China Equity Strategy
Alert: Lending Rate Liberalization Is Negative to NIM Outlook
Look beyond the lending rate liberalization – China’s PBOC announced Friday to abolish controls over lending rates except maintaining the floor for mortgage loans. This move is symbolic because the lending rate floor was in large part not biding, but it hints that the authorities had committed on structural reforms when defending economic growth. The next step to relax the deposit rates ceiling probably in the coming 12 months could mean asymmetric rate hikes to banks. The lending rate liberalization may improve the market sentiment on reform, but leaves little room for rate cuts and is negative to NIM outlook.
Symmetric rate moves are now history – The upcoming interest-rate liberalization is likely to include: 1) removing the ceiling for deposit rates of longer-term or large sum deposits; 2) putting in place the deposit insurance system; 3) drafting the bankruptcy law of financial institutions; and 4) canceling the deposit ceiling completely. All would effectively increase the funding costs of commercial banks going forward. Without the protection of the lending rates floor, future rate hikes or cuts are asymmetry to banks.
It barely moves the cost of capital – The SHIBOR squeeze in June has significantly undermined the risk appetite and pushed up the risk premium in the financial market. The lack of deposit rate liberalization may assure the market that cheap credit will remain for a while. SOEs and local government vehicles may bargain for lower cost of capital. However, the gap between low bank deposit rates and high market rates remains and may again fuel speculation in the shadow banking. It requires to expedite the financial sector reforms (e.g., creation of consumer credit companies and privately owned banks) to channel more credit into the real economy.
Bank divergence expected – Different from the combined liberalization and rate cuts in 2012, no lift on deposit rate ceiling also reduced the chance of policy rate cuts in the near term. Bank NIMs see no immediate squeeze, but NIM outlook could be under pressure as further liberalization means only higher funding costs for banks. NIMs will be depending on each bank’s pricing power and risk appetite. Some banks may decide to lend more to SMEs, meaning taking more risks in a slow growth environment. Others may not be able to resist refinancing at a lower cost, a typical soft budget problem in the loan market. Balancing return and risk will be critical.
Consumers are likely winners in the long run – According to our estimation, the cost of capital will likely increase by around 2 ppts if deposit rates are fully liberalized alongside the deregulation in the financial sector. There were Rmb43tn household deposits by May 2013. The deposit rate increase by 2 ppts would lead to a shift of Rmb860bn transfer from banks/borrowers to depositors.
Publish date: 22/07/13