Chinese banks rush to sell subordinated debt

Total debt is a staggering US$24 billion.

The January 2013 deadline for the Basel III reforms has led to a rush by Chinese banks to expand their capital base. Unless banks unload their subordinated debt, any new issue from 2013 onwards will be subject to the new and tougher regulations on subordinated debt.

Banks will bear higher costs from issuing subordinated debentures when Basel III is implemented on January 1 because the new standard requires subordinated debt, which is part of Tier 2 capital, not to offer redemption incentives or issue step-ups to buyers.

The rules have prompted banks including the Big Four state-owned banks, to speed-up their debt issuance plans. Agricultural Bank of China intends to sell US$8 billion of bonds while China Construction Bank will unload US$6 billion of debt by the end of this year.

Under Basel III, funds raised by banks through subordinated bonds won't be counted as part of their capital base, unless investors are willing to write down the value of the debt entirely or allow the bonds to be converted into shares, according to regulatory and banking sources.

This means sub-debt investors, more often domestic financial institutions and insurers who prefer to be ranked above ordinary shareholders in case of a default, will have to reconsider their risk-assessment models when making such investments.