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RISKS, ORGANIZATION AND STRUCTURE OF BANKING INDUSTRY IN CHINA
LECTURE 2
9/27/2017 1 ACEM, SJTU, Nan Li
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
9/27/2017 2 ACEM, SJTU, Nan Li
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
9/27/2017 3 ACEM, SJTU, Nan Li
Corporate Banks Sovereign Retail Special
Loans
System (IT)
People
Internal
Procedure Interest
rate
Exchange
rate
Stocks
OBS
Liquidity
Risk
Legal
risk
Op
era
tion
al
risk
Credit Risk Ma
rke
t Ris
k
Other Risks
Reputational
Risk Country Risk
Risk of Banks
No minimum
requirement by
BASEL
External
Risks of Financial Intermediation
9/27/2017 4 ACEM, SJTU, Nan Li
Risk Management Objectives
Credit Risk
Market Risk
Financial risk
management
Credit Risk
Market Risk
Operational
Risk
Risk management
Credit Risk
Credit risk
management
1988 Basel Accord 1996 Revision 2004 Basel Accord II
9/27/2017 5
Credit Risk
Market Risk
Operational
Risk
Liquidity and
Systematic
Risk
Overall
Risk management
Basel Accord III
ACEM, SJTU, Nan Li
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
1.40%
1.60%
1.80%
2.00%
Year
Actu
al P
ort
folio L
oss
Unexpected
disaster
Normal
condition:
expected loss
Unexpected loss: in
some cases, the loan
loss is higher than the
expected level
Expected Loss
Loss
EDF
Unexpected loss Disaster loss
Capital Reserve
Loan Loss Provision Capital Reserve Charge off or transfer 9/27/2017 6 ACEM, SJTU, Nan Li
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
9/27/2017 7 ACEM, SJTU, Nan Li
Basel III in China
Type of Banks
Minimum Capital Requirement
最低资本要求
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
Core Tier I Capital (核心一级资本)
Tier I Capital 一级资本
Total Capital 总资本
Systematically Important Banks (系统重要性银行) by 2013
5% 6% 8% 2.5% 0%-2.5% 1%
Non-Systematically Important Banks (非系统重要性银行) by 2019
5% 6% 8% 2.5% 0%-2.5% None
9/27/2017 8 ACEM, SJTU, Nan Li
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
9/27/2017 9 ACEM, SJTU, Nan Li
Basel III in China Ratios Measure Target
Level Schedule to Meet Target
Leverage Ratio
杠杆率
Core Capital/ Total Asset (with OBS)
核心资本/总资产(含表外)
4% (3%) By 2013: Systematically important Banks(系统重要性银行)
By 2016(2018): other banks (非系统重要性银行)
Loan Loss Provision Ratio
拨备率
Loan Loss Provision/ Loan Balance (*counter cyclical)
拨备/信贷余额
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)
Loan Loss Provision/ NPL
拨备覆盖率
150% dynamic adjustsment (allow lower ratios for qualified small and medium banks)
动态调整 Liquidity Index
流动性指标
Liquidity Coverage Ratio(LCR)
100% By the end of 2013
Net stable funding ratio (NFSR)
100% By the end of 2016
9/27/2017 10 ACEM, SJTU, Nan Li
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.
9/27/2017 11 ACEM, SJTU, Nan Li
Number of Banks Meeting Minimum Capital Adequacy Ratio in China in 2012
9/27/2017 12 ACEM, SJTU, Nan Li
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%
9/27/2017 14 ACEM, SJTU, Nan Li
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
9/27/2017 15 ACEM, SJTU, Nan Li
Profit after tax
9/27/2017 16
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000
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
ACEM, SJTU, Nan Li
ROA
9/27/2017 17
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
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
ACEM, SJTU, Nan Li
China Credit Growth 2006-2016
9/27/2017 18
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
40.00
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
20
06
-01
20
06
-08
20
07
-03
20
07
-10
20
08
-05
20
08
-12
20
09
-07
20
10
-02
20
10
-09
20
11
-04
20
11
-11
20
12
-06
20
13
-01
20
13
-08
20
14
-03
20
14
-10
20
15
-05
20
15
-12
20
16
-07
MoM
YoY
ACEM, SJTU, Nan Li
Quality of Credit in China
9/27/2017 19
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
20
06
-03
20
06
-10
20
07
-05
20
07
-12
20
08
-07
20
09
-02
20
09
-09
20
10
-04
20
10
-11
20
11
-06
20
12
-01
20
12
-08
20
13
-03
20
13
-10
20
14
-05
20
14
-12
20
15
-07
20
16
-02
20
16
-09
China Non-Performing Loans Growth Rate (Quarterly) 2006Q1-2016Q4
ACEM, SJTU, Nan Li
Non-Performing Loan Ratio
9/27/2017 20
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Total NPL substandard Doubtful Loss
ACEM, SJTU, Nan Li
Risk Management
• How to manage these risks?
– Interest rate risk
– Credit risk
– Liquidity risk
9/27/2017 22 ACEM, SJTU, Nan Li
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
9/27/2017 23 ACEM, SJTU, Nan Li
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.
9/27/2017 24 ACEM, SJTU, Nan Li
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.
9/27/2017 25 ACEM, SJTU, Nan Li
Applying the Repricing Model
• (Repricing Gap) GAPi = RSAi - RSLi
• Δ NIIi = (RSAi Δ Ri,A – RSLiΔ RiL)
• If Δ RA= Δ RL, then
Δ NIIi = GAPi*Δ Ri= (RSAi – RSLi)* Δ Ri
9/27/2017 26 ACEM, SJTU, Nan Li
Unequal Changes in Rates • If changes in rates on RSAs and RSLs are not equal,
the spread changes.
NII = (RSA × RRSA ) - (RSL × RRSL )
0
2
4
6
8
10
12
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
PRIME
3-Month CD
9/27/2017 27 ACEM, SJTU, Nan Li
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
9/27/2017 28 ACEM, SJTU, Nan Li
Duration: Economic Interpretation
• Measure the price sensitivity (elasticity) of bond value with respect to interest rate.
R
DMD
PdRMDR
dRPDdP
1
1
9/27/2017 29 ACEM, SJTU, Nan Li
Duration Gap
• Duration of portfolio A is the market value of total asset, Ai is the market value of asset i
L is the market value of total liability, Li is the market value of liability i
N
i
i
N
i
Li
L
N
i
i
N
i
Ai
A
LL
DLD
AA
DAD
i
i
11
11
L where
A where,
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 = -DAA RA/(1+RA), L = -DLL RL/(1+RL),
• Assume that RA/(1+RA) = RL/(1+RL)
– E = [-DAA + DLL] R/(1+R) [DA - DLk]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 9/27/2017 31 ACEM, SJTU, Nan Li
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
9/27/2017 32 ACEM, SJTU, Nan Li
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
9/27/2017 33 ACEM, SJTU, Nan Li
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
Rural Commercial Bank, Rural Cooperative Bank, Rural Credit Cooperatives,
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
976+48+940
+1381 = 3345
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
汽车金融, Consumer Finance消费金融, Money Broker货币经纪)
58+25+15+5
=103 9/27/2017 34 ACEM, SJTU, Nan Li
9/27/2017 35
State Council
PBC CBRC
Depository Instituion
State-owned
CB:
ICBC
CCB
BOC
ABC BCommu
Joint-Stock CB
CTIIC
Everbright
Huaxia
Minsheng
Merchant
Industrial
Guangfa
Pingan
Pudong Development
Hengfeng
Zheshang
Bohai
City CB
Rural FI
Rural CB
Rural Cooperativ
e Bank
Rural credi union
Rural County banks
Foreign Bank
Postal Savings Banks
Private Bank
Non-Depository FIs
Policy Bank
DB
EIBC
ADBC
State-owned Asset
management Corporation
Xinda
Huarong
Greatwall
Orient
Other NDFIs Trust,
Finance, Motor
Finance, Consumer Finance, Money Broker
ACEM, SJTU, Nan Li