What China's Interest Rate Cut Means for the Banks

China’s surprise interest rate cut led to a selloff in mainland banking stocks Friday on concerns over the impact of policy easing on the lenders’ net interest margins as well as worries over economic growth.

Pedestrians walk past a branch of the Industrial and Commercial Bank of China (ICBC) in Shanghai.
Philippe Lopez | AFP  Getty Images
Pedestrians walk past a branch of the Industrial and Commercial Bank of China (ICBC) in Shanghai.

Shares of Industrial and Commercial Bank of China (ICBC), the world's biggest bank by market value, and peers China Construction Bank (CCB) and Bank of China (BOC) slipped between 1 and 2.3 percent. Shares of smaller rival China Merchants Bank fell 3.4 percent.

However, banking analysts tell CNBC that the impact of the interest rate cuts on bank earnings this year will be negligible.

Simon Ho, Head of Asian Financial Research at Citi Investment Research says the central bank’s latest package of rate adjustments will hurt net interest margins by around 4 to 5 basis points, and earnings by around 2 to 3 percent.

The People’s Bank of China (PBoC) announced an “asymmetricinterest rate cut on Thursday – lowering the benchmark lending rate by 31 basis points to 6 percent, and deposit rates by 25 basis points to 3 percent.

The central bank - which sets a floor on lending rates and a ceiling on deposit rates - also said banks could lend at 70 percent of the benchmark rate, down from 80 percent, in order to make loans more affordable for borrowers.

Jim Antos, bank analyst, at Mizuho Securities in Hong Kong explains that it takes banks 3-6 months to re-price their loans, and thus the impact on the banks’ net interest margin - the difference between the interest earned by banks and the interest paid on deposits – will be minimal this year.

Antos adds that it is unlikely banks will pass all of the lending rate cuts onto borrowers. “I was in Beijing last week and I asked the banks what the impact of the first rate cut is going to be. They said it’s going to be a lot milder than you might expect,” he said.

“I didn’t detect enthusiasm to give a discount (to borrowers). If you give the banks a choice whether to give a discount or not, the banks aren’t going to be willing to do so. You would be safe to assume that the earnings impact will be negligible for the next year,” he added.

Antos says that banks will use the next few months to assess what their peers are doing, before acting to reduce costs for borrowers.

“Banks are waiting to see the market reacting on the lending side. They are judging to see if smaller guys (banks) move and how their clients are reacting. If you get a line of customers coming in for a discount then this will be taken into consideration,” Antos said, adding that banks are currently on track to meet the government’s new loan target of 8 trillion yuan ($1.25 trillion) in 2012.

But while banks may be shielded this year, some analysts see a more difficult environment for Chinese banks in 2013.

May Yan, banking analyst at Barclays, warns that net interest margins could come under significant pressure next year.

With slowing economic growth and lower loan demand, banks will have to lower lending rates next year in order to meet government loan targets, she said.

“Banks will eventually lower rates, and that’s going to damage to their net interest margin. Net interest margins could decline up to 40-50 basis points next year. This isvery significant as average margins (from loans) are about 2.7-2.8 percent,” said Yan, who predicts bank earnings could decline between 24 and 34 percent in 2013.

Antos, who forecasts that the net interest margins of banks will decline by 25-35 basis points next year, says while this will be negative for bank earnings, it will not be a “disaster”.

Antos says the lenders will respond by expanding their focus on high-yield loans to small to medium sized enterprises (SMEs), which he believes will be a “sufficient factor” to keep earnings under control.