Insurers are lining up to snap up perpetual bonds, with $32.14b of such instruments already hitting the market.
Banks in China are forging increasingly close ties with insurers in a development could multiply systemic risk in the country’s trillion-dollar financial services sector, according to a report from S&P.
As insurance firms scramble for profitable investment options given the lack of depth in the domestic capital markets and stringent restrictions on overseas investments, insurers are turning to bank capital instruments in addition to existing deposits and equity stakes in lenders, effectively deepening their relationship. “The result is high sectorial and obligor concentration toward financial institutions,” Eunice Tan, analyst at S&P said in a report. “We believe the concentration risk will persist.”
The introduction of perpetual bond issuance amongst domestic banks will deepen the intermingling of insurers and banks seeking to meet regulatory capital requirements. At the start of this year, Bank of China Ltd. (BOC) issued the first-ever perpetual bond by a Chinese bank which has been followed by some $32.14b (RMB230b) of such instruments have hit the market. A further $61.9b (RMB443b) are in the pipeline which includes a $16.77b (RMB$120b) offering from Agricultural Bank of China (ABC); $6.98b (RMB$50b) each from China Merchants Bank and Ping An Bank and $5.58b (RMB$40b) each from China Construction Bank, China Everbright Bank and China CITIC Bank.
With higher yields than other low-risk assets, perpetual bonds provide a new and relatively low-cost channel for banks to raise additional tier-1 capital. The bonds can also be used as collateral for accessing central bank liquidity facilities and most issues have been oversubscribed, some by more than 2x.
On the other hand, insurers have been allowed to invest in the perpetual bonds and Tier 2 capital bonds of commercial banks - considered as having better liquidity than alternative investments - following a regulatory announcement in January 2019.
“Insurers are starved for long-term investable assets, given declining investment yields and stricter portfolio rules in recent trends,” said Fan. “Banks' hybrid capital instruments can also help life insurers match their long-duration liabilities.”
Net investment yields of listed Chinese insurers have dropped to 4.94% in 2018 from 5.27% in 2017, data from S&P show. Including investment gains, net investment yields have dropped more sharply from 5.49% in 2017 to 4.32% in 2018.
Rising risks therefore characterise this deepening relationship especially against the trend of concentrated holdings in financial sector assets via direct equity and capital instruments. With banks holding each others’ capital instruments, cross-holding structures may raise systemic risks, including the exposure of insurers to banks.
Holders of hybrid capital may also face equity-conversion or write-down risk and are low priority in addition to the obligation to hold or add to bank holdings in the event of a crisis given the government-owned nature of most banks and major insurers and their responsibility to economic stability.
“For example, increased credit to private, small and mid-sized enterprises could turn out to be a successful economic policy; however, it comes with risks for banks given the susceptibility of the sector to economic downturns. Insurers, in turn, would be exposed to those risks, given their outsized holdings,” she said.
Fan brings to mind of a similar concentration risk in Japan when insurers reeled from heavy losses on their investments in the bank sector after the failure of Resona Bank and other stress during that period. “We believe the bank-insurer relationship is one of mutual benefit. In the event of a bank failure or crisis, however, systemic risks would multiply.”
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