 0.83% 0.57% 0.52% BOC 0.34% 0.49% 0.69% 0.77% 0.52% BOCOM 0.44% 1.15% 1.55% 1.13% 0.74% PSBC 0.10% 0.21% 0.22% 0.17% 0.28% NPL ratio, overdue loan ratio and past-due-but-not-impaired loan ratio of six large commercial banks all fell for the first time in years 2.36% 2.23% 1.22% 1.73% 1.64% 1.66% 1.78% 1.51% Overdue loans ratio NPL ratio 1.00% 0.33% 1.22% 0.60% 0.83% 0.69% 0.47% Past-due-but-notimpaired loans ratio

19 Large Commercial Banks Continued to dispose outstanding NPLs The improvement of six large commercial banks credit asset quality was largely the result of continued efforts in disposing outstanding NPLs. Total write-offs and transfer-outs of those banks amounted to billion in 2017, 5.07% more than that in Such amount accounted for nearly 40% of their total NPL balance. As of 31 Dec 2017, in billions NPL balances Write-offs& transfer-outs Write-offs & transferouts as % of NPL ICBC % CCB % ABC % BOC % BOCOM % PSBC % Total % Figure 11 Continued efforts in NPL disposal While NPL balances flattened out in 2017, write-offs & transfer-outs continued to increase (In billions) NPL balances Write-offs and transfer-outs 19

20 Large Commercial Banks Total liabilities growth slowed with new type of liabilities growing fast By the end of 2017, total liabilities of six large commercial banks increased by 7.71% to trillion. The growth slowed in Among various components of liabilities, customer deposits increased at a faster pace and remained as the major source of funding. Debt securities issued, mostly are new types of liabilities, including tier 2 capital bonds, certificates of deposit, interbank negotiable certificates of deposit and financial bonds, continued to grow rapidly. Figure 12 Liabilities growth slowed Liabilities growth of six large commercial banks in 2017 was slower than 2016 (In trillions) ICBC % 8.56% CCB % 14.61% ABC BOC BOCOM % 7.38% 7.79% 7.61% 10.07% 17.43% 2017 vs vs 2015 PSBC % 12.71% 20

21 Large Commercial Banks Common equity tier 1 capital under pressure Six large commercial banks actively issued preferred stocks and tier 2 capital bonds in 2017 to strengthen their capital base amid expansion of risk assets. These activities helped to boost tier 1 capital adequacy ratios (CAR) and total CAR. However, some banks saw their common equity tier 1 CAR fell, reflecting such capital were under pressure. Common equity tier 1 CAR ICBC 10.57% 11.92% 12.87% 12.87% 12.77% CCB 10.75% 12.12% 13.13% 12.98% 13.09% ABC 9.25% 9.09% 10.24% 10.38% 10.63% BOC 9.69% 10.61% 11.10% 11.37% 11.15% BOCOM 9.76% 11.30% 11.14% 11.00% 10.79% PSBC 7.72% 8.44% 8.53% 8.63% 8.60% Tier 1 CAR ICBC 10.57% 12.19% 13.48% 13.42% 13.27% CCB 10.75% 12.12% 13.32% 13.15% 13.71% ABC 9.25% 9.46% 10.96% 11.06% 11.26% BOC 9.70% 11.35% 12.07% 12.28% 12.02% BOCOM 9.76% 11.30% 11.46% 12.16% 11.86% PSBC 7.72% 8.44% 8.53% 8.63% 9.67% Total CAR ICBC 13.12% 14.53% 15.22% 14.61% 15.14% CCB 13.34% 14.87% 15.39% 14.94% 15.50% ABC 11.86% 12.82% 13.40% 13.04% 13.74% BOC 12.46% 13.87% 14.06% 14.28% 14.19% BOCOM 12.08% 14.04% 13.49% 14.02% 14.00% PSBC 8.84% 9.56% 10.46% 11.13% 12.51% Figure 13 Common equity tier 1 CAR fell slightly Six large commercial banks CAR generally positive, but common equity tier 1 CAR under pressure 12.52% 9.99% 9.99% 13.83% 11.17% 10.88% 14.22% 14.01% 12.18% 12.23% 14.47% 12.35% 11.62% 11.65% 11.64% Total CAR Tier 1 CAR Common equity tier 1 CAR

22 Joint-stock Commercial Banks in 2017 a snapshot Operating performance Credit asset quality Net Profit Non-performing loans Overdue loans billion YOY 6.10% billion billion billion billion Net profit growth in last 5 years 17.07% 9.97% 4.73% 5.56% 6.10% NPL in last 5 years billion Overdue loans in last 5 years billion Return on total assets Return on equity % 13.99% NPL ratio Overdue loans ratio ppts ppts 1.64% 2.55% Net interest income Net fee & commission income ppts ppts billion YOY -5.65% billion YOY 5.62% NPL ratio vs overdue loans ratio NPL ratio Overdue loans ratio NPL ratio vs 90 day or above overdue loan ratio NPL ratio 90 day or above overdue loan ratio Net interest spread 1.69% ppts Net interest margin 1.83% ppts 3.40% 2.86% 3.00% 2.55% 1.98% 2.06% 1.83% 1.36% 0.96% 0.87% 1.70% 1.70% 1.64% 1.54% 1.64% 1.54% 1.15% 1.15% 0.87% 0.53% Cost-to-income ratio Business & administration expenses 30.34% 2.52 ppts billion YOY 7.36% Special mention loans billion Special mention loan ratio 2.77% billion ppts Financial position Total assets trillion Total liabilities trillion Provision coverage ratio % Provision ratio 3.11% YOY 3.29% YOY 2.50% ppts 0.21 ppts Assets growth in last 5 years Liabilities growth last 5 years Provision coverage ratio in last 5 years 13.06% 17.63% 17.81% 18.51% 12.45% 17.49% 17.59% 18.65% % % % % % Provision ratio in last 5 years 3.11% 2.92% 2.67% 2.25% 2.40% 3.29% 2.50% Note: ppts refers to percentage points

23 2.2 Joint-stock Commercial Banks The disparity in net profit growth increases The eight joint-stock commercial banks covered in the newsletter saw stable aggregate net profit growth of 6.10% in 2017, to billion. The growth was higher compared with that in 2016 (5.56%). The disparity among banks was large both in terms of 2017 growth rate and the growth rate different between 2017 and Analysis of profitability indicators suggested that most banks RoA and RoE were lower in 2017 than in Return on total assets (RoA) Return on equity (RoE) CIB 0.95% 0.92% 17.28% 15.35% CMB 1.09% 1.15% 16.27% 16.54% CMBC 0.94% 0.86% 15.13% 14.03% CITIC 0.76% 0.74% 12.58% 11.67% CEB 0.85% 0.78% 13.80% 12.75% PAB 0.83% 0.75% 13.18% 11.62% HXB 0.90% 0.82% 15.75% 13.54% CZB 0.85% 0.76% 17.34% 14.64% Figure 14 A mixed picture for net profit growth The disparity of net profit growth among eight joint-stock commercial banks was large (In billions) CIB CMB CMBC % 7.26% 7.52% 4.40% 3.73% 13.24% CITIC CEB PAB HXB CZB % 2.61% 4.02% 2.74% 2.61% 3.36% 0.90% 4.24% 8.07% 2017 vs vs % 23

24 Joint-stock Commercial Banks Fee & commission income continued to grow Most of the eight joint-stock commercial banks saw their net interest income decreased in 2017 amid plunging asset growth and continued narrowing of NIM, with aggregate amount shrinking by 5.65% to billion. Fee and commission income (i.e. intermediary business ), on the other hand, remained resilient and became the major profit growth engine for these banks in 2017, with aggregate amount increasing by 5.62% to billion. The growth was lower than that in 2016 (13.03%), indicating such business was also under threat. Figure 15 Intermediary business continued to grow Seven of the eight joint-stock commercial banks saw net interest income down in 2017, whereas fee & commission income continued to grow CIB % 5.98% CMB CMBC -8.59% -8.65% 7.62% 5.18% Net interest income CITIC -6.12% 10.83% Fee and commission income CEB -6.64% 9.47% PAB -3.14% 10.10% HXB -3.41% 25.59% CZB -3.32% 7.20% 24

25 Joint-stock Commercial Banks NIS and NIM still under pressure Thanks to rising interest rates in financial markets, most joint-stock commercial banks yield on interest-generating assets improved in Yet this effect was more than offset by increasing funding costs which led to a much higher rise in cost on interest-paying liabilities. Consequently, the NIS and NIM continued their downward trend in past a few years. The rise of cost on interbank liabilities, debt securities issued and due to central banks were most evident. NIS CIB 2.23% 2.23% 2.26% 2.00% 1.44% CMB 2.64% 2.44% 2.60% 2.37% 2.29% CMBC 2.31% 2.41% 2.09% 1.74% 1.35% CITIC 2.40% 2.19% 2.13% 1.89% 1.64% CEB 1.95% 2.05% 2.01% 1.59% 1.32% PAB 2.14% 2.40% 2.62% 2.60% 2.19% HXB 2.50% 2.52% 2.41% 2.28% 1.88% CZB 2.41% 2.38% 2.12% 1.89% 1.62% NIM CIB 2.44% 2.48% 2.45% 2.23% 1.73% CMB 2.82% 2.64% 2.76% 2.50% 2.43% CMBC 2.49% 2.59% 2.26% 1.86% 1.50% CITIC 2.60% 2.40% 2.31% 2.00% 1.79% CEB 2.16% 2.30% 2.25% 1.78% 1.52% PAB 2.31% 2.57% 2.81% 2.75% 2.37% HXB 2.67% 2.69% 2.56% 2.42% 2.01% CZB 2.63% 2.62% 2.31% 2.07% 1.71% Figure 16 NIS and NIM narrowed further NIS & NIM of eight joint-stock commercial banks continued to narrow in % 2.52% 2.47% 2.16% 2.33% 2.31% 2.29% 2.03% 1.83% NIM 1.69% NIS

26 Joint-stock Commercial Banks Asset growth plunged amid tougher regulatory environment By the end of 2017, total assets of eight joint-stock commercial banks increased only by 3.29% to trillion. The growth was much slower than that in 2016 (18.51%). Most of those banks saw asset their growth slowed by over 10 percentage points, with one bank s growth even in the negative territory. This drastic asset growth plunge happened under the tougher regulatory environment, where most banks adjusted their balance sheet by scaling down interbank assets and rebalancing investment portfolio. Figure 17 Asset growth plunged Eight joint-stock commercial banks asset growth plunged in 2017 compared to 2016 (In trillions) CIB % 14.85% CMB % 8.54% CMBC % 30.42% CITIC % 15.79% 2017 vs 2016 CEB % 26.91% 2016 vs 2015 PAB % 17.80% HXB % 16.61% CZB % 31.33% 26

27 Joint-stock Commercial Banks Scaling down interbank assets Among various components of the assets of eight joint-stock commercial banks, loans continued to growth, whereas interbank assets decreased significantly in 2017, as banks scaled down interbank activities in response to the changing regulatory environment. Financial investment portfolio also registered negative or low growth. Those banks credit expansion was largely driven by efforts in retail banking segment, with such loans grew rapidly. As for investment portfolio, the change of each component varied among different banks. Figure 18 Interbank assets decreased sharply Loans continued to grow for eight joint-stock commercial banks, while interbank assets decreased sharply CIB % -3.51% 13.65% CMB % 8.34% 8.78% CMBC % -3.22% 13.87% Loans and advances CITIC % % 10.83% Financial investments CEB % -1.53% 13.08% Interbank assets PAB % 15.64% 6.26% HXB % 14.46% 19.55% CZB % -8.16% 46.46% 27

28 Joint-stock Commercial Banks Encouraging signs emerged for credit asset quality By the end of 2017, total NPL for eight joint-stock commercial banks increased by 9.36% to billion. Yet their NPL ratio went down. In addition, other indicators of these banks, such as special mention loan ratio, overdue loans ratio and past-due-but-not-impaired loans ratio all fell, showing encouraging signs on their credit asset quality. NPL ratio CIB 0.76% 1.10% 1.46% 1.65% 1.59% CMB 0.83% 1.11% 1.68% 1.87% 1.61% CMBC 0.85% 1.17% 1.60% 1.68% 1.71% CITIC 1.03% 1.30% 1.43% 1.69% 1.68% CEB 0.86% 1.19% 1.61% 1.60% 1.59% PAB 0.89% 1.02% 1.45% 1.74% 1.70% HXB 0.90% 1.09% 1.52% 1.67% 1.76% CZB 0.64% 0.88% 1.23% 1.33% 1.15% Overdue loan ratio CIB 1.06% 2.25% 2.74% 2.15% 1.59% CMB 1.50% 2.10% 2.85% 2.14% 1.74% CMBC 1.74% 2.74% 3.94% 3.50% 3.18% CITIC 1.83% 3.47% 2.96% 3.26% 2.86% CEB 1.85% 3.47% 4.09% 2.87% 2.46% PAB 3.13% 4.49% 4.72% 4.11% 3.54% HXB 1.60% 2.43% 3.96% 4.72% 3.99% CZB 0.86% 1.63% 1.83% 1.20% 1.07% Figure 19 Credit asset quality improved Past-due-but-notimpaired loan ratio CIB 0.33% 1.16% 1.29% 0.68% 0.37% CMB 0.71% 1.03% 1.22% 0.52% 0.34% CMBC 0.92% 1.58% 2.36% 1.85% 1.56% CITIC 0.82% 2.18% 1.64% 1.70% 1.27% CEB 1.06% 2.28% 2.60% 1.40% 1.06% PAB 2.25% 3.48% 3.30% 2.49% 1.88% HXB 0.71% 1.35% 2.44% 3.06% 2.27% CZB 0.29% 0.80% 0.66% 0.25% 0.22% Ratios for NPL, overdue loans and past-due-but-not-impaired loans all fell in unison for joint-stock commercial banks 2.86% 3.40% 3.00% 2.55% Overdue loans ratio 1.71% 1.73% 1.92% 1.70% 1.64% NPL ratio 0.87% 0.87% 1.15% 1.54% 1.45% 1.08% Past-due-but-notimpaired loans ratio

29 Joint-stock Commercial Banks Relying on write-offs and transfer-outs to dispose NPLs Eight joint-stock commercial banks continued to mitigate credit risk by disposing outstanding NPLs in Aggregate write-offs and transfer-outs of those banks reached billion, accounting for nearly 60% of NPL balances. As of 31 Dec 2017, in billions NPL balances Write-offs& transfer-outs Write-offs & transfer-outs as % of NPL CIB % CMB % CMBC % CITIC % CEB % PAB % HXB % CZB % Total % Figure 20 Continued to dispose NPLs Eight joint-stock commercial banks NPL balances increased in 2017, and the write-offs and transfer-outs remained large (In billions) NPL balances Write-offs and transfer-outs 29

30 Joint-stock Commercial Banks Liabilities growth slowed with large disparity among banks Changing regulatory environment s impact on eight joint-stick commercial banks liabilities was also evident in By the end of 2017, total liabilities of these banks increased only by 2.50% to trillion. The growth was much slower than in 2016 (18.66%), with some banks even registering negative growth. Interbank assets of these banks shrank sharply in 2017, whereas due deposits growth slowed too. Deposit growth varied among different banks, with some recording negative growth. New types of liabilities, such as interbank negotiable certificates of deposit, increased relatively faster for these banks. Figure 21 Liabilities growth slowed Eight joint-stock banks saw much lower liabilities growth in 2017 (In trillions) CIB 5.99 CMB 5.81 CMBC % CITIC % CEB % 4.58% 4.97% 8.33% 15.06% 15.49% 28.04% 31.65% 2017 vs 2016 PAB % 17.29% 2016 vs 2015 HXB % 15.83% CZB % 31.10% 30

31 Joint-stock Commercial Banks Pressure in common equity tier 1 capital Eight joint-stock commercial banks CAR rose steadily in 2017, thanks to their active issuance of various instruments such as preferred stocks and tier 2 capital bonds. That said, CAR changes varied among different banks. So were their challenges in capital base, with the common equity tier 1 experiencing most pressure. Common equity tier 1 CAR CIB 8.68% 8.45% 8.43% 8.55% 9.07% CMB 9.27% 10.44% 10.83% 11.54% 12.06% CMBC 8.72% 8.58% 9.17% 8.95% 8.63% CITIC 8.78% 8.93% 9.12% 8.64% 8.49% CEB 9.11% 9.34% 9.24% 8.21% 9.56% PAB 8.56% 8.64% 9.03% 8.36% 8.28% HXB 8.03% 8.49% 8.89% 8.43% 7.73% CZB 9.17% 8.62% 9.35% 9.28% 8.29% Tier 1 CAR CIB 8.68% 8.89% 9.19% 9.23% 9.67% CMB 9.27% 10.44% 10.83% 11.54% 13.02% CMBC 8.72% 8.59% 9.19% 9.22% 8.88% CITIC 8.78% 8.99% 9.17% 9.65% 9.34% CEB 9.11% 9.34% 10.15% 9.34% 10.61% PAB 8.56% 8.64% 9.03% 9.34% 9.18% HXB 8.03% 8.49% 8.89% 9.70% 8.85% CZB 9.17% 8.62% 9.35% 9.28% 9.96% Figure 22 Total CAR rose steadily Total CAR CIB 10.83% 11.29% 11.19% 12.02% 12.19% CMB 11.14% 12.38% 12.57% 13.33% 15.48% CMBC 10.69% 10.69% 11.49% 11.73% 11.85% CITIC 11.24% 12.33% 11.87% 11.98% 11.65% CEB 10.57% 11.21% 11.87% 10.80% 13.49% PAB 9.90% 10.86% 10.94% 11.53% 11.20% HXB 9.88% 11.03% 10.85% 11.36% 11.78% CZB 11.53% 10.60% 11.04% 11.79% 12.21% Eight joint-stock commercial banks used different instruments to strengthen capital base in 2017, as a result CAR rose steadily 10.78% 8.82% 11.48% 11.63% 11.91% 12.54% 9.12% 9.54% 9.72% 9.97% Total CAR Tier 1 CAR 8.82% 9.03% 9.29% 9.05% 9.18% Common equity tier 1 CAR

32 Rural & City Commercial Banks in 2017 a snapshot Operating performance Credit asset quality Net Profit Non-performing loans Overdue loans billion YOY 10.19% billion billion 8.95 billion 0.43 billion Net profit growth in last 4 years NPL in last 4 years Overdue loans in last 4 years 20.96% billion billion 14.34% 14.74% % Return on total assets Return on equity % 14.17% NPL ratio Overdue loan ratio ppts ppts 1.34% 2.11% Net interest income billion YOY 0.87% Net interest spread 1.84% ppts Net fee & commission income billion YOY 3.50% Net interest margin 1.94% ppts ppts NPL ratio vs overdue loan ratio 1.56% 1.05% NPL ratio 2.73% 1.25% Overdue loans ratio 2.50% 2.11% 1.36% 1.34% ppts NPL ratio vs 90 day or above overdue loan ratio NPL ratio 90 day or above overdue loan ratio % 0.86% 1.63% 1.25% 1.61% 1.36% 1.40% 1.34% Cost-to-income ratio 29.58% 1.40 ppts Business & administration expenses billion YOY 7.26% Special mention loans billion Special mention loan ratio 2.59% 7.25 billion ppts Financial position Total assets trillion Total liabilities trillion Provision coverage ratio % Provision coverage ratio 3.14% YOY 12.13% YOY 11.33% 8.10 ppts 0.06 ppts Assets growth in last 4 years Liabilities growth last 4 years Provision coverage ratio in last 4 years Provision ratio in last 4 years 29.28% 26.23% 23.02% 28.47% 26.23% 23.28% % % % % 2.65% 2.92% 3.08% 3.14% 12.13% 11.33% Note: ppts refers to percentage points

33 2.3 Rural & City Commercial Banks Net profit growth slowed, with volatility among individual banks The 20 rural & city commercial banks covered in the newsletter generated an aggregate of billion net profit in 2017, increased by 10.19% compared with 14.74% in Among individual banks, the difference and volatility of their profit growth was large. In general, city commercial banks saw lower growth rate while rural commercial banks higher. Figure 23 Different growth trend for rural & city commercial banks City commercial banks saw lower net profit growth while rural commercial banks higher (In billions) Shanghai Jiangsu % 9.83% 12.96% 11.91% Chongqing RCB % 10.70% Ningbo 9.36 Shengjing 7.57 Huishang % 19.12% 10.12% 10.52% 11.66% 12.62% Guangzhou RCB % Jiutai RCB % 2.09% 65.16% Jinzhou 9.09 Tianjin 3.94 Harbin % -8.40% 10.86% 6.99% 10.04% 67.06% Changshu RCB % 7.35% Zhongyuan 3.91 Zhengzhou 4.33 Chongqing % 16.24% 11.54% 7.14% 20.53% 7.48% 10.48% Wuxi RCB 0.99 Jiangyin RCB % -5.83% 12.38% 7.88% Qingdao 1.90 Gansu % 47.95% 75.08% Zhangjiagang RCB % 2.16% 2017 vs vs

34 Rural & City Commercial Banks Income growth presented different pictures City commercial banks saw negative or low growth in net interest income and high growth in fee and commission income in Yet rural commercial banks presented different pictures: interest income growth stood out. Figure 24 Different trends for income growth While city commercial banks fee & commission income growth stood out, so did rural commercial banks interest income Shanghai Jiangsu % -0.73% 1.61% 10.18% Chongqing RCB 10.80% 8.37% Ningbo Shengjing -6.69% -8.64% % 6.43% Guangzhou RCB % 9.59% Huishang 10.13% 14.15% Jiutai RCB % 4.47% Jinzhou -8.97% 19.97% Tianjin Harbin % -2.30% 2.14% 45.03% Changshu RCB 7.73% 42.16% Zhongyuan 8.91% 71.37% Wuxi RCB -9.19% 16.03% Zhengzhou Chongqing -2.34% % 5.70% 53.58% Jiangyin RCB -7.16% 7.39% Qingdao Gansu -4.10% -6.66% 12.22% 46.96% Zhangjiagang RCB -9.01% 7.26% Net interest income Fee and commission income 34

35 Rural & City Commercial Banks NIS and NIM continued to fall The 20 rural & city commercial banks NIS and NIM continued to fall and under pressure. Although yield on interest-generating assets rose slightly, cost on interest-paying liabilities rose much faster and resulting narrowing NIS and NIM. NIM Shanghai 2.21% 2.02% 1.73% 1.25% Jiangsu 2.45% 1.94% 1.70% 1.58% Ningbo 2.51% 2.38% 1.95% 1.94% Shengjing 2.32% 2.14% 1.75% 1.50% Huishang 1.82% 2.71% 2.59% 2.31% Jinzhou 2.63% 3.51% 3.67% 2.88% Tianjin 2.06% 2.08% 1.76% 1.25% Harbin 2.71% 2.68% 2.74% 2.26% Zhongyuan 4.97% 3.96% 3.26% 2.76% Zhengzhou 3.31% 3.12% 2.69% 2.08% Chongqing 2.81% 2.52% 2.38% 2.11% Qingdao 2.43% 2.36% 2.23% 1.68% Gansu 2.82% 2.89% 3.08% 2.91% Chongqing RCB 3.37% 3.20% 2.74% 2.62% Guangzhou RCB 2.91% 2.50% 1.98% 1.70% Jiutai RCB 3.40% 3.01% 2.67% 2.38% Changshu RCB 3.08% 3.04% 3.22% 2.91% Wuxi RCB 2.41% 2.00% 1.96% 2.15% Jiangyin RCB 2.95% 2.77% 2.34% 2.33% Zhangjiagang RCB 3.02% 2.80% 2.24% 2.33% Figure 25 NIS and NIM under pressure NIS & NIM for the 20 rural & city commercial banks continued to fall 2.50% 2.51% 2.11% 2.32% 2.22% 2.09% 1.94% NIM 1.84% NIS

36 Rural & City Commercial Banks Asset expansion slowed By the end of 2017, total assets of 20 rural and city commercial banks increased by 12.13% to billion. Their growth was much lower than in 2016 (23.02%). The slowdown was more apparent for city commercial banks, whereas rural commercial banks saw stable or even faster growth. Figure 26 Slower asset growth for city commercial banks City commercial banks asset growth slowed while rural commercial banks remained stable Shanghai Jiangsu 2.98% 21.13% 10.78% 23.87% Chongqing RCB 12.78% 12.05% Ningbo Shengjing Huishang 16.61% 23.53% 13.82% 29.05% 20.31% 18.65% Guangzhou RCB -2.33% Jiutai RCB 11.31% 13.41% 34.88% Jinzhou 34.20% 49.05% Tianjin Harbin Zhongyuan 6.79% 16.20% 4.68% 21.17% 20.53% 41.58% Changshu RCB Wuxi RCB 12.19% 19.79% 10.02% 7.92% Zhengzhou Chongqing 19.03% 13.31% 16.66% 37.84% Jiangyin RCB 5.11% 15.04% Qingdao Gansu 10.18% 10.65% 48.47% %* Zhangjiagang RCB 14.41% 9.50% 2017 vs vs 2015 *Bank of Gansu s total assets changed significantly in 2016 due it was in restructuring and IPO stages. 36

37 Rural & City Commercial Banks Loans and financial investments continued to grow while interbank assets shrank Loans and financial investments of rural and city banks continued to grow at a faster pace, while interbank assets shrank. Most of these banks increased their investments in bonds and nonstandard assets, with investments still being the largest component of assets. As for financial investments, those banks investments classified as receivable increased and remained the major part of the portfolios. Individual banks loan growth and loan mix presented a mix picture. Figure 27 Shrinking interbank assets Loans and financial investments of 20 rural and city commercial banks grew, while interbank assets shrank Shanghai Jiangsu Ningbo Shengjing Huishang -9.05% % % % 19.69% 19.90% 17.88% 12.33% 13.46% 21.88% 18.74% 22.23% 13.32% 23.84% Loans Financial investments Interbank assets 60.02% Chongqing RCB Guangzhou RCB Jiutai RCB % -0.26% -4.71% 12.49% 20.42% 20.08% 3.94% 24.43% 63.75% Jinzhou Tianjin % 22.24% 12.23% 16.96% 71.48% 80.90% Changshu RCB % 16.64% 16.86% Harbin Zhongyuan Zhengzhou % % 17.38% 6.42% 20.92% 24.00% 15.63% 21.58% 33.54% Wuxi RCB Jiangyin RCB % 9.80% 13.15% 2.14% 5.78% 7.63% Chongqing Qingdao % % 17.29% 32.51% 12.55% 7.63% Zhangjiagang RCB 11.08% 21.83% 0.79% Gansu % 20.32% 62.07% Loans Financial investments Interbank assets 37

38 Rural & City Commercial Banks Credit assets quality improved NPL balances of 20 rural and city commercial banks increased by 16.41% to billion at the of NPL balance growth slowed across banks, with divergence between different banks. In general, NPL ratio, special mention loan ratio, overdue loan ratio and past-due-but-not-impaired loan ratio of those banks all went down. NPL ratio Shanghai 0.98% 1.19% 1.17% 1.15% Jiangsu 1.30% 1.43% 1.43% 1.41% Ningbo 0.89% 0.92% 0.91% 0.82% Shengjing 0.44% 0.42% 1.74% 1.49% Huishang 0.83% 0.99% 1.07% 1.05% Jinzhou 0.99% 1.03% 1.14% 1.04% Tianjin 1.09% 1.34% 1.48% 1.50% Harbin 1.13% 1.40% 1.53% 1.70% Zhongyuan 1.92% 1.95% 1.86% 1.83% Zhengzhou 0.75% 1.10% 1.31% 1.50% Chongqing 0.69% 0.97% 0.96% 1.35% Qingdao 1.14% 1.19% 1.36% 1.69% Gansu 0.39% 1.77% 1.81% 1.74% Chongqing RCB 0.78% 0.98% 0.96% 0.98% Guangzhou RCB 1.54% 1.80% 1.81% 1.51% Jiutai RCB 1.19% 1.42% 1.41% 1.76% Changshu RCB 0.93% 1.43% 1.40% 1.14% Wuxi RCB 1.15% 1.17% 1.39% 1.38% Jiangyin RCB 1.91% 2.17% 2.41% 2.39% Zhangjiagang RCB 1.51% 1.96% 1.96% 1.78% Figure 28 Credit assets quality improved NPL ratios, overdue loan ratios and past-due-but-not-impaired loan ratios of rural and city commercial banks all went down 2.73% 2.50% 2.25% Overdue loan ratio 2.02% 1.03% 1.05% 1.51% 1.25% 1.36% 1.34% 1.19% 0.79% NPL Ratio Past-due-but-notimpaired loans ratio

39 Rural & City Commercial Banks Differentiated efforts to dispose NPLs Write-offs and transfer-outs of 20 rural and city commercial banks totaled billion in 2017, accounting for 36.44% of NPL balances. Figure 29 Slowed write-offs and transfer-outs 55 As of 31 Dec 2017, in billions NPL balances Write-offs& transfer-outs Write-offs & transfer-outs as % of NPL Shanghai % Jiangsu % Ningbo % Shengjing % Huishang % Jinzhou % Tianjin % Harbin % Zhongyuan % Zhengzhou % Chongqing % Qingdao % Gansu % Chongqing RCB % Guangzhou RCB % Jiutai RCB % Changshu RCB % Wuxi RCB % Jiangyin RCB % Zhangjiagang RCB % Chongqing RCB % While NPL balance continued to increase for 20 rural and city commercial banks, their write-offs and transfer-outs decreased slightly NPL balances Write-offs and transfer-outs 39

40 Rural & City Commercial Banks Liabilities growth slowed Total liabilities of 20 rural and city commercial banks increased by 11.33% to trillion in The growth was slower than in 2016 (23.28%), dragged by decreasing interbank liabilities and slower deposits. City commercial banks slower growth trend was more evident, whereas rural commercial banks growth remained relatively stable. These banks continued to issue interbank negotiable certificates of deposit, leading to rapid growth in debt securities issued. Their interbank liabilities decreased slightly. Relatively, their deposit grew faster. Figure 30 City commercial banks liabilities growth slowed City commercial banks liabilities growth was slower, while most rural commercial banks saw steady growth Shanghai Jiangsu 1.29% 20.85% 9.49% 23.62% Chongqing RCB 12.23% 12.03% Ningbo Shengjing Huishang 16.80% 24.32% 13.88% 30.18% 20.99% 18.16% Guangzhou RCB -4.16% Jiutai RCB 10.29% 13.89% 36.63% Jinzhou Tianjin 6.76% 15.61% 33.68% 47.94% Changshu RCB 12.69% 19.46% Harbin Zhongyuan 4.02% 22.06% 19.70% 45.91% Wuxi RCB 10.38% 7.21% Zhengzhou Chongqing 16.88% 11.74% 17.01% 38.94% Jiangyin RCB 5.23% 14.59% Qingdao Gansu 7.61% 9.85% 15.95% 52.59% Zhangjiagang RCB 14.57% 10.00% 2017 vs vs

41 Rural & City Commercial Banks Common equity tier 1 CAR went down Common equity tier 1 CAR of 20 rural and city commercial banks went down in 2017, as the growth of risk-weighted assets outpaced that of core capital. Tier 1 CAR and total CAR of those banks rebounded in 2017 but still under pressure. Figure 31 CAR under pressure Common equity tier 1 CAR Shanghai 10.38% 10.32% 11.13% 10.69% Jiangsu 8.76% 8.59% 9.01% 8.54% Ningbo 10.07% 9.03% 8.55% 8.61% Shengjing 11.04% 9.42% 9.10% 9.04% Huishang 11.50% 9.80% 8.79% 8.48% Jinzhou 8.64% 8.96% 9.79% 8.44% Tianjin 10.64% 9.33% 9.48% 8.64% Harbin 13.94% 11.14% 9.34% 9.72% Zhongyuan 16.98% 14.80% 11.24% 12.15% Zhengzhou 8.66% 10.09% 8.79% 7.93% Chongqing 9.63% 10.49% 9.82% 8.62% Qingdao 9.72% 12.48% 10.08% 8.71% Gansu 9.85% 8.57% 8.58% 8.71% Chongqing RCB 10.12% 9.88% 9.85% 10.39% Guangzhou RCB 11.16% 10.28% 9.90% 10.69% Jiutai RCB 13.82% 12.49% 10.35% 9.47% Changshu RCB 12.08% 11.31% 10.90% 9.88% Wuxi RCB 10.49% 10.69% 10.28% 9.93% Jiangyin RCB 12.85% 12.87% 12.80% 12.94% Zhangjiagang RCB 13.35% 13.92% 12.26% 11.82% Common equity tier 1 CAR of 20 rural and city commercial banks continued to fall, with their tier 1 and total CAR also under pressure 12.84% 12.91% 12.30% 10.64% 10.14% 9.88% 12.91% 10.41% Total CAR 10.64% 10.05% 9.72% 9.44% Tier 1 CAR Common equity tier 1 CAR

42 42

43 Features 1. Banks wealth management business is set to transform under the New AM Regulations 2. Addressing shadow banking risks to ensure banks ongoing stability 3. Leveraging New Provision Regulations to enhance risk management 4. Quantifying the implications of new financial instrument reporting standards (IFRS 9): equity to decrease by 1%-3%, Common Equity Tier 1 CAR under pressure

44 44

45 3.1 Banks wealth management business is set to transform under the New AM Regulations Asset management (or wealth management in this context) business has grown rapidly in recent years in China, playing an important role in meeting investing and financing demand of households and corporate while optimising social financing structure. Yet the risk of such business are piling as a result of improper business activities, multilayered product structuring, implicit guarantees in the event of default, and evasion of financial and macro regulations. In order to regulate financial institutions asset management business, unify the regulation on asset management-like products among financial institutions, contain financial risks and channel funds to real economy, the PBoC together with other regulatory bodies released Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (Consultation Paper) in November 2017 ( New AM Regulations. From Bank wealth management products (WMPs) perspective, the New AM regulations are addressing a number of issues, including: 1. Reducing maturity mismatch risk In order to reduce duration mismatch risk, Banks need to strengthen maturity management of their WMPs, with close-end WMPs maturity no shorter than 90 days. Banks are advised to set management fees according to product maturity, the longer maturity, the lower the annualised fee. 2. Banning on-balance-sheet WMPs Asset management business is banks off-balance sheet activities. As a result, banks are not supposed to guarantee principal and/or returns when dealing with customers. In the event the fund user(s) of a product are unable to repay principal and/or interest, it is not allowed for banks to service the debt instead in any form. No on-balance sheet WMPs are permitted in whatsoever. 3. Prohibiting fund pooling activities Banks are required to manage, book and account each WMP separately under the New AM Regulations. They are prohibited to participate in fund pooling-like activities such as issuing products with rolling over features, products under collective operations, or products with separate pricing mechanism between assets and liabilities. 4. Discouraging implicit guarantee in the event of default Banks are expected to make effort in investor education to improve their financial literacy, raise their awareness of risk. This will help to rebuild the market consensus of those who sell fulfil the duty, those who buy bear the risk a significant step toward breaking the implicit guarantee practices in the event of product default. 5. Imposing operational risk reserve requirement The New AM Regulations require banks to make 10% of their product management fees as risk reserve charges, or either make provisions on operational risk capital or corresponding risk capital reserves, with the cap of the reserve setting at 1% of products balance. Risk reserves will be used to cover losses arising from illegal, improper, contract breaching conducts by banks, and losses arising from operational or technical errors. 6. Restricting multi-layered product structuring practices The News AM Regulations dictate that an AM can invest in another AM product provided the invested product does not hold a third product, except for mutual fund. 45

46 By the time this report went to print, the New AM regulations has not been finalised yet. But its implications on banks wealth management products are expected to be profound and far reaching. The business is set to transformation. We believe the New AM regulations will impact banks WMPs in following areas: 1. Current business model of WMPs is no longer sustainable Most existing WMPs hold assets with longer maturities than those in their liabilities. Since the New AM Regulations require each product to reduce the maturity mismatch between assets and liabilities, it might be difficult to attract funds from investors. In other words, the current business model is no longer sustainable in the future. 2. Principal-preserved WMPs will fade out According to New AM Regulations, banks cannot on-balance sheet WM business, nor can they guarantee principal and/or returns to customers, such principle guaranteed/preserved products will fade out and become history. 3. Better use of funds calls for dedicated management New AM Regulations explicitly require separate management, booking and accounting of each investment products. This call for a better use of funds and more dedicated management. Prohibition of fund pooling activities will also bring challenges to maturity management, accurate accounting and fund repayment. 4. Valuation capability to be improved under fair value management New AM Regulations require such portfolio to be management on a fair value basis to reflect the risk and return of underlying assets. This call for asset managers capability transformation in many areas from management to operations. Efforts need to be made in reining maturity mismatch and issuance with rolling over features - introducing certain degree of penalty might be useful. The practices of implicit guarantee in the event of product default are also need to be strongly discouraged. Given the fact that investors risk awareness vary, and that it takes time to establish the market consensus of those who sell fulfil the duty, those who buy bear the risk, there are risks that investors might walk away. 5. Risk reserve requires more sophisticated skills for practitioners Under the New AM Regulations, practitioners skills, especially on investment and operations are to be improved. As a result, banks need to increase staff training so as to prevent improper and illegal activities that will bring loss to investors. 6. Product structuring to be refined Streamlining product layers facilitates regulators to supervise investment scope and leveraging, and in turn ensure the security and stability of invested funds. What remained to be clarified is the format and definition of layer. As such, banks are advised to closely monitor any further regulatory updates and plan ahead for adjustment of existing product structuring. 46

47 3.2 Addressing shadow banking risks to ensure banks ongoing stability Takeaways from a series of China s top decision making meeting and documentation since 2017 (including the 19 th Party Congress, Central Financial Work Conference, Government Work Report, and the inaugural meeting of China Banking and Insurance Regulatory Commission) suggest that preventing and mitigating financial risks is the top priority for the country s senior leadership. Addressing shadow banking risks is among the top of the tops. While some shadow banking businesses did support the real economy, the inherited risks are alarming: these activities are beyond the reach of supervision, distorting regulatory indicators, and magnifying risks - posing challenges to macro prudential regulation. Consequently, the shadow banking activities must be tamed. Over past one year, Chinese regulatory authorities measures generally followed a two-phased approach, firstly understanding the situation and then taking actions: The regulatory inspections commonly referred to as three, three, four, ten (three types of violations, three types of arbitrages, four types of improper conducts, and ten types of malpractices) by the banking regulators to understand real situations; Policies regarding shadow banking include: Guiding Opinions on Regulating the Asset Management Business of Financial Institutions (Consultation Paper) (the New AM Regulations, see article 3.1 for more details), Guiding Opinions on Regulating Bank-trust Business and Guiding Opinions on Regulating Banks Entrusted Loans; In the State Council issued new circular to comprehensively improve financial statistics, to be driven by the PBoC. On the measures to contain shadow banking businesses, measures are focused on asset and liability side: Asset side: imposing provision requirement on certain assets Liability side: risk provision requirement on certain liabilities In additional, some credit-like investments of banks were included in the PBoC s macro prudential assessment (MPA) since 2016, so did off-balance sheet WMPs since 1Q The purpose of above measures is to treat shadow banking activities as credit business and those who conduct such business to be regulated as banking institutions. Stringent regulations are expected to contain the size of shadow banking and prevent its inherited risks. Most banks are feeling the pain of those measures, which was reflected in banks 2017 results, with the effect on medium and small banks (Joint-stock, Rural and City Banks) being most obvious. Eight Joint-stock Commercial Banks and 20 Rural & City Commercial Banks assets and liabilities grew significantly more slowly in 2017 (see details in section 2.2 and 2.3). In 2018, the banking regulatory authority released Notice on Further Inspecting Banks Malpractices, in attempt to continue its effort in regulating shadow banking activities; 47

48 Financial investments and interbank activities were among the most affected components in banks balance sheet. Investments as a percentage of total assets dropped for Joint-stock Commercial Banks, and the percentage rise slowed for Rural and City Commercial Banks. Interbank assets percentage in total assets continued to slide. The New AM Regulations, one of the efforts to contain shadow banking activities, have brought impact on banks wealth management products (WMPs), too. According to China Bank Wealth Management Annual Report 2017, the balance of WMPs increased by 1.69% to trillion at the end of The growth was percentage points slower than that of Figure 32 Investments as a % of total assets dropped for JSCBs, and the % rise slowed for RCCBs 23.01% 17.87% 28.33% 23.17% 37.98% 30.91% 44.53% 44.61% 35.27% 32.95% A one-size-fits-all approach to dealing with shadow banking may not be ideal, as some of these businesses do support the real economy - flexibility is still needed. JSCBs RCCBs In summary, addressing shadow banking risks Figure 33 will inevitably impact banks business in the short run, even on their capital adequacy. Yet a more Interbank assets as a % of total assets dropped transparent balance sheet is favourable for their continually for both JSCBs and RCCBs prudential operation and development in long run % 16.09% 16.73% 14.82% 12.54% 11.10% 8.98% 7.12% 7.99% 5.63% JSCBs RCCBs 48

49 3.3 Leveraging New Provision Regulations to enhance risk management With the growing credit asset quality risk, banks in China have been increasing their loan impairment charges to mitigate the challenge. Yet rising provisions has also threatened their profit growth and capital adequacy, and in turn crippled banks capacity to serve the real economy. To alleviate banks pressure and encourage them to accelerate the disposal of non-performing loans (NPLs), properly reflect asset quality, and ensure their capacity to fuel economic growth, the banking regulatory authority in Q issued a circular (the New Provision Regulations ) to adjust banks provision requirements. Moving to a bank specific, interval-based supervision approach that corresponding to a certain supervision interval, from the existing single and universal approach (current threshold is 150% for provision coverage ratio and 2.5% for provision ratio, applicable to all banks). Under the new approach, the intervals for provision coverage ratio range from 120% to 150%, and provision ratio 1.5% to 2.5%. Each bank s applicable provision supervision interval will be considered from three perspectives: 1) accuracy of loan classification; 2) disposal of NPLs; and 3) capital adequacy (see the next page for elaboration on each consideration), whichever is the higher. According to their 2017 annual reports, the 34 banks in our analysis have all met the regulatory threshold for provision coverage ratio, mostly with higher readings than in According to the New Provision Regulations, banks provision coverage ratio and provision ratio requirement will move to a bank specific approach Figure 34 Provision coverage ratios on the rise The 34 banks in our analysis have all met the regulatory threshold for provision coverage ratio, mostly with higher readings than in % % % % % % % % % % % % RCCBs JSBCs LCBs

50 Banks who met certain criteria is likely be applicable to lower supervision interval As mention above, three considerations governing a bank s applicable supervision interval under the New Provision Regulations: 1) Accuracy of loan classification This consideration is based on the extent a bank classified its loans overdued 90 days or above into NPL. Those who classified higher percentage of 90- day-or-above overdue loans as NPL is likely to be applicable to lower supervision interval. The extent a bank classified its loans overdued 90 days or above into NPL Minimum requirement for provision coverage ratio Minimum requirement for provision ratio 100% 120% 1.5% [85%,100%) 130% 1.8% [70%,85%) 140% 2.1% Below 70% 150% 2.5% 2) Disposal of NPLs This consideration looks into a bank willingness to dispose its NPLs by examining its outstanding NPL disposal as % of new NPL formation. Those dispose higher percentage of outstanding NPL is likely to be applicable to lower supervision interval. Outstanding NPL disposal as % of new NPL formation Minimum requirement for provision coverage ratio Minimum requirement for provision ratio 90% and above 120% 1.5% [75%,90%) 130% 1.8% [60%,75%) 140% 2.1% Below 60% 150% 2.5% 3) capital adequacy This consideration encourages banks to maintain a higher capital adequacy ratio (CAR), as those who do is likely to be applicable to lower supervision interval. Those who are unable to meet a certain level of CAR will not be applicable to lower supervision interval. The New Provision Regulations reflected a case by case supervision approach with greater flexibility. It also provide incentives for banks to dispose NPLs in a timely manner, classify loans appropriately, and improve capital management. Those who follow the new regulations are expected to be able to apply to more favourable supervision interval. CAR (for domestic SIBs) CAR (for domestic non-sibs) Minimum requirement Minimum for requirement provision for provision coverage ratio ratio 13.5% and above 12.5% and above 120% 1.5% [12.5%,13.5%) [11.5%,12.5%) 130% 1.8% [11.5%,12.5%) [10.5%,11.5%) 140% 2.1% Below 11.5% Below 10.5% 150% 2.5% Note: 1. [ means greater than or equal to, ) means less than. 2. SIBs refer to systematically important banks. 50

51 Based on above three considerations, and the 2017 annual financial statements of the 34 banks in our analysis, we estimated the number of banks falling into each applicable supervision interval (see table below). The result suggests that most banks are eligible to lower supervision interval in one or two categories, yet there is only one bank consistently falling into the same category in all three categories. It is advised that listed banks should leverage the New Provision Regulations to improve credit risk management, profitability and capital adequacy. Applicable provision coverage ratio interval Applicable provision ratio interval Accuracy of loan classification Disposal of NPLs Capital Adequacy LCBs %~130% 1.5%~1.8% JSBCs RCCBs LCBs %~140% 1.8%~2.1% JSBCs RCCBs LCBs %~150% 2.1%~2.5% JSBCs RCCBs LCBs % 2.5% JSBCs RCCBs

52 3.4 Quantifying the implications of new financial instrument reporting standards (IFRS 9): equity to decrease by 1%-3%, Common Equity Tier 1 CAR under pressure International Financial Reporting Standards No.9: financial instruments (IFRS 9), with the aim of enhancing the relevance and understandability of information about financial instruments, was released on July China Accounting Standards (CAS 22, 23, 24) has also been amended in 2017 accordingly to ensure the convergence with its global counterparts. For those listed in H share and A+H share markets, above new standards will be implemented from 1 January According to IAS 8 - Accounting Policies, Changes in Accounting Estimates and Errors, entities that have not applied a new standard or interpretation that has been issued but is not yet effective must disclose that fact and any and known or reasonably estimable information relevant to assessing the possible impact that the new pronouncement will have in the year it is applied. Most listed banks that applicable to the new standards have disclosure the expected implications with quantitative information in their 2017 annual reports. The new standards will affect banks in three areas: 1) classification and measurement; 2) impairment; and 3) hedge accounting. Disclosures from 20 of the 34 listed banks in our analysis (see a detailed table on page 53) that are both applicable to the new standards and revealed quantitative implications show that most banks equity is expected to increase as a result of re-classification and measurement; conversely, their equity is expected to decrease upon the application of the expected credit loss (ECL) model. A comprehensive study of these 20 banks suggests that the net effect of the new standards upon adoption is likely to have equity decreased by 1% to 3%, causing by the application of the ECL model. In additional, some banks explicitly predicted that Common Equity Tier 1 CAR would drop by no more than 20 basis points upon adoption, indicating the new standards do bring pressure banks capital. Generally speaking, the net effect on equity is negatively correlated with banks size: Large Commercial Banks expect to decrease by a smaller proportion; Rural & City Commercial Banks expect to decrease by a larger proportion; the effect on Joint-stock Commercial Banks is in-between, with wider variation between individual banks. Bank group IFRS 9 s implications for equity Large Commercial Banks No more than 1%~2% Joint-stock Commercial Banks No more than 1%~3% Rural & City Commercial Banks No more than 2%~3% 52

53 Below is a summary of those who disclosed implications upon adoption of new standards in their 2017 annual reports: Bank Impact on net asset Size (in RMB) ICBC Decrease No more than 1.7% CCB Decrease Around 1% ABC Decrease No more than 2% BOC Decrease Around 2% PSBC Decrease No more than 1% BOCOM Decrease No quantified disclosure CZB Decrease No more than 1% CIB N/A N/A CMBC Decrease No more than 3% CMB Decrease Retained earning to decrease by 9 billion Other comprehensive income to increase by 3.2 billion Equity to decrease by 5.8 billion or 1.26% CITIC Decrease 6.1 billion PAB Decrease Beginning retailed earning to decrease by 4.9 billion Other comprehensive income to increase by 402 million Equity to decrease by 4.5 billion or 2.04% CEB Decrease 2.87% HXB N/A N/A Shanghai N/A N/A Jiangsu N/A N/A Shengjing Decrease No more than 2% Gansu Only results announcement released, not full financial statements and footnotes Not disclosed Huishang Only results announcement released, not full financial statements and footnotes Not disclosed Ningbo N/A N/A Tianjin Decrease No more than 2% Harbin Decrease Less than 2% Zhongyuan Decrease Around 3% Qingdao Core tier 1 CAR to decrease No more than 20 basis points Jinzhou Decrease Around 2% Chongqing Only results announcement released, not full financial statements and footnotes Not disclosed Zhengzhou Decrease 1 billion or 3% Changshu RCB N/A N/A Jiutai RCB Only results announcement released, not full financial statements and footnotes Not disclosed Chongqing RCB Not specified No more than 1% Wuxi RCB N/A N/A Jiangyin RCB N/A N/A Zhangjiagang RCB N/A N/A Guangzhou RCB Decrease Around 1% 53

54 54

55 Appendix Financial highlights of listed banks Banking and capital markets contacts

56 56