Chinese banks: China’s formerly bad debt-ridden banks are now among the world’s most profitable and highly-valued lenders. But tougher regulators are threatening to change that. Chinese authorities are mulling stringent rules to prepare banks for a rainy day. Shares are likely to struggle as a result.
China’s state-controlled banks have enjoyed rapid loan growth, guaranteed margins, low bad debt and plump balance sheets, partly thanks to helpful regulators. Beijing cleaned their books, and pushed them to go public. The government also fixed their interest margins — the difference between what they pay for deposits and charge for loans — at 3.5 per cent, double the level in markets like Hong Kong.
Stricter regulators are now threatening this cosy arrangement. China’s Banking Regulatory Commission is understandably worried about bad debt risks, after banks doubled new lending in 2009. CBRC is now looking at forcing them to set aside provisions on new loans, and capping their leverage. It may also impose higher capital requirements.
Those measures will hit bank profits hard. CBRC is reportedly considering asking banks to set aside 2.5 per cent of every new loan. Assuming operating costs of 2 per cent, the move would wipe out the interest margin on new lending in the first year, according to Credit Suisse. Such a change would cut the profit of mid-sized lenders such as Citic Bank by half this year, according to BOCI.
Meanwhile, interest margins are also likely to be squeezed as the CBRC gradually allows them to compete for deposits by setting their own rates. One-year deposit rates are currently capped at 2.25 per cent, below this year's inflation target of 3 per cent.
Regulators may also push up the industry’s average capital adequacy ratio as high as 15 per cent of risk-weighted assets from the current average of 11 per cent. That will require banks to shrink their balance sheets or issue equity. Another round of capital raising would further dampen market sentiment.
Chinese banks now trade at 2 times forecast book value for 2010, versus about 1.3 times for their Western counterparts. With new rules cutting into their profits and loan margins shrinking, it is time for investors to re-think whether the shares really deserve such a premium.
