Central bank instrument to facilitate increased trading in perpetual bonds

China's central bank will provide additional liquidity to help commercial banks meet capital adequacy requirements and ease lending concerns.

The People's Bank of China unveiled a bill swap mechanism on Thursday through which financial institutions can swap commercial bank perpetual debt－that is, debt without a maturity date－for central bank bills to be used for borrowing collateral.

Following the announcement, State-owned lender Bank of China became the first lender to issue debt without any maturity date on Friday. BOC, one of China's five biggest lenders by total assets, plans to raise at least 40 billion yuan ($5.9 billion) via perpetual bonds, to keep its risk buffer tier-1 capital above the minimum statutory requirement.

"The swap facility will increase liquidity for perpetual bond trading. But at the same time, the leverage level in the financial sector may go up," said Deng Haiqing, an economist with wallstreetcn.com, a business and financial information platform.

The new tool will increase high-quality collateral securities for financial institutions which have purchased the perpetual bonds, and generate more demand from market participants for such an instrument, said a notice on the PBOC website.

But not all the perpetual bonds can be swapped, according to the central bank, as the issuers should meet certain standards. Li Qilin, chief economist at Lianxun Securities, predicted that a special type of bond from about 65 banks could be eligible for the swap. Those qualified banks can issue 65 percent of the financial institutions' total loans.

Meanwhile, the China Banking and Insurance Regulatory Commission, the industry regulator, said on Thursday that it would allow Chinese insurance firms to invest in banks' tier-2 capital debt and capital bonds without fixed terms.

This would enable more than 16 trillion yuan of insurance capital to be invested in the perpetual bond market, said analysts.

On Friday, the second cut so far in 2019 of banks' reserve requirement ratio took effect, freeing a net 800 billion yuan along with the first cut on Jan 15. The capital injection will help to ease liquidity pressure on financial institutions and boost financing for the real economy.

Chinese regulators are exploring more channels to raise banks' capital adequacy ratio, as the average level for that has been falling, and they are required to shift off-balance-sheet lending back onto the books, even as bad assets are increasing amid the economic slowdown.

The lack of capital has constrained the lending ability of Chinese banks－one of the key reasons that the policymakers showed dissatisfaction with credit growth after a series of monetary easing policies to support economic growth.

Chinese banks need more capital as they are compelled to move onto their books and face more soured loans amid slower economic growth.

According to data from the CBIRC, at the end of the third quarter in 2018, Chinese commercial banks' average tier-1 capital adequacy ratio was 11.33 percent, down from 11.35 percent at the end of 2017.