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China to reduce local government bond risk weightings to attract bank buyers

Chinese authority is considering to reduce the risk weightings for bank holdings of local government bonds from the current 20 per cent to zero, according to the state-run China Securities Journal. A zero risk weighting would mean that banks could expand their purchases of such bonds without affecting their capital adequacy ratios.

In addition, Beijing has required that local government bonds’ yields be at least 40 basis point higher than the average yields of treasuries of the same maturity in the previous five trading days. Local governments are not allowed to impose pressure on undertaking banks of the bond sales for lower yields or to intervene in bond market in any non-market way.

The measures come as part of a whole package from Beijing to help local government to sell more bonds and the market has felt the changes.

During the two week after the MoF’s call for faster bond sales, local governments sold about 200 billion yuan and 300 billion worth of bonds respectively. It’s the first time that one-week bond sales exceeded 300 billion yuan so far this year.

In the meantime, these bonds are being issued at higher yields.

On August 21, the local government of Zhenjiang province issued 3-year and 5-year bonds at 3.63 per cent and 3.76 per cent respectively, both 40 bp higher than the average yields of 3-year and 5-year treasuries in the previous five trading days of 3.23 per cent and 3.36 per cent.

The yields on bonds issued by Guangdong and Jiangsu provinces are also 40 bp higher than treasuries of the same maturities, said a bond trader.

Previously, local government bonds were issued at a yield almost the same as treasuries.

Higher yield are obviously getting bond buyers more interested. The  3-year bonds issued by Zhenjiang provinces see 6.65 times bidding, the highest on record and the 5-year bond bidding also hit a rare high of 5.95 times, according to the 21 Century Business Herald.

The zero risk weighting could released a great amount of banks’ capitals, solving the key constraint on banks’ credit expansion, according to the China International Capital Corporation.

Currently, commercial banks holds about 15.8 trillion yuan local government bonds, according to China Central Depository & Clearing Co. With risk weighting cut to zero, additional 3 trillion yuan bank capitals will be released.

The policy changes have made local government bonds a better buy and motivated commercial banks to increase active allocation, said several analysts and traders, compared to previous passive allocation under the pressure from the central government.

“Banks are becoming increasingly interested these days, especially when the yields of quasi-municipal bonds issued by local government financing vehicles are dropping fast,” said a banker from a mid-sized bank in Jiangsu,”even more so when you think that purchases of local government bonds are exempt from tax and have less impact on capital adequacy.”

While local government bonds getting popular among banks, other type of bond offerings are expected to feel pressure from a squeeze-out.

The 10-year bonds issued by the China Development Bank see yields climb to 4.3 per cent, a critical resistance level, said Li Zhifeng, director of fixed-income investment at Silver Leaf Investment in Shanghai.

“Investors should stay vigilant about the huge amount of local government bond supplies expected in August and September”, according to the CICC, “it’s worth noting the PBOC’s supporting monetary measures.”

“The PBOC will have no choice but to ease liquidity to support the faster bond sales,” according to the TF Securities.

The central bank injected 149 billion yuan via one-year medium-term lending facility, the second MLF operation so far this month, after 383 billion yuan injection via one-year MLF on 15th August and analysts are expecting more injection via MLF or cut in required-reserve-ratio.

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