Taking a cue from the larger economy, which is looking to make the transition from quantity to quality, China’s four biggest banks have decided to slow down growth and focus instead on better profit margins.
In 2010 the earnings of the top four Chinese banks, the Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BoC) and Agriculture Bank of China (AgBank) rose a whopping 26-46 percent, but largely due to record lending the previous year.
Now they want their bottom lines to depend less on an expanding loan book and more on higher lending rates, which is possible because of recent tightening measures.
“Actually the [Chinese] government’s interest is to enhance the profitability of its banks and slow down the amount of lending,” says Emil Wolter, Head of Regional Strategy, RBS.
Tighter liquidity, Better Profitability
China has raised interest rates four times and bank reserve ratios six times since October to fight stubbornly high inflation. The latest was a 25 basis point hike last week. These measures suck liquidity and allow banks to charge higher rates, which results in a higher net interest margin, or NIM.
China’s central bank sets an upper limit on the deposit rate and a lower limit on the lending rate, which can give Chinese banks a spread of 3 percent.
But due to the rush to increase lending in the past 2 years, Chinese banks have been charging lower interest rates, which is one of the reasons why their average NIM is around 2 percent. But this is set to change.
“This year we are going to see deceleration of loan growth but we will see stronger profitability simply because we are going to get higher NIMs,” says Stanford Bernstein’s Senior Bank Analyst Michael Werner. He expects NIM expansion for Chinese banks to average 17 basis points this year and 15 basis points in 2012.
Loan Growth to Slow
All the big banks have said their lending is going to fall in 201l. In fact total yuan loans fell to $1.1 trillion in 2010 from a record $1.4 trillion in 2009 and are estimated to be below $1.1 trillion this year. The big four banks would cap their combined new loans at $0.43 trillion this year, according to Chinese media reports, compared with $0.47 trillion last year.
China’s largest bank by assets, ICBC, has already seen loan growth slow to 2.2 percent in the first two months of 2011 whereas interest income rose 30 percent compared with the same period last year, according to sources quoted by Reuters.
Bank of China, the country’s third largest bank, says loan growth this year is likely to decline from the 13.5 percent in 2010, but will still stay in double digits.
A bank’s loan portfolio typically comprises 75 percent corporate loans and about 20 percent mortgages. According to May Yan, Head of China Banks Research from Barclays Capital, “We are probably going to see lower mortgage volume growth this year. But on the other hand we are seeing much better pricing power on mortgages.”
She says that mortgages were previously given out at 30 percent below the benchmark rate of 6.80 percent, but now they are at the benchmark rate or even higher due to the tightening measures. In the long run this will prevent an asset bubble and lead to good asset quality.
Non-Performing Loans: A Non-Issue
For the four major Chinese banks, the average non-performing loan, or NPL, ratio dropped to around 1.1 percent in 2010 from 2 percent in 2009 and is expected to decline further this year, compared with 20 percent in 1990 and around 5 percent only 3 years ago.
Many expect more NPLs down the road after the massive loan issuance in 2009, especially from local government financing vehicles. About 15 percent of bank lending goes to local governments, according to CreditSights research.
But ICBC says its NPL ratio for loans to local governments was only 0.3 percent in 2010. Even for AgBank, which is most exposed to lower-quality rural lending, the NPL ratio was 1.5 percent in 2010.
However, some analysts believe a lot of the loans to local governments haven’t had a chance to go bad yet because they were issued over the past two years. CreditSights’ Senior Banking Analyst, David Marshall, says the key issue is what will happen in the next two years. “If the China economy weakens, this could be a huge issue for the banks.”
But if China’s economy maintains the momentum, slower loan expansion could still be positive for the banks. “I believe loan growth for China banks will slow down from 20 percent last year to 15 percent this year, which means earnings will slow. But with margins widening, profitability can be higher,” says Marshall.