Standard & Poor's

Lenders likely to take a hit as interest margin shrinks

PUBLISHED : Saturday, 16 June, 2012, 12:00am
UPDATED : Saturday, 16 June, 2012, 12:00am

Profitability of mainland banks will be hit this year as the government liberalises interest rates, says Standard & Poor's.

The rating agency expects banks' net interest margin - the spread between loan returns and deposit costs - to shrink by 12-13 basis points. The banking sector, it estimates, will earn US$17 billion less this year than what it could have earned without the interest rate changes, and US$42 billion less next year, provided the lenders maintain their present assetliability mix.

The central bank last week allowed banks greater flexibility when setting interest rates for loans and deposits, a significant move towards interest rate liberalisation. The move came as government-set interest rates failed to beat inflation, increasingly causing deposit flights, and the economy's overall efficiency continued to deteriorate with state-owned firms thriving on cheap credit.

The runaway inflation and consequent failure to preserve household income is hindering the government's efforts to shift economic growth to a model driven by consumption rather than investment.

The slowdown in deposit growth has also led banks to resort to so-called wealth management products, or structured investment products that offer higher returns. But this has distorted banks' liquidity ratios and increased risks due to lack of transparency. With the new regulations, S&P predicts the proportion of loans below the benchmark rate will bounce to 20 to 30 per cent of the total loans in the next 18 months from the 5 per cent at the end of March.

The squeeze in earnings will drive banks to become more open to issuing loans at higher interest rates to small and medium enterprises, loans that are considered more risky, said Liao Qiang, director of financial institutions ratings at S&P.

Mainland lenders' asset quality is also likely to deteriorate. The sector's non-performing assets could rise by 2 to 3 percentage points this year in a soft-landing scenario, assuming no write-offs of bad loans, said S&P.