“WHAT IF”SERIES II–WHAT IF BIG BAN601985中国核电KSRAISE CAPITAL-

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CHINESE BANKS：“WHAT IF”SERIES II–WHAT IF BIG BANKSRAISE CAPITAL?

A persisting concern, but it is not likely, nor a bad thing; stay positive

Possible capital raising by big-four banks has been among the key discussiontopics with investors, especially when valuations approach 1x PB. Manyinvestors are still concerned about misuse of proceeds to recognize more badloans and potential dilution. However, we believe big banks are unlikely toraise common equity in the near term, given their ability to self-generate capitalwith an ROE of 12-15% and limited regulatory pressure （c.300bps buffer ofCET-1）。 That said, even if it happens the capital raising would not necessarilybe negative. The asset quality of big banks is improving so that stronger capitalcould strengthen financial stability. We stay positive on deposit-funded banks.

Base-case scenario: no need to raise core common equity

Our assumption of no capital raising is rooted in four reasons:

Big banks are able to self-generate capital, as their ROEs of 12-15% arehigher than the minimum ROE of c.11% required to sustain assetexpansion. We forecast big banks’ CET-1 ratio will rise to 12.7% in 2019E（3Q17: 12%）。

Big banks’ CET-1 ratio is c.300bps higher than the minimum regulatoryrequirement. Total Loss-Absorbing Capacity （TLAC） likely kicks in sevenyears later, and we expect big banks to meet the targets smoothly.

RWA density （RWA/total assets） has been declining due to a shift in loanbook towards retail loans and the implementation of internal-rating-basedapproach （IRB）。 This implies less capital consumption than in the past.

Capital raising by big banks would add pressure on China’s fiscalpositions, as the central government owns 71% of big banks, on average.

What if capital raising materialized? Not necessarily a bad thingIf the capital raising plans were indeed announced, which might start with ABC（the bank with the lowest CET-1 among big banks）， fundamentally we do notview it a negative surprise. In the past, the market’s concern on capital raisingwas due to the fear of the misuse of capital to recognize more NPLs, as themarket perceived the reported NPL ratio as understated. But now, the assetquality of big banks is improving, as evidenced by the lower NPL formation. Assuch, stronger capital is actually positive to enhance system financial stability.

Smaller banks under capital pressure; positive catalysts: CCyB and D-SIBs

In contrast with big banks, smaller banks are under notable capital pressuredue to heavier shadow banking exposure and tighter regulations （see ourreport “Mounting capital pressure”）。 We have noted that listed smaller banksalready proposed Rmb957bn capital raising plans which have not beencompleted （Fig 13）。 This is why we still prefer big banks. For the sector as awhole, we see a potential introduction of CCyB and D-SIBs as positivecatalysts, as they may reassure the market that there is an additional line ofcapital to prevent any unexpected shocks. Top pick: BOC – the key beneficiaryof US rate hike, “OROB” initiative and domestic asset-quality improvement.