In response to significant changes in the asset structure of commercial banks, especially with a rapid rise in the proportion of non-credit assets, the China Banking and Insurance Regulatory Commission (CBIRC) announced the Measures on Risk Classification of Financial Assets of Commercial Banks on 10 February 2023 to standardise the risk management of financial assets held by banks.
The measures represent a substantial revision of the Guidelines on Risk Classification of Loans, promulgated in 2007. The new regulations cover four main areas: risk classification requirements for financial assets; risk classification requirements for restructured assets; risk classification management for banks; and supervision and management.
CLASSIFICATION REQUIREMENTS
Partner
Jingtian & Gongcheng
Different targets, different concept. Compared with the guidelines, the measures expand the scope of classification beyond bank loans to include a wider range of financial assets held within a bank’s balance sheet such as bonds, other investments, interbank assets and receivables, and off-balance sheet items that pose a credit risk. In terms of classification for non-retail financial assets, the measures depart from the guidelines – which used a single loan as the object for categorisation – and instead require a focus on evaluating the debtor and their ability to perform based on factors such as financial position, willingness to repay, repayment history, late payments, and security status.
Additionally, the measures mandate that banks distinguish enterprise group members with debts that have been classified as non-performing during classification, and prudently assess the potential impact on the debt risk of other members.
Quantitative indicators for risk classification recognition. Compared with the guidelines, which provide general provisions on loan classification, the measures explicitly designate the number of days overdue, credit impairment ratio and overdue ratio as key indicators for determining the debtor’s solvency.
Specific guidelines are provided for the classification of assets based on the duration and proportion of overdue payments. Assets are classified as: normal; concern; subprime; doubtful; and loss, with the latter three collectively designated as non-performing assets.
According to the overdue day criteria, debts with overdue principal and interest earnings (except for technical or operating delay of no more than seven days) past due for more than 90, 270 and 360 days, are classified as: concern; subprime; doubtful; and loss. The occurrence of credit impairment and impairment of expected credit losses of 50% and 90% of the carrying balance correspond to: subprime; doubtful; and loss. Financial assets of the same non-retail debtor, with more than 20% of all bank debts overdue for more than 90 days, are classified as subprime. If more than 10% of the claims in the bank are classified as non-performing, then all its claims in the bank will be classified as such.
RESTRUCTURED ASSETS
While the guidelines contained only one article on restructured loans, the measures significantly increase provisions for risk classification in this area. These assets are defined as restructured when banks adjust debt contracts in favour of the debtor during times of difficulty, or provide refinancing for the debtor’s existing debts, such as borrowing from the debtor to repay old debts or financing new debts. The measures also provide clear rules for identifying and classifying the risk of restructured assets.
In response to the need for greater regulatory supervision over restructured loans, banks are required to set a restructuring observation period for restructured assets, beginning on the first repayment date agreed on following the contractual adjustment, and must include at least two repayment periods lasting no less than one year. If the debtor’s financial difficulties are resolved within the observation period, the assets in question may no longer be considered restructured. Conversely, failure to repay in full and on time during the period will result in a restart of the observation period, with any subsequent non-performance date as the starting point for calculation.
After the restructuring observation period ends, if the assets meet the criteria for the “normal” or “concern” categories, and all overdue claims and related expenses have been paid, they must be settled within at least two consecutive repayment periods or six months (whichever is longer).
Additionally, future ability to fulfil the contract must be assessed, and if the debtor has no credit impairment with the bank, the assets may be classified as at least “concern”. If no repayments are made in accordance with the contract or the financial position does not improve during the observation period, the assets to be reorganised shall again be classified as at least “subprime” and the observation period shall be recalculated.
The prerequisite for asset restructuring is that the debtor is experiencing financial difficulties at the time the bank adjusts the contract or provides refinancing.
SUPERVISION AND MANAGEMENT
The measures provide guidelines for banks regarding risk classification management, and regulations for regulatory bodies overseeing risk classification. The measures emphasise that they serve as the minimum requirements for the classification of financial assets, providing a foundation for banks to enhance their systems and refine their methods.
The ultimate responsibility for classification results rests with the board of directors. Banks should undertake and enhance their risk classification processes, classification adjustments, internal audits, information systems, dynamic monitoring, accrual and write-off procedures, and file management, all in accordance with the measures.
The measures clarify that the CBIRC has the authority to supervise and inspect the risk classification of banks. If a bank violates the regulatory requirements on risk classification, the CBIRC can hold prudential meetings with the bank’s board of directors and senior management, issue a supervisory opinion letter with a deadline for rectification, require the bank to formulate a practical rectification plan and submit it for supervisory record, increase provisions and regulatory capital, or order effective measures to mitigate the risk of financial assets.
SCOPE AND TRANSITION
The measures limit the scope of application to commercial banks. They only recommend that other banking financial institutions – including national development banks and policy banks, rural co-operative banks, village banks, rural credit co-operatives, and branches of foreign banks supervised by the CBIRC and its dispatched agencies – take them as reference.
The measures will be officially enforced on 1 July 2023, followed by a transitional period. Banks will be required to reclassify all existing business by 31 December 2025.
Wang Zhenxiang is a partner at Jingtian & Gongcheng
Room 3001, Area A, China Resources Tower
No.1366 Qianjiang Road, Hangzhou 311500, China
Tel: +86 571 8992 6523
Fax: +86 571 8992 6501
E-mail: wang.zhenxiang@jingtian.com
