Financial ties between China banks and insurers raise systemic risk: S&P

HONG KONG -- Easing regulations have allowed China's insurers to increase holdings in bank-related assets, including capital instruments. But while this benefits banks that need capital, and insurers looking for yield and duration, growing financial-sector cross-holdings could multiply systemic risk, S&P Global Ratings said in a report published today.

"While bank-capitalisation instruments widen the scope of investment options for insurers, there are risks. The main one is concentrated holdings in financial sector assets," said S&P Global Rating credit analyst, Eunice Tan.

S&P says China's insurers are short on investment options. The country's evolving capital markets still lack depth, overseas investments are restricted, and there is a limited supply of long-dated central-government bonds.

"As a result, exposure to the country's banks tend to be high, including through equity and deposits.

"We expect the concentration to rise further, after regulators eased investment limitations for the insurance sector earlier this year.

S&P says this year's introduction of perpetual bonds issuance among domestic banks adds another investment option for insurers. Banks have already either completed or announced RMB673 billion (US$95 billion) in perpetual bond issuance.

"Perpetual bonds provide a new channel at relatively low costs for banks to raise additional tier-1 (AT1) capital," the S&P report says.

"We expect the pipeline to remain strong for perpetual bonds, as well as for preference shares, another AT1-capital instrument for banks.

"Banks are issuing capital instruments to meet regulatory requirements in the face of limited ability to accumulate capital internally.

"More broadly, the largest domestic banks face a nudge to support GDP growth by providing funds and liquidity to favored sectors--private and small and micro enterprises."

S&P said bank-capitaliszation instruments have higher yields than Chinse government bonds, and offer duration to help insurers' match longer-term liabilities.

"The debt is subordinate--meaning debtholders effectively won't get paid back if the bank fails or its capital sharply erodes.

"However, given that most such instruments are issued by China's largest banks, many investors consider them to be "too big to fail" - that is, authorities would not allow premiere banks to get weak enough to trigger the point of non-viability.

"The downside is concentration risk which, in our view, extends beyond the insurance sector's holdings of bank-related assets. Many Chinese banks hold peers' capital instruments.

"While measures are in place to limit concentration risk, we believe such cross-holdings are prevalent, and would add to systemic risks in the event of distress.

"China's regulators have been fairly explicit in their view that the insurance industry can and should play a role in stabilising economic cycles and managing risks

"As such, insurers may be tasked to provide additional capital to support national interests. In extreme cases, there could be pressure for insurers to maintain holdings in bank securities in the event of crisis."

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