(Yicai) Aug. 2 -- Chinese local governments have cranked up the issuance of special purpose bonds this year to supplement the capital of small and mid-sized banks amid ongoing operating pressures at the lenders.

Twelve provincial-level governments issued about CNY135.2 billion (USD18.8 billion) of SPBs in the seven months ended July 31, compared with CNY63 billion (USD8.9 billion) for the whole of last year, according to open-market data.

Bolstering smaller banks through the issuance of SPBs has picked up pace this year because new regulations will come in next year that will further pile pressure on them to replenish capital. With net interest margins narrowing, their ability to supplement capital has also shrunk.

These lenders do not have many external channels for replenishing capital, a researcher at a mutual fund manager told Yicai. When the banking sector comes under pressure, the market worries that the bonds smaller banks sell to lift their secondary capital will become riskier, the person noted, adding that in such cases support from the SPB issuance becomes more important. 

The new regulations stipulate the minimum capital requirements small and mid-sized lenders need to meet: the core tier-one capital adequacy ratio should not be lower than 7.5 percent; and the capital adequacy ratio should not be less than 8.5 percent. Many have fallen very close to the minimum required.

The banking sector’s net interest margin shrank to a record low of 1.74 percent in the first quarter, down from 1.91 percent in the fourth quarter of last year, according to data from the National Financial Regulatory Administration. That for smaller rural commercial banks plunged 25 percentage points, the most among lenders.

To help the banks ease these pressures, the local governments will mainly inject the funds raised via SPBs into the lenders in two ways: by deposits made under equity transfer agreements or through their affiliated financial holding firms taking stakes in the banks.  

If the share conversion conditions are not triggered, those banks that accept deposits through equity transfer agreements will only need to tap operating profits as the source of debt repayment in the future and repay the local government an equal amount of principal. The debt repayment funds from the other method will mainly come from dividends and the marketized transfer of corresponding equities after a few years. 

If banks still fail to improve their operations after capital boosts via SPBs, then the burden will shift to local governments, generating new government debt issues, according to an investment manager at one urban commercial bank.

But according to a China International Capital report, based on the experience in handling the risk of small and mid-sized banks over the past five years, their risk exposure should have a limited impact on the financial market and the real economy this year, and there is no need to worry too much about its systemic risk.

Editors: Tang Shihua, Martin Kadiev