By Tamora Vidaillet
27 April 2007
Reuters News
(c) 2007 Reuters Limited
BEIJING, April 27 (Reuters) - Chinese banks will probably maintain buoyant profits even as Beijing intensifies its battle against lending growth, but they will need to work a lot harder to maintain fat margins in the years ahead.
Profits at many Chinese banks swelled last year as surging loan growth greased the wheels of an economy that expanded 10.7 percent, the fourth consecutive year of double-digit growth.
To keep the economy from overheating, the central bank has raised interest rates three times in the past year, and increased six times the proportion of deposits banks must hold in reserve. Economists expect further tightening, perhaps as early as Friday.
But few analysts expect such tightening to substantially erode lending and profit growth.
'Loan growth may moderate in the coming months, but not to the extent that it will really hurt profits,' said May Yan, a banking expert with Moody's Investors Service in Hong Kong.
Lenders will face bigger challenges from eventual interest rate liberalisation and from growing opportunities for firms to bypass banks and raise funds from the bond and equity markets.
Most Chinese banks derive no more than 10 percent of their revenues from fees for products and services, a fraction of the norm in developed markets.
Banks enjoy a built-in margin because the central bank imposes a cap on deposit rates and a floor on lending rates, guaranteeing a spread of more than 3 percentage points.
The profits have helped major banks clean up their balance sheets as part of a government-led restructuring. Now that process is largely complete, analysts say banks need to prepare for the dismantling of the controls on deposit and lending rates.
'Risks associated with headwinds to profitability come from how the banking environment will change and not loan volume growth,' said one banking analyst on condition of anonymity.
'The question is at what point does the policy of the built-in spread change, because that is what keeps margins high.'
LIMITED FALL-OUT
Those margins helped banks to report bumper 2006 results.
Net income at Industrial and Commercial Bank of China Ltd. , the country's largest lender, grew 31 percent to 49.3 billion yuan ($6.39 billion). Merchants Bank Co. Ltd. , the biggest non-state lender, posted an 88 percent rise in net profit to 7.1 billion yuan.
Jing Ulrich, chairman of China equities at JPMorgan, who remains bullish on bank stocks, expects liberalisation to begin within the next two years, rewarding those lenders that offer better services and have mastered risk-adjusted loan pricing.
But analysts Nick Lord and Christina Fok at Macquarie say banks could be in for a shock imminently: they suspect the central bank could raise deposit rates by more than lending rates in the coming days as a "warning shot across the bows" to emphasise concerns over rapid loan and investment growth.
Although an erosion of margins could sour sentiment in the near term, banks would probably be able to increase profits by more than 20 percent a year over the next two years, partly on the back of rising fee income, Lord and Fok said in a report.
For Dominic Chan of CLSA, the picture is more clouded.
He expects monetary tightening and deteriorating asset quality will reduce earnings per share for China's five banks listed in Hong Kong by 5 percent on average this year.
'You should expect much slower loan growth for the whole of 2007,' said Chan, who expects China to raise rates on Friday.
CHASING FEES
Non-interest earnings have surged at a number of banks that have spent the last couple of years bolstering everything from credit cards and wealth management to settlement services.
ICBC's net fee and commission income soared 55 percent last year to 16.3 billion yuan, accounting for 9 percent of its operating income.
But fee income is rising from a low base, and analysts say banks will have their work cut out to beef up these business lines quickly enough to offset the hit to profits when Beijing finally does free up lending and deposit rates.
'Many smaller banks are still insolvent, so taking away the spread would put them in a very precarious situation,' said Charlene Chu, rating agency Fitch's director in China.
'I don't see this happening in the next couple of years.'
Overall, many analysts are cautiously optimistic about the ability of Chinese banks to weather eventual change.
'I would not say they are 100 percent ready, but I don't think they would run into trouble immediately,' said Zhao Xinge, an associate finance professor with the China Europe International Business School in Shanghai.
'In the past two or three years, they have been doing a lot in areas like selling mutual funds or wealth management products,' he said. ($1=7.720 Yuan)
