LECTURE 2 RISKS, ORGANIZATION AND STRUCTURE OF BANKING INDUSTRY IN CHINA 1
Example of Simple Bank Balance Sheet Assets Cash 5 Marketable Securities 10 Loans 80 Fixed Assets 5 Total 100 Liabilities Deposits 90 Subord L.T. Debt 5 Equity Capital 5 Total 100 2
Risks Faced by FIs What are the risks faced by the FIs when they provide the services to the economy? Interest Risk Credit Risk Liquidity Risk 3
Risks of Financial Intermediation Corporate Banks Sovereign Retail Special Loans Internal Procedure People System (IT) External Operational risk Credit Risk Risk of Banks Other Risks Market Risk Interest rate Exchange rate Stocks OBS No minimum requirement by BASEL Liquidity Risk Legal risk Reputational Risk Country Risk 4
Risk Management Objectives Overall Risk management Credit risk management Financial risk management Market Risk Risk management Operational Risk Market Risk Liquidity and Systematic Risk Operational Risk Market Risk Credit Risk Credit Risk Credit Risk Credit Risk 1988 Basel Accord 1996 Revision 2004 Basel Accord II Basel Accord III 5
Actual Portfolio Loss Capital Reserve EDF Unexpected disaster Normal condition: expected loss 2.00% 1.80% 1.60% 1.40% 1.20% 1.00% Unexpected loss: in some cases, the loan loss is higher than the expected level 0.80% 0.60% 0.40% 0.20% 0.00% Year Expected Loss Unexpected loss Disaster loss Loss Loan Loss Provision Capital Reserve Charge off or transfer 6
Basel Accords in China 2004/02: (localized)basel I Definition of capital, similar with difference Risk weight and conversion factor of OBS activities Capital adequacy ratio 8%, (4% for core capital) same Detailed methods to compute interest rate risk, market risk (stock risk, exchange rate risk, commodity risk, option risk), capital requirement for market risk only applicable for large commercial banks 7
Basel III in China Type of Banks Systematically Important Banks ( 系统重要性银行 ) by 2013 Non- Systematically Important Banks ( 非系统重要性银行 ) by 2019 Minimum Capital Requirement 最低资本要求 Core Tier I Capital ( 核心一级资本 ) Tier I Capital 一级资本 Total Capital 总资本 Conservation Buffer 留存超额资本 Countercyclical Buffer 逆周期超额资本 Additional Capital Requirement for Systematically Important Banks 系统重要性银 行附加资本 5% 6% 8% 2.5% 0%-2.5% 1% 5% 6% 8% 2.5% 0%-2.5% None 8
Basel Accords in China 2007/02: Basel II starts Banks may choose to follow Basel II or Basel I By 2012, 5 large SOCB and 1 joint stock bank apply for Basel II 2012/11/30: Basel III starts Macro prudential and micro prudential policy Capital and liquidity regulation Improve both quantity and quality of the capital Introduce new concept: conservation buffer, countercyclical buffer, leverage ratio, liquidity coverage ratio, and stable funding ratio Four key indices: Capital adequacy ratio Leverage ratio Loan Loss Provision Liquidity Ratios Basel: LCR, NSFR +China: liquidity ratio, loan-to-deposit ratio, core liability ratio, liquidity gap ratio, concertration ratio, interbank deposit concerntration ratio 9
Basel III in China Ratios Measure Target Level Schedule to Meet Target Leverage Ratio Core Capital/ Total 4% (3%) By 2013: Systematically important 杠杆率 Asset (with OBS) 核心资本 / 总资产 ( 含表外 ) Banks( 系统重要性银行 ) By 2016(2018): other banks ( 非系统重要 Loan Loss Provision Ratio 拨备率 Loan Loss Provision/ Loan Balance (*counter cyclical) 拨备 / 信贷余额 性银行 ) 2.5% By 2013: Systematically important Banks( 系统重要性银行 ) By 2016: other banks ( 非系统重要性银行 ) Allow dynamic adjustsment under Pillar Two ( 在第二支柱下适度动态调整 ) Liquidity Index 流动性指标 Loan Loss Provision/ NPL 拨备覆盖率 Liquidity Coverage Ratio(LCR) Net stable funding ratio (NFSR) 150% dynamic adjustsment (allow lower ratios for qualified small and medium banks) 动态调整 100% By the end of 2013 100% By the end of 2016 10
Basel III in China By 2011Q4, Capital Adequacy Ratio: 12.7% Tier I capital Ratio: 10.2% Already meet and exceed the Basel III requirement (to be met by 2019) But still less than the 13.5% and 12.5% requirements in China for systematically and nonsystematically important banks, respectively, capital gap is 1 trillion RMB. 11
Number of Banks Meeting Minimum Capital Adequacy Ratio in China in 2012 12
Health Check of Banking Industry In first half of 2017, Total Asset: 239 trillion, Total Loan: 121 trillion Capital adequacy ratio: 13.2%, Loan Loss Provision ratio 175.1%, NPL: 1.86%, Liquidity ratio: 48% 14
Recent Concern Increasing interbank competition Reduction in interest spread Interest spread < 2% Profit merely 1% or less Increase in fee generating activities Increase in Interest rate risk and Liquidity risk Increase in NPL Credit risk 15
Profit after tax 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 Policy banks & the CDB Large commercial banks Joint-stock commercial banks Non-bank financial institutions Foreign banks Rural City and Urban 16
ROA 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% 2007 2008 2009 2010 2011 2012 2013 2014 2015 Policy banks& the CDB Largecommercialbanks Joint-stock commercialbanks Non-bank financialinstitutions Foreign banks rural city&urban 17
2006-01 2006-08 2007-03 2007-10 2008-05 2008-12 2009-07 2010-02 2010-09 2011-04 2011-11 2012-06 2013-01 2013-08 2014-03 2014-10 2015-05 2015-12 2016-07 China Credit Growth 2006-2016 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% MoM YoY 40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 18
2006-03 2006-10 2007-05 2007-12 2008-07 2009-02 2009-09 2010-04 2010-11 2011-06 2012-01 2012-08 2013-03 2013-10 2014-05 2014-12 2015-07 2016-02 2016-09 Quality of Credit in China 30% 20% 10% China Non-Performing Loans Growth Rate (Quarterly) 2006Q1-2016Q4 0% -10% -20% -30% -40% -50% -60% 19
Non-Performing Loan Ratio 20.00% 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Total NPL substandard Doubtful Loss 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 20
China Non-Performing Loans 21
Risk Management How to manage these risks? Interest rate risk Credit risk Liquidity risk 22
Interest Rate Risk: Models Repricing Gap Model Focuses on book value using accounting approach Main concern is net interest income Duration Model Focuses on market value Main concern is maintaining value and achieving targets 23
Repricing Model Repricing or funding gap model based on book value. Contrasts with market value based maturity and duration models recommended by the Bank for International Settlements (BIS). Rate sensitivity means time to repricing. Repricing gap is the difference between the rate sensitivity of each asset and the rate sensitivity of each liability: RSA - RSL. 24
Maturity Buckets Repricing can be the result of a rollover of an asset or liability, or because the asset is variable-rate instruments Commercial banks must report repricing gaps for assets and liabilities with maturities of: One day. More than one day to three months. More than 3 three months to six months. More than six months to twelve months. More than one year to five years. Over five years. 25
Applying the Repricing Model (Repricing Gap) GAP i = RSA i - RSL i Δ NII i = (RSA i Δ R i,a RSL i Δ R il ) If Δ R A = Δ R L, then Δ NII i = GAP i *Δ R i = (RSA i RSL i )* Δ R i 26
1/1/1990 1/1/1991 1/1/1992 1/1/1993 1/1/1994 1/1/1995 1/1/1996 1/1/1997 1/1/1998 1/1/1999 1/1/2000 1/1/2001 1/1/2002 1/1/2003 1/1/2004 1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 Unequal Changes in Rates If changes in rates on RSAs and RSLs are not equal, the spread changes. NII = (RSA R RSA ) - (RSL R RSL ) 12 10 8 6 PRIME 3-Month CD 4 2 0 27
Duration Model A market value-based model for assessing and managing interest rate risk: Duration Computation of duration Economic interpretation Immunization using duration Problems in applying duration 28
Duration: Economic Interpretation Measure the price sensitivity (elasticity) of bond value with respect to interest rate. dr dp D P MD dr P 1 R MD D 1 R 29
Duration Gap Duration of portfolio A is the market value of total asset, A i is the market value of asset i L is the market value of total liability, L i is the market value of liability i N i i N i L i L N i i N i A i A L L D L D A A D A D i i 1 1 1 1 where L where A,
Immunization Bank wants to measure the exposure of market value of equity E to interest rate changes. E=A-L => E=A-L. Use duration model, A = -D A A R A /(1+R A ), L = -D L L R L /(1+R L ), Assume that R A /(1+R A ) = R L /(1+R L ) E = [-D A A + D L L] R/(1+R) [D A - D L k]a(r/(1+r)) The formula shows 3 effects: Leverage adjusted D-Gap The size of the FI The size of the interest rate shock 31
Financial Institutions in China Banking (Depository) Institutions State-Owned Commercial Bank 大型商业银行 Joint-Stock Commercial Bank 股份制商业银行 City Commercial Bank 城市商业银行 Rural Financial Institution 农村金融机构 Rural Commercial Bank, 农村商业银行 Rural Cooperative Bank, 农村合作银行 Rural Credit Cooperatives, 农村信用社 three-type rural Financial Institution (rural county bank, 三类新型农村金融机构 ) Postal Savings Bank of China 中国邮政储蓄银行 Private Bank 民营银行 Foreign Bank 外资银行 32
Financial Institutions in in China Non Depository Financial Instiutions Policy Bank ( 政策性银行 ) State-Owned Asset Management Corporation ( 国有资产管理公司 ) Deals with the non-performing loans of state owned commercial banks Non-banking Financial Instiutions Trust Company 信托公司 Finance Company 财务公司 Financial Leasing Company 金融租赁公司 Motor Finance Company 汽车金融公司 Consumer Finance Company 消费金融公司 Money Broker Company 货币经纪公司 33
Type of Institution Number of Institutions Policy Bank 政策性银行 3 State-Owned Commercial Bank 大型商业银行 5 Joint-Stock Commercial Bank 股份制商业银行 12 Postal Savings Bank of China 中国邮政储蓄银行 1 City Commercial Bank 城市商业银行 162 Rural Financial Institution 农村金融机构 976+48+940 Rural Commercial Bank, Rural Cooperative Bank, Rural Credit Cooperatives, +1381 = 3345 and three-type rural Financial Institution (rural county bank) 农商行, 农合行, 农信社, 三类新型农村金融机构 Private Bank 民营银行 6 Foreign Bank 外资银行 50+ State-Owned Asset Management Corporation 国有资产管理公司 4 Non-Bank Financial Company Trust Company 信托公司 77 Finance Company 财务公司 261 Financial Company 金融公司 (Financial Leasing 金融租赁, Motor Financial 58+25+15+5 汽车金融, Consumer Finance 消费金融, Money Broker 货币经纪 ) =103 34
State Council CBRC PBC Depository Instituion Non-Depository FIs Stateowned CB: ICBC CCB BOC ABC BCommu Joint-Stock CB CTIIC Everbright Huaxia Minsheng Merchant Industrial Guangfa Pingan Pudong Development Hengfeng Rural FI Rural CB Rural Cooperativ e Bank Rural credi union Rural County banks City CB Postal Savings Banks Private Bank Foreign Bank Policy Bank Zheshang 35 Bohai DB EIBC ADBC State-owned Asset management Corporation Xinda Huarong Greatwall Orient Other NDFIs Trust, Finance, Motor Finance, Consumer Finance, Money Broker