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With Chinese financial regulators easing regulations and making it simpler for insurers to hold bank-related assets, research by S&P Global Ratings has raised concerns about increasing systemic risk.
In a report, titled ‘China Credit Spotlight: The Ties that Bind Banks and Insurers,’ S&P said that while loosened regulations have benefited banks that need capital and insurers that need yield and duration, these growing financial-sector cross-holdings could multiply systemic risk.
“While bank-capitalization instruments widen the scope of investment options for insurers, there are risks,” said Eunice Tan, credit analyst at S&P Global Ratings. “The main one is concentrated holdings in financial sector assets.”
The report added that Chinese insurers are suffering from a dearth of investment options. Despite the immense size of the Chinese economy, its capital markets still lack depth, and overseas investments are restricted. There is also a limited supply of long-dated central government bonds.
This results in high exposure to the country’s banks including through equity and deposits. S&P Global Ratings expects the concentration to rise further, after regulators eased investment limitations for the insurance sector earlier this year.
Bank-capitalization instruments deliver higher yields than Chinese government bonds, and these also offer duration, which helps insurers match longer-term liabilities. This type of debt is subordinate, which means debtholders effectively won’t get paid back if the bank fails or its capital sharply erodes. As these are mostly issued by China’s largest banks, many investors consider them to be ‘too big to fail.’
S&P pointed out the downside to this, which is concentration risk that, in its opinion, extends beyond the insurance sector’s holdings of bank-related assets. Many Chinese banks hold peers’ capital instruments, and while there are measures to limit concentration risk, these cross-holdings are prevalent, and would add to systemic risks in the event of distress.
“China’s regulators have been fairly explicit in their view that the insurance industry can and should play a role in stabilizing economic cycles and managing risks,” said Tan. “As such, insurers may be tasked with providing additional capital to support national interests. In extreme cases, there could be pressure for insurers to maintain holdings in bank securities in the event of crisis.”
