As the Total Loss Absorbing Capacity (TLAC) assessment in early 2025 approaches, China's Global Systemically Important Banks (G-SIBs) have been announcing plans to issue new financing instruments.
Since January 26th, the Bank of China, the Agricultural Bank of China, and the Industrial and Commercial Bank of China have successively issued announcements stating their intention to issue Total Loss Absorbing Capacity non-capital debt instruments (hereinafter referred to as "TLAC bonds"), with a combined planned issuance amount of no more than 260 billion yuan, intended to supplement their own TLAC.
Unlike common commercial bank capital replenishment tools such as convertible bonds and tier-two capital bonds, TLAC bonds are financial bonds issued by G-SIBs to meet TLAC requirements. They have loss absorption capabilities, do not belong to the capital of commercial banks, and have a claim priority sequence after ordinary financial bonds but before bank capital instruments.
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As of the end of 2023, China has five commercial banks on the list of Global Systemically Important Banks, namely the five state-owned major banks: Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank, and Bank of Communications. According to relevant regulatory rules, the four major banks that were selected earlier, namely the Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, and China Construction Bank, should achieve a risk-weighted ratio of 16% by the beginning of 2025 and 18% by the beginning of 2028.
According to previous calculations by CITIC Securities, the TLAC compliance gap for the four major banks is about 2 trillion yuan. Fitch Ratings estimates that the issuance demand for capital instruments or TLAC eligible debt instruments will reach 1.7 trillion yuan and 6.3 trillion yuan by the beginning of 2025 and 2028, respectively.
It is worth noting that TLAC bonds are a new financing instrument, and there is uncertainty regarding market acceptance.
In this regard, Fitch Ratings' Asia-Pacific Financial Institutions Ratings Director, Xue Huiru, stated that compared to ordinary financial bonds, TLAC bonds are expected to have higher yields due to their write-down or conversion loss absorption clauses. Compared to other Tier 1 capital instruments and Tier 2 capital bonds, TLAC bonds have a higher claim priority, and it is anticipated that these bonds will have a certain appeal to market investors.
The three major banks plan to issue 260 billion yuan in TLAC bonds.
The Bank of China is the first Chinese G-SIB to announce plans to issue TLAC bonds.On the evening of January 26th, Bank of China announced its intention to issue TLAC (Total Loss-Absorbing Capacity) bonds with a scale not exceeding 150 billion yuan, with the funds raised to be used to supplement the bank's overall loss absorption capacity. The issuance interest rate will be determined in reference to market interest rates, and the issuance market will include both domestic and international markets.
Subsequently, Agricultural Bank of China and Industrial and Commercial Bank of China also announced their plans to issue TLAC bonds to supplement their total loss absorption capacity, with the Agricultural Bank's issuance scale not exceeding 50 billion yuan and the Industrial and Commercial Bank's not exceeding 60 billion yuan.
Both Bank of China and Agricultural Bank stated in their announcements that the loss absorption method for these TLAC bonds is write-down absorption, meaning that when the bank enters the resolution phase, losses can be absorbed through the write-down of TLAC bonds.
In addition, on February 2nd, China Construction Bank announced that its board of directors had reviewed and passed a proposal regarding the group's annual financial bond issuance plan, which will be further submitted to the shareholders' meeting for consideration. However, the announcement did not disclose the specific content of the proposal.
Regarding the specific issuance timing, the three major banks (Bank of China, Agricultural Bank, and Industrial and Commercial Bank) all indicated that the proposals related to the issuance of TLAC bonds have been approved by the board of directors and will be submitted to the shareholders' meeting for review.
Liao Zhiming, Chief Analyst of the Banking Industry at China Merchants Securities, stated that according to the regulatory approval process, after the board resolution and shareholders' meeting approval, it is necessary to report to the State Financial Regulatory Administration and the central bank for approval. The central bank will include TLAC bonds in the balance management scope of the financial bonds issued by the issuer. The quota approval is valid for two years.
"Considering the approval process will take some time, we expect that the first TLAC bond in China will be issued in the second quarter of 2024, and the four major banks may all issue TLAC bonds in appropriate amounts within the year, with Bank of Communications also expected to issue TLAC bonds subsequently," said Liao Zhiming.
Since there have been no precedents for issuance, the details of the TLAC bond issuance interest rate, term, and location are of great interest to the market.
Xue Huiru stated that compared to other Tier 1 capital instruments and Tier 2 capital bonds, TLAC non-capital bonds have a higher order of priority in compensation. According to the TLAC management method, when a globally systemically important bank enters the resolution phase, regulators can forcibly require the write-down or conversion of external total loss absorption capacity non-capital debt instruments, but TLAC bonds should absorb losses after Tier 2 capital instruments.
From the perspective of the banks' issuance costs, due to the higher compensation order of TLAC bonds, their issuance costs may be slightly lower than those of Tier 2 capital bonds and other Tier 1 capital instruments. Compared to ordinary financial bonds, because TLAC bonds have loss absorption clauses such as write-down or conversion, the expected yield is likely to be higher.Liao Zhiming anticipates that the actual term of China's TLAC bonds will be 3 years, structured as 3+1 years, meaning that they will be actively redeemed at the end of the third year. Consequently, the pricing of TLAC bonds will be between the 3-year ordinary financial bonds of state-owned major banks and the remaining 3-year term secondary capital bonds.
"As of January 26, 2024, the yield of 3-year ordinary financial bonds of major banks is 2.55%, and the yield of secondary capital bonds with a remaining term of 3 years is 2.74%. Based on the current interest rate level, we expect the pricing of major bank TLAC bonds to be around 2.65%. Since interest rates may further decline in the future, the actual issuance rate of TLAC bonds may be below 2.6%," said Liao Zhiming.
Regarding the issuance location, Bank of China and Agricultural Bank of China plan to issue TLAC bonds in both domestic and international markets, while Industrial and Commercial Bank of China will issue in the domestic market.
Xue Huiru expressed that banks will weigh multiple factors when determining the domestic and international issuance plans and ratios for TLAC non-capital debt. On one hand, as one of the top five banks, they are benchmarked against more than 30 global systemically important banks abroad, so issuing TLAC non-capital bonds overseas may help enhance their international influence. On the other hand, banks will also consider cost factors. In an environment where there are differences in domestic and international interest rate levels, approval processes, and credit evaluation systems, they may also issue domestic TLAC non-capital debt instruments for cost considerations.
A 2 trillion TLAC gap remains to be filled.
The aforementioned three major banks have all stated in their announcements that issuing TLAC bonds is to enhance their total loss absorption capacity and meet the regulatory requirements of global systemically important banks.
To effectively address the "too big to fail" issue, the leaders of the G20 approved the "Total Loss-Absorbing Capacity (TLAC) Term for Global Systemically Important Banks" submitted by the Financial Stability Board (FSB) in November 2015, which clarified the international unified standard for total loss absorption capacity and proposed that large financial institutions should have sufficient loss absorption capacity. The so-called total loss absorption capacity refers to the total sum of capital and debt instruments that global systemically important banks can use to absorb losses through write-downs or conversion into common shares when entering the resolution phase.
In October 2021, the People's Bank of China (hereinafter referred to as "the central bank"), the former China Banking and Insurance Regulatory Commission, and the Ministry of Finance issued the "Total Loss-Absorbing Capacity Management Measures for Global Systemically Important Banks" (hereinafter referred to as "TLAC Management Measures"), stipulating that the risk-weighted ratio of external total loss absorption capacity of Chinese global systemically important banks shall not be lower than 16% from January 1, 2025, and not lower than 18% from January 1, 2028; the leverage ratio of external total loss absorption capacity shall not be lower than 6% from January 1, 2025, and not lower than 6.75% from January 1, 2028. They should also meet the regulatory requirements for buffer capital such as conservation capital, countercyclical capital, and additional capital.
In November 2023, the list released by the FSB showed that there are a total of 30 global systemically important banks, with China's five major banks (Bank of Communications, Agricultural Bank of China, Industrial and Commercial Bank of China, China Construction Bank, and Bank of China) included. Among them, Bank of Communications was included for the first time in 2023 and has a three-year TLAC compliance transition period, while the other four major banks (Agricultural, Industrial, Construction, and Bank of China) are about to face the first phase of the TLAC compliance test at the beginning of 2025.
According to the TLAC Management Measures, the risk-weighted ratio of external total loss absorption capacity refers to the ratio of the bank's external total loss absorption capacity after deductions to risk-weighted assets. In recent years, Chinese global systemically important banks have actively cooperated in implementing cross-cycle and counter-cyclical adjustments, increased credit support for the real economy, and the rapidly growing credit scale has also led to a faster increase in risk-weighted assets, resulting in an expansion of the TLAC compliance gap.According to Fitch's estimates, without considering the offsetting effect of the deposit insurance fund and the transitional arrangements for Bank of Communications, the issuance demand for capital instruments or TLAC-eligible debt instruments will reach 1.7 trillion yuan and 6.3 trillion yuan by January 2025 and January 2028, respectively. "If the growth rate of banks' risk-weighted assets increases significantly in the future, it will further widen their capital replenishment gap," said Xue Huiru.
Fitch Bohua calculated, based on the third-quarter data of 2023, that by the beginning of 2025, the overall TLAC gap for the "Big Four" banks in the first phase is about 2.6 trillion yuan, and by the beginning of 2028, the TLAC gap in the second phase is about 7.9 trillion yuan; Bank of Communications, having just been included in the list of Global Systemically Important Banks, has a three-year buffer period, and the static gap for the first phase TLAC requirement is about 40 billion yuan.
CITIC Securities, based on the semi-annual report data of 2023, estimates that the TLAC compliance gap for the four major banks, including Agricultural Bank, is about 2 trillion yuan.
It is worth noting that the TLAC management method stipulates that the deposit insurance fund managed by the deposit insurance fund management institution can be included in the external total loss-absorbing capacity of Global Systemically Important Banks. When the minimum requirement for the risk-weighted ratio of external total loss-absorbing capacity is 16% or 18%, the maximum scale of the deposit insurance fund that can be included is 2.5% or 3.5% of the bank's risk-weighted assets.
"Considering the offsetting effect of the deposit insurance fund and the transitional arrangements for Bank of Communications, the capital gap of the five major banks in 2024 will be significantly reduced," Xue Huiru stated.