China’s debt-equity swap plan spells trouble for banks

Equities are riskier than loans.

China is reportedly preparing a CNY 1 trillion pilot programme to exchange bank loans for equity, a move intended to alleviate mounting bad loans and financial pressures on Chinese firms. A report by Fitch Ratings says that this plan will have a negative effect on the banking sector, as it will allow risk to mount further in the banking sector.

“Banks' ability to support such a plan in a large scale is limited given their slowing profit growth, rising credit costs and more stringent regulatory capital requirements,” Fitch said.

“The scale of the reported swap plan would not be significant for the banking system as a whole, but if the programme were to be markedly scaled up, it could have a sufficient effect on bank assets and capital to be negative for bank credit profiles,” Fitch noted.

Fitch added that a debt-for-equity swap plan without fundamental improvement in borrowers' creditworthiness will only push back resolution of growing asset-quality pressures.

“To be sure, if companies are able to use the swap to improve their financial profiles and sustainability of their business models, then it could help to resolve the NPL issue and contribute to macroeconomic reform over the long run. As such, the types of companies that will be allowed to use the swap programme will determine to what extent it will have a negative effect on banks,” Fitch said.