China's latest move to lower the regulatory requirement on the ratio of allowance for loan impairment losses to nonperforming loans will encourage commercial banks to classify bad loans more accurately and to step up the disposal of distressed debt, researchers said.

The requirement on the ratio will be lowered from 150 percent to a range of 120 to 150 percent. Ratios will vary from bank to bank, depending on the accuracy of a bank's loan classification, how active it has been in the disposal of nonperforming loans, and the level of its capital adequacy, said the China Banking Regulatory Commission, the country's top banking regulator, in a recent notice.

According to the CBRC, if a bank has calculated 100 percent of its loans that are past due by 90 days or more as nonperforming loans, the regulatory requirement on its ratio of allowance for loan impairment losses to nonperforming loans will be lowered from 150 percent to 120 percent. The requirement on its ratio of allowance for loan impairment losses to total loans will also be lowered from 2.5 percent to 1.5 percent.

However, if a bank has calculated less than 70 percent of its loans that are past due by at least 90 days as nonperforming loans, the regulatory requirements will remain unchanged.

Xiong Qiyue, a research fellow of the Institute of International Finance at the Bank of China, said: "Banks have lots of freedom to decide which loans to count as nonperforming loans. The new rules will encourage banks to count a larger proportion of their loans that are past due by 90 days or more as bad loans. This will help the banking sector present a real picture of financial risks."

Zeng Gang, director of banking research at the Chinese Academy of Social Sciences' Institute of Finance and Banking, agreed with Xiong and said: "According to the CBRC, the regulatory requirement on the ratio of allowance for loan impairment losses to nonperforming loans will vary from bank to bank. This is actually an encouragement for the banks that have classified their nonperforming loans truthfully."

Chinese banks have sufficient allowances for loan impairment losses to handle risk exposures due to high regulatory requirements, said people with a good knowledge of the banking sector.

The average ratio of allowance for loan impairment losses to nonperforming loans in China is more than 180 percent industrywide, far beyond the international level, said Wang Zhaoxing, vice-chairman of the CBRC and a member of the 13th National Committee of the Chinese People's Political Consultative Conference.

"With a lower requirement on the ratio, banks will have more funds for lending and their returns on lending will increase. This will help banks step up support for the real economy," said Zeng of the Chinese Academy of Social Sciences.

In addition, regulators will also allow the banks that dispose nonperforming loans more actively to enjoy lower regulatory requirements. Wang of the CBRC said this will help accelerate disposal of bad loans.