Policy Banks - Why they are unique, and why we like them

With our new series of articles we intend to explain the Chinese local bond market, how it operates and address the most common questions. In this second insight we focus our attention on China’s policy banks bonds. Policy banks are a unique feature to China.

They consist of three government-backed banks that have been used since 1994 as the primary channels of financing for the major infrastructure projects in China. They are the Chinese Development Bank (‘CDB’), the Agricultural Development Bank of China (‘ADBC’), and the China Export Import Bank.

Policy Banks are owned by the State Council, which is the top echelon of the Chinese Communist Party – their ownership and structure make them unique. They are wholly owned by the state and, even though they do not have explicit government guarantees, we believe they are essentially sovereign, not only because of the ownership structure, but also because of the critical importance of these institutions in the Chinese development strategy. Here are some examples to show their relevance within China’s economic growth process.

The CDB is the second-biggest issuer of debt in China, after the central government and according to the bank regulations, CDB debt is treated as risk-free for banks, just like Central Government Bonds (CGBs). Its bonds are in fact more liquid than CGBs.

China Development
Bank (CDB)

The ADBC provides financing to support the development of the agricultural sector of China, which still accounts for some 30% of China’s total employment. It is a strategically critical financing arm that provides lending for purchase of basic crops, rural land transfers, infrastructure projects in the agricultural sector, as well as environmental protection projects.

Agricultural Development
Bank of China (ADBC)

The Export-Import Bank of China is, like the export-import banks in other countries, responsible for providing bridge financing for China’s external trade. Its critical role in China and its ownership structure, similar to the other two development banks, make its debt a non-financial, non-credit security, and considered “risk-free”.

Export-Import Bank
of China (CEXIM)

As defaults by these institutions are very unlikely, their bonds are the most actively traded segment in the Chinese bond market and together with CGBs, are the only types of bonds included or being considered for inclusion in global bond indices.

* Tax rate for domestic investors ranges from 3% - 31%.
Source: Eurizon SLJ Capital Ltd & WIND as at 31/12/2020.

Below are the main characteristics of policy banks bonds and why we like them:
  • Low risk exposure
    Policy Bank bonds share the same international ratings as Chinese government bonds
  • Favoured by commercial banks
    A dominant holder of Chinese bonds. Policy Bank bonds and sovereign bonds are given the same risk weighting by commercial bank risk assessments
  • Liquidity
    Policy Bank bonds rank among the most liquid bonds in the China onshore bond market
  • Cost efficiency
    Foreign investors are exempt from tax* when investing in Policy Bank bonds
  • Yield
    Whilst they enjoy the same credit rating as sovereign bonds, Policy Bank bonds have carried a yield premium
  • Default risk
    In light of their ownership by the State Council of China, and their structural importance to the development plans of China, Policy Bank bonds are deemed to carry a very low risk of default.

* The effect of and relief from tax is subject to legislation from the Communist Party of China, which may change over time.

Next time we will analyse Chinese Central Government Bonds, their risk/return characteristics more in line with high-quality developed markets sovereign bonds than emerging markets’ and their low correlation to other bond markets.

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