Major Chinese banks are asking for more hedging instruments
allowing them to juggle foreign exchange losses as the yuan
appreciates.
"As the yuan increases in value, Chinese banks are becoming more
exposed to potential exchange losses when they convert overseas
profits into yuan and conduct foreign exchange transactions with
their own assets," said Wen Bin, a senior strategic analyst with
the Bank of China (BOC).
"Chinese commercial banks need more derivative instruments to
hedge against exchange losses," said Wen, adding that the country's
foreign currency exposures of US$80 billion were mainly
concentrated in the Industrial and Commercial Bank of China (ICBC),
the China Construction Bank (CCB), Bank of China and Bank of
Communications.
The current instruments used for exchange rate hedging are
insufficient as the common consensus among overseas investors views
the yuan as continuing to appreciate, ruling out option
transactions, he said.
An option transaction is one of the hedging instruments
available to Chinese banks. It gives the buyer the right, without
obliging them, to buy or sell at a set price on or before an agreed
date.
At present, the role of the option transaction as a hedging tool
for Chinese banks has been almost nullified because the transaction
usually involves high premiums signifying difficulty in predicting
the growth margin of the yuan's value. The buyer is thus able to
cancel the option transaction by which time the premium may have
already exceeded the exchange losses.
"With option transactions incapable of guarding against exchange
losses, at the moment Chinese banks can only rely on swap and
forward transactions," said CCB president Guo Shuqing.
A swap transaction involves the exchange of two currencies on a
fixed date assuming that the two currencies will be of equal value
on that date. A forward transaction is an obligation to fulfill a
pledge made for a future date, without requiring the payment of a
premium. It can not be broken even if the buyer is set to incur a
loss.
As the Chinese government controls capital account foreign
exchange flows, Guo called on banking regulators and the central
bank to relax their hedging restrictions, freeing up Chinese banks
to hedge their foreign currency exposures.
There are a number of regulations currently in place which
hinder the efficiency of conducting swap and forward transactions
and, unlike overseas banks, Chinese banks are not allowed to
combine hedging tools freely.
China's three largest state-owned commercial banks - ICBC, CCB
and BOC - have faced exchange losses of billions of yuan since the
currency has risen 3.88 percent in value since July 2005 through
exchange reforms.
The three banks have large amounts of US dollars and other
foreign currencies principally since completing substantial initial
public offerings overseas.
BOC, the country's largest foreign exchange bank, suffered
exchange losses of 3.5 billion yuan (US$438 million) in the first
half of last year while CCB suffered losses of 2.4 billion
yuan.
Goldman Sachs, the world's biggest investment banking firm, has
predicted BOC's profits will shrink 3.3 percent and net profits 0.6
percent for every one percent rise in the yuan's value.
Many bank executives have said their banks will suffer from a
depreciation in foreign currency assets if the yuan continues to
appreciate.
Foreign currencies account for 0.52 percent of the total assets
of China's five major listed banks - the three listed state-owned
banks, the Bank of Communications and China Merchants Bank, the
China Securities Journal reported on Monday.
However, the five banks' earnings per share (EPS) will decrease
an average 0.014 yuan for every five percent rise in the yuan's
value, the report quoted an anonymous analyst as saying.
EPS stood at 0.09 yuan for the ICBC and 0.07 yuan for the BOC on
June 30 last year, according to the two banks' half-year reports in
2006.
However, BOC vice president Zhu Min maintained an optimistic
outlook, calling the foreign currency assets yielded higher than
the domestic currency assets, which could offset the exchange
losses caused by the yuan appreciation.
Zhu said BOC's net foreign currency exposure remained too
minimal to pose a substantial threat to the bank.
The bank rose to number six in the world in terms of assets at
the end of last year, with total assets of 4.7 trillion yuan and a
capitalization of US$120.8 billion.
(Xinhua News Agency January 16, 2007)