(Yicai) Nov. 11 -- Beijing’s new debt resolution plan will improve bank asset quality, perhaps strengthen banks' provision for risky assets to increase profits and enhance capital allocations, and therefore it is a positive move overall, even though it will result in a narrowing of lenders’ earnings and a drop in their credit growth rate, industry insiders said.

The debt swaps will drag down banks’ net interest margin and loan growth rate, but they will improve bank asset quality, and significantly alleviate market concerns about the fallout from non-performing loans in urban investment and infrastructure construction, said Wang Jian, a banking analyst at brokerage Guosen Securities.

The Chinese government lifted the debt ceiling by CNY6 trillion (USD834.8 billion) on Nov. 8 to replace existing implicit local government debts. And the Ministry of Finance said that CNY800 billion (USD110 billion) will be allocated from newly added local government special bonds each year for five consecutive years specifically for debt resolution, starting this year, half of which can be used to replace implicit debts.

CNY2 trillion (USD278.3 billion) of implicit debts for shantytown renovation due in 2029 and subsequent years will still be repaid under the original contracts, Minister of Finance Lan Fo'an said.

The overall exposure of Chinese commercial banks to urban investment companies was around CNY40 trillion (USD5.5 trillion) as of the end of 2022, accounting for approximately 12 percent of lenders’ total assets, according to data from Shenzhen-based Guosen Securities.

"This round of debt swaps may slightly reduce banks' income from interest, but it can lower the long-term risks associated with the exposure,” said Lin Yingqi, a banking analyst at investment bank China International Capital Corporation. “By improving asset quality and reducing borrowing costs, it will offset the impact of shrinking net interest margins and save on expenditure."

Assuming the scale of implicit debt replacement is CNY2.8 trillion (USD389.6 billion) each year from 2025 to 2027 and if 90 percent of this comes from bank loans, the drop in banks’ income from interest each year will be approximately CNY70 billion (USD9.7 billion) to CNY80 billion, according to a report by CICC.

This translates to a narrowing of the net interest margin by 2 basis points and a 2 percent fall in profits, the Beijing-based firm added. But the impact on urban and rural commercial banks with a relatively high exposure to urban investment companies will be greater.

This round of debt swaps will also lead to a 1 percentage point dip in the annual growth of bank loans, and a 2 percentage point drop in the growth rate of medium and long-term business loans, Lin said.

"The slowdown in loan growth will be converted into an increase in government bonds, keeping the growth rate of total bank assets neutral," Lin said.

“We can expect there to be follow-up policies that will help reduce the cost of banks’ liabilities and mitigate the impact of debt swaps on the net interest margin,” Wang said. However, the debt resolution plan will benefit bank fundamentals, and especially alleviate market concerns about the exposure of non-performing loans related to implicit debts.

The move reduces the amount of interest paid on local government debts, Wang said. This gives local governments more policy space to support investment, consumption, as well as scientific and technological innovation, while at the same time promoting stable economic growth and structural adjustments.

Debt resolution also alters banks' allocation of capital, so they can extend more credit in the future, which is also beneficial to the real economy, he added.

Editor: Kim Taylor