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Fitch Ratings, an international rating agency, said yesterday it welcomes the announcement by the central government to inject US$45 billion of fresh capital available into two of China's State-owned banks.

The development is a positive move that will strengthen the banking sector, whose financial condition has been a cause for concern for the agency in its ratings of the Chinese banks, Fitch said.

"If used to offset the effect of writing off non-performing loans (NPLs), the new capital would go a long way toward dealing with the two bank's NPLs -- based on official numbers," said David Marshall, managing director of Fitch Ratings, Bank.

Alternatively, it could be used to boost the banks' currently weak capital adequacy, he said.

China has not issued domestic debt to finance the recapitalization, but has used the country's growing foreign exchange reserves, an unusual move that will also have the effect of reducing the country's official foreign exchange reserves.

In order to fully implement the recapitalization, the banks need to change their legal status, he said.

Currently, as State entities of China, the two banks are not limited liability companies and have no share capital as such.

They therefore cannot issue new shares in exchange for the new capital, making the precise nature of the "recapitalization" somewhat unclear, particularly whether the capital will eventually become common equity, permanent and non-interest bearing share capital.

The banks' status is likely to change as part of the planned reforms that will see them reorganized into limited liability companies with improved corporate governance, he said.

A further aspect which remains unclear is the treatment of accounts of the nation's central bank, the People's Bank of China's, as it will be exchanging foreign exchange reserves for investments in two banks whose value is uncertain given the underlying need for the capital to absorb loan losses.

Fitch understands that the capital injection will be carried out using assets from the central bank by a new company, Central Huijin Investment Co, which will be jointly managed by the Ministry of Finance, the People's Bank of China and the State Administration of Foreign Exchanges, said Brian Coulton, senior director of Fitch Ratings, Sovereignty.

"The institutional arrangements are important for the fiscal transparency of this exercise which is essentially fiscal in nature involving potential losses for the government," he said.

Fitch's individual ratings, which are assigned primarily on the basis of public information, of both banks are "E" and its long-term debt rating assigned to Bank of China is 'BBB--'. China Construction Bank is not rated.

This long-term rating reflects the strong support from the government, rather than the bank's stand-alone financial strength and is therefore unlikely to change.

Fitch also assigns a long-term rating of 'BBB--' to the Industrial and Commercial Bank of China, which it does not plan to change as it continues to believe the government will support the bank in times of need.

Fitch's individual ratings, which measure financial strength of both banks, will be reviewed in coming months to assess whether their improved capital position, and hence the ability to absorb necessary bad debt charge-offs, is sufficient to justify upgrades.

Fitch recognizes that while a one-time recapitalization is helpful, the banks' future survival depends on their ability to maintain good asset quality, an especially challenging task in China, Coulton said.

Nevertheless, Fitch considers that the scale of the recapitalization, and its positive implications, a review of the banks' very low individual ratings is merited.

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