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In one door and out the other is a good way to describe the flow of Chinese bank profits. The state-owned commercial banks are as profitable as they've ever been, but their profits are being passed along to shareholders at a rate that is reducing their capital base to unsound levels.
While most large state-owned enterprises in China pay meager dividends (5-10%), the state-owned commercial banks are the exception. The five largest banks payed out an average of 37% and 39% of their net profits, in 2009 and 2010 respectively.
This is quite strange given the lingering concern over a potential resurgence of non-performing loans (NPLs) and new capital adequacy requirements issued by the CBRC. To meet these new requirements the four large commercial banks raised a total of 264.4 billion RMB last year through new share issuances and bond sales.
Why would banks be paying out generous dividends at the same time they are going back to the capital markets to raise additional money?
The answers lies in the shakeup within the Chinese government over ownership of the state-owned commercial banks.
Huijin, the state-owned investment fund that acts as the owner of the 4 large commercial banks, was originally controlled by the People's Bank of China (PBoC). After a bureaucratic shake-up a new sovereign wealth fund, China Investment Corporation (CIC) emerged as the owner of Huijin. Importantly, CIC is controlled by the Ministry of Finance (MoF) and therefore control over the commercial banks was transferred from PBoC to MoF.
MoF was unwilling (or politically unable) to foot the bill to start up CIC with fiscal revenues. Instead, an alternative financing structure was chosen. MoF issued a 1.55 trillion RMB bond and used the proceeds to purchase $200 billion in foreign reserves from PBoC. These funds (and the corresponding debt) were transferred to CIC. CIC then used these funds to purchase Huijin, effectively transferring ownership of the large commercial banks from the PBoC to the MoF.
Unfortunately, because these activities were financed through bonds issuances (rather than fiscal outlays) CIC began its operations encumbered with a mountain of debt. According to CIC chairman Lou Jiwei, the fund has to earn 300 million RMB per day on its investments in order to meet its bond payments and operational costs.
This is the context in which to view the banks decision to pay high dividends. CIC and MOF put the banks under intense pressure to pay high dividends because CIC itself must make large payment to MoF in order to service its debt. Some of the commercial banks have voiced skepticism over a policy of paying high dividends while seeking new capital. While dividends payouts may be reduced as banks struggle to meet the new capital requirements, Chinese banks will continue to pay out much higher rates of dividends than other state-owned firms as long as CIC owes a tremendous amount of money to MoF.