China’s rate reform adds to concerns for bank investors as eventual industry overhaul will deprive the banks of virtually risk-free profits

China’s rate reform adds to concerns for bank investors

12:16am EDT

By Pete Sweeney and Gabriel Wildau

SHANGHAI (Reuters) – Beijing’s move to scrap the floor on lending rates is not yet a game-changer for Chinese banks, but it may have just started the countdown to an eventual industry overhaul which will deprive the banks of virtually risk-free profits.

China bank stocks mostly fell on Monday, the first trading session following the rate reform announced late on Friday. An index of banks listed in Shanghai was down 1.7 percent in late morning trading, compared with a decline of 0.4 percent for the broader Shanghai Composite Index .SSEC.SS.Any liberalization is seen as positive for China’s financial sector and the world’s second-largest economy. But many Chinese investors fear the nation’s banks, which for years have made easy profits from state-mandated spreads between borrowing and lending rates, will struggle to benefit from more competition.

Reflecting such skepticism, the Shanghai-listed banks trade at a median price-to-earnings ratio of 4.98 based on projected twelve-month earnings and a median price-to-book of 0.97, Thomson Reuters data shows.

Some economists believe nimble banks can reap some benefits after the People’s Bank of China (PBOC) announced on Friday that banks could lend at any rate they wanted, enabling them to lure more business by offering lower rates.

However, with few loans extended at or near the previous lending limits, the latest change is seen as having little practical impact.

It could, though, be a prelude to much bigger reform – removing the cap on deposit rates, currently set at 3 percent for one-year deposits – which would dismantle the system that enables lenders to effectively make guaranteed profit margins.

“China has removed almost all controls on lending rates, and rates in the money market and capital market are also effectively free. The next and more important step is, of course, the ceiling on deposit rates,” said Wang Tao, head of China research at UBS in Beijing.

That may take some time. The central bank has made it clear it considered lifting the deposit cap as the “most risky” step and promised to proceed with caution and only after implementing various safeguards, including a deposit insurance scheme.

Bank of America Merrill Lynch economist Lu Ting said that as an interim step – just like Japan in late 1970s – China could allow banks to issue floating-rate negotiable certificates of deposits, which could also be traded in the secondary market.

In the meantime, the latest move might help boost confidence in the sector’s overall competitiveness and efficiency on the assumption that more reform would follow. Barclays analysts said that it could be positive for bank stocks in the near term.

The ability to offer lower rates would also allow banks to provide an attractive alternative to short-term bond issues, Bank of America Merrill Lynch said in a research note.

How retail Chinese investors will react is an open question, however. Investors have been wary of Chinese financial firms, which many believe are saddled with underperforming loans dating back to China’s stimulus-driven spending spree in the aftermath of the 2008-2009 global financial crisis.

And economists say the latest initiative could give some big, influential state-owned companies leverage to secure lower borrowing costs at the banks’ expense.

That could put some pressure on China’s biggest banks, such as Industrial and Commercial Bank of China Ltd (601398.SS: QuoteProfileResearchStock Buzz), China Construction Bank Corp (601939.SS: Quote,ProfileResearchStock Buzz), Bank of China Ltd (601988.SS: QuoteProfileResearchStock Buzz) and Agricultural Bank of China Ltd (601288.SS: QuoteProfileResearchStock Buzz).

For smaller banks, which rely more on short-term interbank funding, the immediate concern is that their costs will rise even before the final leg of the rate liberalisation kicks in.

Last month, the central bank engineered a cash crunch in the interbank market out of concerns that credit was being funneled into speculative real estate investments and poorly conceived local government investment projects.

Though interbank rates have since retreated from peaks near 30 percent, dealers expect cash to stay tight in coming months.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: