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Interest rate cut puts China banks' profits on the line

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China's banks are facing their toughest year since the onset of the global financial crisis in 2009, with interest rate cuts and liberalisation of the deposit rate system eating into their profit margins.

[SHANGHAI] China's banks are facing their toughest year since the onset of the global financial crisis in 2009, with interest rate cuts and liberalisation of the deposit rate system eating into their profit margins.

The People's Bank of China (PBOC) cut interest rates for the third time in six months on Sunday in a bid to lower companies'borrowing costs, whilst giving banks more flexibility over how much they pay depositors.

That will hit bank earnings as lenders face competitive pressure to pay more for deposits but charge less for loans, just as China's economy is growing at its slowest pace in 25 years.

Some analysts estimate that the three rate cuts and the raising of the deposit rate ceiling could reduce banks' annual profits this year by up to 22 per cent. "Our lives are going to get a lot harder," said a senior banker at a Shanghai branch of a top-ten Chinese bank, who added that his team are already only breaking even on some deals.

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The banker declined to be identified as he is not authorised to speak to the media.

China's five biggest lenders, including Industrial & Commercial Bank of China Ltd. and Bank of China Ltd , saw their profits grow by less than 2 per cent in the first quarter of 2015 from a year earlier, a marked slow-down from their rampant double-digit growth of a few years ago.

Banks are also wrestling with mounting bad loans, even as government leaders admonish bankers for charging excessive fees, such as those for arranging loans, another source of income that lenders can ill afford to lose.

China's commercial bank non-performing loan ratio increased to 1.39 per cent at the end of March, as sour lending increased by 139.9 billion yuan (US$22.53 billion) to 982.5 billion yuan, representing a 52 per cent jump in bad loans from 12 months earlier.

Net interest margins - the difference between a bank's borrowing rate and interest earned on loans - have been tightening since November, when the PBOC embarked on the current round of easing.

The latest three cuts and the rise in the deposit ceiling could cut banks' 2015 net profits by between 6 and 22 per cent, according to a Morgan Stanley research report, which forecast there would be at least one more interest rate cut this year.

Full interest rate liberalization, meaning banks will be completely free to decide the rates they charge for deposits and loans, may come by the end of 2015, PBOC governor Zhou Xiaochuan said in March at the annual meeting of China's rubberstamp parliament, the National People's Congress.

That liberalisation is likely to erode margins at China's smaller lenders more than at their larger counterparts, according to analysts, as they will probably raise their deposit rates higher to lure funds. "Small banks, like Ping An Bank and Hua Xia, and city banks, will likely be hurt more than peers," said Goldman Sachs in a research report.

Shares in small and mid-tier banks China Minsheng Banking Corp and Bank of Beijing Co dropped more than two percent in early morning trading on Monday.

Smaller banks Hua Xia Bank Co, Ping An Bank Co , China Merchants Bank Co and Shanghai Pudong Development Bank Co also saw their shares decline more than one percent, while China's biggest four state-owned lenders only dipped slightly.There may be one positive impact from the rate cut though - cheaper lending rates will lower companies' financing costs, making them less likely to default on loans. "To the extent that the rate cuts help to support the growth outlook, we consider them as credit positive as both stronger economic growth and lower borrowing costs will help borrowers to service their debts," said Thomas Byrne, senior vice president at Moody's Investors Service in a press statement. REUTERS

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