context: 2019 is likely to see monetary easing and fiscal expansion to stabilise the economy. As banks extend more credit, they will have to be recapitalised to stay solvent and risk resilient. Raising funds from the capital market will avoid injecting too much liquidity into the market and creating inflationary pressure. PBoC first mooted using perpetual bonds as a form of recapitalisation on 26 Dec 2018; Bank of China was first to issue 40 bn bonds with regulator approval.

People’s Bank of China (PBoC) has set up a central bank bill swap (CBS) mechanism to provide liquidity via commercial banks’ perpetual bond issuance. Open market first-class traders can swap perpetual bonds from qualified commercial banks with central bank bills from PBoC. Meanwhile, AA-rated and above perpetual bonds can be used as collateral for medium-term lending facilities (MLF), targeted MLF, standing lending facilities (SLF) and re-lending.

The swap will be open to bidding for quantity among open market first-class traders, based on fixed fees. Its maturity should be no longer than three years. Exchanged central bank bills cannot be cashed out; they can only be collateral. Because the tool is essentially a bond-for-bond swap, it has a neutral impact on principal.

Banks have to meet the following conditions to release perpetual bonds

  • latest end-quarter capital adequacy ratio no lower than 8 percent
  • non-performing loan ratio with over 90-day default no higher than 5 percent
  • no loss in three consecutive years
  • latest end-quarter asset scale no lower than 200 bn
  • capable of enhancing support to the real economy after recapitalisation

A recent 21st Century Business Herald editorial argues the instrument will turn perpetual bonds into attractive and liquid financial assets for investors. While PBoC is trying to fulfil its role to support the real economy with systemic innovation, the ultimate solution to unhealthy expansion of credit lies in structural reform, adds the editorial.

Xu Yao 许尧 China Construction Bank analyst emphasises that CBS

  • will not generate new currency and has no effect on overall liquidity—it is not quantitative easing
  • is tasked to improve liquidity and lower premium for perpetual bonds, facilitating their issuance
  • may transfer risks to PBoC; extra arrangements needed to prevent this
  • is unusual operation and should exit once the economy stabilised