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April 15, 2013

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Leaner profits shadow banking industry

THE speed of earnings growth at China's top five banks in 2012 more than halved from two years earlier, as the nation's economy expanded at its slowest pace in 13 years and interest rate deregulation began to erode margins.

China's Big Five - Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China and Bank of Communications - reported aggregate net profit of 775 billion yuan (US$124 billion) for 2012.

Although that represented a 15 percent increase from a year earlier, it was a significant drop from 26 percent growth in 2011 and 32 percent expansion in 2010.

Profit growth is expected to slow further to 6.9 percent this year and 4.5 percent in 2014, according Haitong Securities Co, China's second-biggest brokerage firm. Economists and analysts said the rapid growth in bank earnings in the past few years was not sustainable, given regulatory reforms aimed at liberalizing interest rates. Last year for the first time, the Chinese central bank allowed lenders to float deposit rates up to 10 percent above benchmark rates.

Net interest margins for the Big Five are expected to fall to an average 2.47 percent this year and to 2.29 percent in 2014, from 2.55 percent last year, according to Haitong.

Despite the slowdown in growth momentum and the contraction in margins, the Big Five are still heavily criticized for using their dominant market position and government backing to reap easy profits.

"The spread between benchmark deposit and lending rates set by the central bank is higher than that of foreign countries," said Wang Xiaolu, deputy director of the National Economic Research Institute under the China Reform Foundation. "Therefore, they made a windfall profit because of policy controls in China, not their hard labor. It's a monopoly profit, which has led to uneven income distribution among the industries."

Lu Zhengwei, chief economist at Industrial Bank, argued a net interest margin at 2.5 percent is acceptable since it's currently 0.6 percentage point lower than the saving and loan spread.

"When comparing with overseas markets, the figure is not too high or too low - just about the middle level," Lu said.

Contracting margins are not the only reason behind stalling growth.

Financial results from the bank show the drop in growth of non-interest income was steeper than that of interest income. Non-interest income - including bank card charges, settlement and clearing fees, agency charges, financial advisory fees, loan commitment commissions, and custodian and fiduciary fees - plunged to 7 percent last year from 35 percent in 2011.

"Fee income growth slowed to single digits at the Big Five, which reflects the economic downturn and stricter monitoring over bank charges last year," Industrial Securities Co said in its latest research report. "Non-interest income normally accounts for between 40 percent and 50 percent of total earnings at leading foreign banks. The ratio of the Chinese banking industry is around 20 percent at the moment, which can be largely improved."

According to Haitong, fee and commission growth at the Big Five is expected to pick up, reaching 9 percent this year and 15 percent in 2014.

Policy implications

However, policy implications in the short run will hinder any revenue rebound in fees, said Industrial Securities. The government stepped up measures last year to regulate arbitrary bank charges. Fee rates for debit cards were reduced in February for the first time since 2003.

New rules introduced recently by the China Banking Regulatory Commission to tighten the regulation of wealth management products also weigh on the growth of fee income.

Wealth management products typically carry higher interest returns than traditional deposits and have become a major source of banks' funding base.

However, much of that money is channeled through a "shadow banking" system that finances riskier investments such as real estate projects and local government borrowing.

Fitch Ratings estimated that sum at 13 trillion yuan by the end of last year and cited the risk shadow banking poses to Chinese banks in its decision this week to cut China's long-term local currency debt rating by a notch to A-plus.

China's banking regulatory commission recently vowed even greater efforts to scrutinize wealth products after several well-publicized defaults last year.

Moody's Investors Service said the new rules require separate books for individual products, capital reserves for risk exposure and caps on investment in non-traded debt. The measures are "credit positive" for the lenders, Moody's said. However, the actions are expected to further reduce fee income of the banks.

Ba Shusong, deputy director-general of Financial Research Institute at the State Council's Development Research Center, said banks have become enamored of the wealth management business because they are struggling amid fierce competition for funds.

In order to meet the loan-to-deposit ratio set by the regulator, short-term products are widely used to increase liquidity.

"Policy arbitrage will exist until the regulatory indicators are improved to reflect a dynamic measure of banks' performance," said Ba. "It's a new challenge for regulators. It's time to phase out the loan-to-deposit ratio."

The ratio, which regulates the maximum amount of loans a lender can extend based on deposits held for a specified period of time, is now capped at 75 percent.

Shang Fulin, chairman of the CBRC said last month that alternative measures are under study and may replace the current ratio to better supervise the industry.

An easing of the ratio would ease pressure on banks and perhaps help stanch the effects of eroding margins and competition for deposits.




 

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