Government support crucial in rating Chinese banks

A new approach has been suggested.

Moody's Investors Service says a key element in its rating of Chinese banks is the level of government support that the banks receive.

According to a release from Moody's Investors Service, the overall support that the Chinese authorities provide to China's banking system is strong.

"However, economic and policy developments, including the targeted allocation of credit to particular industries, and the newly introduced deposit insurance scheme will eventually require the government to take a more nuanced and differentiated approach in providing support to individual banks," says Simon Chen, a Moody's Vice President and Senior Analyst.

Moody's analysis is contained in its just-released report titled "Chinese Banks: Government Support to Remain Strong But Become More Nuanced," and is authored by Chen.

Moody's report says that maintaining stability in China's financial system will remain the top policy priority, given that the Chinese authorities will be keen to manage the potential adjustment risks associated with the increased use of market discipline mechanisms, in a system that has long operated under implicit guarantees.

Here's more from Moody's Investor Service:

Moody's points out that its Joint Default Analysis under its bank rating methodology aims to capture and quantify such differences in support levels.

For example, Moody's ratings for the five largest Chinese banks by assets incorporate 45 notches of uplift, because the ratings take into account the banks' systemic importance and high levels of state ownership.

In contrast, Moody's has typically assigned 13 notches of uplift to the ratings of midsized joint stock commercial banks.

Moody's report further points out that its Joint Default Analysis focuses on the following two broad considerations:

1) Potential contagion risk impact on market and local economy: This captures the risk that the unmitigated failure of a bank would trigger panic and undermine general confidence in the broader financial system. At the same time, this represents a bank's perceived value and importance in furthering the government's policy agenda and the activities of local economies.

2) Form and extent of public involvement: This factor reflects the economic interests the government or government-related institutions would miss out on if a bank were to cease operating as a going concern.

These interests could be tangible, such as the actual equity stake held either directly or indirectly by the government in a bank.

In addition, Moody's points out that there would likely be reputation risks to the government if it decided not to support a bank in which it holds a significant stake, and in which the government is perceived to have some influence on bank strategy.

Moody's Joint Default Analysis does not take into account the indirect support the government provides to banks on a regular basis; for example, in supporting a bank's key borrowers.

Such indirect support is instead taken into account in Moody's consideration of the banks' standalone baseline credit assessment.