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Chinese Banks Resilient Despite SHCOMP Slump
By: Louis Wong
Articles (12) Profile

China banking stocks are showing resilience amid the recent market selloff. The Shanghai Composite Index has plummeted nearly 30 percent from the recent high of 5178 seen on 12 June, whereas the drop in share prices of the four largest state-owned commercial banks, in the same corresponding period ranged from 5.3 percent to 9.6 percent.

These banks are namely Industrial Bank of China (1398.HK), China Construction Bank (939.HK), Bank of China (3988.HK) and Agricultural Bank of China (1288.HK),  The strength of chinese banking stocks can be attributable to several factors.

Why Chinese Banks Are Still Stable

Source: Telegraph UK

Earnings growth at Chinese banks have been under pressure due to lower loan growth, narrowing net interest margin and deteriorating asset quality. Bank of China and China Construction Bank posted their slowest first-quarter profit growth in six years.

Meanwhile, Industrial and Commercial Bank of China saw net profit rise 1.4 percent, the slowest pace in eight years. Interest-rate cuts and lowering banks’ reserve requirement ratio by the People’s Bank of China helped spur new-loan demand.

New bank loans totaled CNY3.61 trillion in the first quarter, versus CNY3 trillion in the same period last year, while total social financing (TSF) amounted to 4.61 trillion yuan in the first three months, versus CNY5.6 trillion a year earlier. As a result, new loans in the first quarter made up for 78.3 percent of TSF, a rise of 24.1 percentage points versus a year earlier.

Additionally, China plans to scrap a longstanding rule that caps lending by commercial banks at 75 percent of their deposit, a measure that aims to boost credit expansion. The State Council will propose the amendment which needs to be approved by the Standing Committee of the National People’s Congress.

It is estimated that the removal of the loan-to-deposit ratio (LDR) requirement would potentially allow the 16 listed banks on the A-share market to release up to CNY6.6 trillion in extra lending. Additionally, this would help improve banks’ net interest margin as they do not need to compete to pay more for deposits.

CSRC’s Initiatives To Help Banks

Recent comments by the China Securities Regulatory Commission (CSRC) indicated that the securities regulator was looking into allowing commercial banks to apply for securities licenses as part of reforms that will permit financial institutions to conduct mixed businesses.

Currently, the Securities Law mandates that securities, banking, trust and insurance should be operated and regulated separately. The Commercial Banking Law also prohibits commercial banks from conducting brokering business. However, the lines between these disparate businesses have been increasingly blurred in recent years.

Loosening the restriction will help generate new source of income for banks. The Bank of Communications (3328.HK) is reportedly planning to acquire a 33.3 percent stake in Huaying Securities from Royal Bank of Scotland and the Industrial Bank (601166.SH) is said to be waiting for approval from the State Council to acquire Huafu Securities.

As part of the government’s push to reform and revitalize state-owned lenders, the Bank of Communication has won approval from the State Council to look into taking more private shareholding to diversify its shareholder structure.

This is taken as a signal that other state-owned banks would soon start diversifying ownership, bringing on board commercially adept strategic investors and incentivizing employees through stock option scheme. It is expected Bank of China and China Construction Bank will follow Bank of Communication with their own reforms.

Tough Times Ahead

While opportunities abound, challenges remain. As China moves closer to full interest rate liberalisation, it will exert more downward pressure on banks’ net interest margin.  With asset quality continuing to deteriorate and the average overdue period increasing, there is growing pressure on banks’ overdue to eventually falling into the non-performing loan (NPL) category.

The aggregate NPL balance of the banking industry at the end of 2014 was 641.5 billion, an increase of 38.2 percent from the end of 2013, while the NPL ratio rose 0.24 percentage points to 1.23 percent.

Finally, China’s newly announced deposit insurance scheme, covering 99.6 percent of depositors for up to 500,000 yuan each, came into effect on 1st May. The scheme would likely put  pressure on banks’ margins.

 

Louis is one of the most experienced fund managers in Hong Kong and has more than 25 years of solid experience in the financial markets. He employs a strict criteria for choosing his stocks, which is deeply insistent on having a thoughtful and sophisticated analysis of the company before making any investment decision.

Please click here for more information about this author.


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