China's banking commission said Tuesday it had recently allowed commercial banks to calculate subordinated debt as capital. This latest move is meant to help the sector, ridden with bad loans, broaden its capital base.

The China Banking Regulatory Commission (CBRC) had issued a circular allowing banks to treat proceeds from subordinated bonds as tier-two capital, or non-core capital, it said in a press release.

The new rule "enables commercial banks to broaden capital-raising channels, enhance capital strength, and is conducive to improving the situation of inherited bank capital inadequacy and limited capital-replenishing channels,'' it said.

The announcement was in line with remarks by CBRC Chairman Liu Mingkang last week that "a variety of methods'' will be adopted to recapitalize the four State-owned commercial banks.

Subordinated debt is largely defined as no-guarantee five-year upward bank liability that ranks after other liabilities, like deposits, in terms of claims on bank assets.

It was said that the central government is also considering a massive capital injection for the four banks, which currently hold more than half of the nation's banking assets.

The majority of Chinese banks, including three of the four State-owned commercial banks, have fallen short of the 8 per cent minimum requirement of capital adequacy ratio, making the sector vulnerable to financial risks. This is especially so given their massive non-performing loans.

Total non-performing loans currently stand at around a staggering 2 trillion yuan (US$240 billion), according to banking regulators.

China formulated its capital supervision framework in the 1990s according to the Basel Capital Accord of the 1988, but stopped short of including subordinated debt as part of second-tier capital, as many countries do. Previously, only additional paid-in capital, undistributed profits, reserves, and stock offerings were eligible venues for broadening the capital base of commercial banks.

"It's certainly good news, as now we have something clear to follow,'' said a senior official with the Industrial and Commercial Bank of China (ICBC), the nation's largest State-owned commercial lender.

The ICBC was the first to apply for a subordinated debt issue after the CBRC's establishment earlier this year. The official, who declined to be named, said his bank was following an unpublicized draft regulation and is currently re-writing documents according to the new rule.

The rule is applicable to State-owned commercial banks, joint-stock commercial banks and city commercial banks, and the scale of the bond issue should not exceed 50 per cent of the issuer's core capital, the commission said.

Starting in the fifth year before maturity, the issue will be only partly calculated as second-tier capital, beginning with 80 per cent and ending at 20 per cent in the final year.

Subordinated bank debt is commonplace in developed countries, the commission said. Among the world's 50 largest subordinated debt-issuing banks, such debts account for an average 5.3 per cent of their total risk-weighted assets, it said.

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