China plays odd game of left-pocket, right-pocket

July 6, 2010

China is playing an odd game of left-pocket, right-pocket in order to top up its banks’ coffers. The five biggest lenders are in the middle of raising some $57 billion in equity to meet tough new capital standards. Some will come from outside investors. But some will come from the banks themselves.

At first, it seemed banks might turn to Hong Kong’s equity market to supply much of that $57 billion — a figure that includes share placings by Bank of China, ICBC, CCB and Bank of Communications, plus the upcoming initial public offering of Agricultural Bank. But falling markets raised the worry that investors’ appetites would wane, leading them to pick and choose — say, ICBC over AgBank.

So plans seem to be changing. Bank of China has decided to spread its $8.9 billion rights issue across both Hong Kong and Shanghai. ICBC is reportedly thinking likewise for its $10 billion equity placing. That means less pressure on Hong Kong. But since China’s government holds most of its controlling stakes in the banks via Shanghai, it also puts Beijing on the hook for around 40 percent of the total equity bill.

Much of that falls on Central Huijin, the government fund that owns shares in many of the banks. It has said it will follow its rights. But Huijin is short of cash, so is likely to issue bonds to pay for the new shares — some $18 billion worth, according to Reuters. Those will be doled out to lenders in the interbank market. In other words, banks will be lending the government money to buy shares in themselves.

The circularity is a little dizzying. True, the loan is likely to carry a better yield than plain old treasuries — maybe 20 percent higher. But the interest payments will be dependent on the banks paying dividends to their biggest shareholder. And to repay the debts later, Huijin would probably have to sell bank shares.

What’s good about all this is that the banks get their capital. The government gives a clear message that lenders aren’t going to be allowed to get into trouble any time soon. But by using this bizarre alchemy to top up its stake, China’s policymakers send another message too — that lenders are more than ever their playthings. If anything, that looks like a step backwards.

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