China rate cuts put spotlight on banks' profitability
By Hu Xiaocen |
July 18, 2012, Wednesday
|
Print Edition
Print Edition
LIN Zhijian, a financial risk analyst at one of the Big Four auditing firms, is no stranger to the pinch of China's second interest rate cut in one month.
"A friend called me the day after the People's Bank of China announced the latest cut in interest rates, telling me that he sold most of the bank shares he had held for a long time. He said the cut heightened his worries about the profitability of lenders," Lin said.
Other investors may have been thinking along the same lines. Share prices of listed banks have tumbled 4.9 percent on average since the central bank's announcement on July 5.
"The interest rate cuts will shrink lenders' net interest margins and long-term profitability," UBS said in its latest report. "We expect the negative effects of the cut to be gradually reflected in third-quarter earnings and annual reports this year. In 2013, results will be even more impacted."
The report said net profit growth of lenders listed on the A-share market will fall by 1.4 percentage points this year and 2.6 percentage points next year.
Citigroup said net interest margins in the banking sector will be further squeezed by rate cuts and ongoing interest rate deregulation that favors deposit rates over borrowing rates. The latest cut by the central bank reduced the one-year deposit rate by 25 basis points to 3 percent, and lowered the lending rate by 31 basis points to 6 percent.
But when looking at mid- and long-term rates, it's the opposite. Deposit rates for two years and above were cut by 35 to 40 basis points, in general, while lending rates over a year edged down by 25 basis points.
JPMorgan Chase said it believes the central bank's intention was to ease the pressure of tightened interest rate margins by widening the spread between long-term lending costs and borrowing costs.
Risk management
"If lenders increase the proportion of mid- and long-term loans and manage to support long-term loans with a steady flow of short-term deposits, their profits won't suffer as much from the cut," Lin insisted. "In fact, I believe the central bank intended to push the lenders to shore up their risk management and pricing capabilities to benefit from the cut. The better they manage their money flow, the more profits they can make."
But there's a gap between reality and expectations.
The proportion of short-term loans to longer-term ones worsened last month. Mid- to long-term lending retreated to 30.7 percent of total new lending in June after a rebound in May, China Investment Securities said in a report on Monday.
CEBM Group, an independent investment advisory firm, wrote in a report published on the same day that the proportion may bounce back to a healthier level of maybe 40 percent to 45 percent in the second half.
Although big lenders have a more profitable lending "structure" than smaller ones, the central bank reports the situation has deteriorated in the past year.
By the end of May, the mid- and long-term loan balance at big lenders was 2.6 times as much as the combined short-term loan balance, compared with 3 times a year ago. At smaller lenders, short-term loans outweighed mid- and long-term lending, moving back from a ratio of 1.1 times. The interest rate cut will have a more severe impact on the profit of smaller lenders.
Estimated average decline
According to estimates from UBS, Shenzhen Development Bank, China Minsheng Bank, Shanghai Pudong Development Bank, and Bank of Ningbo will post an average drop of 4.9 percentage points in net profit next year, compared to an estimated average decline of 2.6 percentage points for all listed lenders.
The situation worsens when the lenders have fewer funds to make loans in a maturing market where the investors have more options. "Growth in bank deposits slowed significantly last year," Ma Weihua, president of China Merchants Bank, said at an economic forum in Singapore last week. "Funds were withdrawn from banks and invested in the securities and fund industries."
Ma said the banks must change with the times and shift their attention to lending to smaller companies if they want to survive the market transformation.
"It's not easy to say if my friend was right about the banking industry when he decided to sell his shares," said Lin. "But I am sure that a more liberal market with intensified competition will just make the players stronger and smarter."
"A friend called me the day after the People's Bank of China announced the latest cut in interest rates, telling me that he sold most of the bank shares he had held for a long time. He said the cut heightened his worries about the profitability of lenders," Lin said.
Other investors may have been thinking along the same lines. Share prices of listed banks have tumbled 4.9 percent on average since the central bank's announcement on July 5.
"The interest rate cuts will shrink lenders' net interest margins and long-term profitability," UBS said in its latest report. "We expect the negative effects of the cut to be gradually reflected in third-quarter earnings and annual reports this year. In 2013, results will be even more impacted."
The report said net profit growth of lenders listed on the A-share market will fall by 1.4 percentage points this year and 2.6 percentage points next year.
Citigroup said net interest margins in the banking sector will be further squeezed by rate cuts and ongoing interest rate deregulation that favors deposit rates over borrowing rates. The latest cut by the central bank reduced the one-year deposit rate by 25 basis points to 3 percent, and lowered the lending rate by 31 basis points to 6 percent.
But when looking at mid- and long-term rates, it's the opposite. Deposit rates for two years and above were cut by 35 to 40 basis points, in general, while lending rates over a year edged down by 25 basis points.
JPMorgan Chase said it believes the central bank's intention was to ease the pressure of tightened interest rate margins by widening the spread between long-term lending costs and borrowing costs.
Risk management
"If lenders increase the proportion of mid- and long-term loans and manage to support long-term loans with a steady flow of short-term deposits, their profits won't suffer as much from the cut," Lin insisted. "In fact, I believe the central bank intended to push the lenders to shore up their risk management and pricing capabilities to benefit from the cut. The better they manage their money flow, the more profits they can make."
But there's a gap between reality and expectations.
The proportion of short-term loans to longer-term ones worsened last month. Mid- to long-term lending retreated to 30.7 percent of total new lending in June after a rebound in May, China Investment Securities said in a report on Monday.
CEBM Group, an independent investment advisory firm, wrote in a report published on the same day that the proportion may bounce back to a healthier level of maybe 40 percent to 45 percent in the second half.
Although big lenders have a more profitable lending "structure" than smaller ones, the central bank reports the situation has deteriorated in the past year.
By the end of May, the mid- and long-term loan balance at big lenders was 2.6 times as much as the combined short-term loan balance, compared with 3 times a year ago. At smaller lenders, short-term loans outweighed mid- and long-term lending, moving back from a ratio of 1.1 times. The interest rate cut will have a more severe impact on the profit of smaller lenders.
Estimated average decline
According to estimates from UBS, Shenzhen Development Bank, China Minsheng Bank, Shanghai Pudong Development Bank, and Bank of Ningbo will post an average drop of 4.9 percentage points in net profit next year, compared to an estimated average decline of 2.6 percentage points for all listed lenders.
The situation worsens when the lenders have fewer funds to make loans in a maturing market where the investors have more options. "Growth in bank deposits slowed significantly last year," Ma Weihua, president of China Merchants Bank, said at an economic forum in Singapore last week. "Funds were withdrawn from banks and invested in the securities and fund industries."
Ma said the banks must change with the times and shift their attention to lending to smaller companies if they want to survive the market transformation.
"It's not easy to say if my friend was right about the banking industry when he decided to sell his shares," said Lin. "But I am sure that a more liberal market with intensified competition will just make the players stronger and smarter."
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