Banks to sink or swim with removal of rate caps

Deposit and loan margins will likely narrow, though not as much as expected, after the central bank removed a cap on deposit rates as part of its interest rate liberalization, central bank governor Zhou Xiaochuan told Caijing magazine on Tuesday.

Zhou said loan rates likely will rise, along with deposit rates, but uncertainties remain as to whether the rate margin will widen or narrow.

What is certain is that after the liberalization, risk premiums will stay little changed across sectors, and money will be spent more efficiently.

Zhou's comments came after Beijing wrapped up its annual Central Economic Work Conference. A communique issued in the wake of the meeting listed interest rate liberalization as one of the six top economic priorities for next year. In its 60-point blueprint guiding China's reforms over the next decade, Beijing promised the liberalization will be completed by 2020.

The People's Bank of China, the central bank, has been loosening its control over interest rates in recent years as a key part of China's broader market-oriented financial reform. The last remaining control is a ceiling on deposit rates, which analysts believe distorts fund pricing and shelters banks from competition.

The average interest rate margin at Chinese banks was 2.63 percent at the end of September, according to China Banking Regulatory Commission data.

The rate was up slightly over the 2.59 percent seen in the previous quarter.

Zhang Qi, an economist with Haitong Securities Co Ltd, predicted lenders would struggle in the post-liberalization era.

"For lenders, making money will not be as easy," he said.

Zhou said that, barring a crisis, the central bank has no incentive to give financial institutions any special treatment, indicating that it won't shelter banks that are struggling to compete. "In normal times, we hope banks will provide better financial services to the society through competition."

A thinner interest rate margin likely will take a toll on Chinese lenders, whose balance sheets already are laden with bad loans stemming from China's 4 trillion yuan ($654.12 billion) stimulus to save the economy at the height of the financial crisis in 2008.

Chinese banks' share prices already had dropped last year, despite their healthy earnings, as investors feared the effects of interest rate liberalization.

The bank shares' average price-to-earnings ratio, a key measure of valuation, is about 6, compared with 11 in the entire A-share market.

To help the State-owned lenders get through a rough patch, Beijing has been making efforts to strengthen its balance sheets.

In August, Premier Li Keqiang promised to extend a pilot plan to sell bonds backed by bank loans. The bonds will be traded for the first time on exchanges. The move is expected to help banks unload problematic loans.

Last week, China Cinda Asset Management Co Ltd raised 2.5 billion yuan at its listing in Hong Kong, and a bulk of the money will be spent buying up bad assets from the banking industry.

Cinda is one of the four bad debt managers founded in 1999 by Beijing to clear up bad loans from China's State-owned banks. The other three also are expected to raise funds in the near term.