Understanding China’s eager embrace of Basel III

Although it may come as something of a surprise, it is starting to look like the country in Asia taking the lead on Basel III implementation is not one of the usual suspects—Hong Kong, Singapore, or Australia—but, rather, China. While many regulators around the globe have indicated their general support for Basel III (some not entirely wholeheartedly), few have issued a comprehensive and detailed implementation plan, such as was issued in Chinese by the China Banking Regulatory Commission (CBRC) on April 27th. Is this simply a case of youthful enthusiasm by one of several countries newly admitted onto the Basel Committee on Banking Supervision a year or so ago, or are there particular reasons why China is so enthusiastic about Basel III? 

Let’s look at some of the key aspects of the Basel III implementation plan for China. 

1. It’s a tough plan that is tougher than the minimum standard set down by Basel. Banks will need to maintain a capital adequacy ratio (CAR), in normal times, of at least 10.5% (up from the current 8.0%), and at least 7.5% of this will have to be in the form of common equity tier 1 (which is 0.5% more than the minimum required by Basel). Banks will also have to maintain a leverage ratio (tier 1 capital to total assets) of at least 4%; again, this is tougher than Basel, which requires 3%.
2. It anticipates the additional capital charge that is likely to be required of the world’s systemically important financial institutions by requiring them to hold an additional 1%, bringing their minimum to at least 11.5%. This makes the CBRC only the second regulator in the world (after the Swiss) to have declared their position on this.
3. It incorporates forward-looking, expected loss-based provisioning, a key part of the G20 reform proposals, which has to date not been resolved internationally. Banks in China will need to build up their provisions to the higher of 150% of non-performing loans, or 2.5% of total loans.

An interesting package; but why are the Chinese applying this form and why the sudden enthusiasm?There are two main reasons for this. First, the Chinese authorities see the promotion of Basel III as a powerful catalyst for the necessary continued enhancement of capital, liquidity, risk management and governance in Chinese banks. In short, the need for China to comply with this new and important international standard further strengthens the authorities’ arm in pressing the banks to focus on these issues—and provides a comprehensive blueprint for how banks need to develop in these areas.

Second, it is a good time for Chinese banks to be building up their capital and their provisioning. In recent years they have grown their loan books dramatically, and there may be a feeling that all that stimulus-related lending may bring some debt problems with it eventually, although there have been few signs of this to date. Basel III suggests banks build up capital, liquidity and provisioning when times are good—and times are currently pretty good for Chinese banks’ profitability and asset quality.

It seems that the authorities in China appear to be making very intelligent use of components of Basel III to address domestic issues they see with their banks, and the banking system as a whole. The task now though, of course, is to get the banks to comply with it. Building strong capital and liquidity ratios is no problem—indeed the major banks already largely comply—but building the sound risk management and governance frameworks that underlie Basel III will be far more of a challenge. Also, it’s important that adoption of the risk management and governance principles of Basel III is not limited to the very largest banks – the city commercial banks and other major banks also need to buy in. 

*Simon Topping heads KPMG’s Financial Services Regulatory Center of Excellence, Asia Pacific, and is a former senior regulator with the Hong Kong Monetary Authority. The ideas expressed in this article are his own personal views.