Local governments in debt-ridden China rush to save small banks with $21B in special bonds

As authorities attempt to control spillover risks from a worsening property crisis and a faltering economy, local governments in China have sold record amounts of so-called special bonds this year to infuse capital into struggling smaller banks.

The proceeds of special-purpose bonds, an off-budget debt financing tool used by Chinese local governments, are usually allocated toward particular policy objectives, like funding for infrastructure projects.

As per the deal prospectuses, local governments intend to recapitalize themselves by buying convertible bonds or equity from smaller banks, the majority of which are state-owned, using the proceeds from the most recent bond sales.

As of now, in 2023, the governments have used these bonds to generate 152.3 billion yuan ($21.05 billion) to restock small and medium-sized banks' capital, according to statistics from the official data.

Analysts note that the total amount of money raised thus far pales in comparison to the banks' requirements.

According to an October analysis by S&P Global Ratings, based on a scenario where up to 20% of regional lenders risk capital deficiency, China's small, regional banks would need to resolve a capital shortage of an estimated 2.2 trillion yuan.

This year's special-purpose bond value, which is more than twice that of the 63 billion yuan issued in 2022 and the highest since the instruments were introduced in 2020 to support smaller lenders affected by the COVID-19 pandemic, highlights Beijing's efforts to avert a repeat of the 2008 financial crisis.