Depositors lament profits of doom

PUBLISHED : Monday, 16 April, 2012, 12:00am
UPDATED : Monday, 16 April, 2012, 12:00am


Fat profits at financial institutions have led to banker bashing around the world, and China is no exception.

While US and European bankers draw criticism for collecting bonuses despite being rescued by taxpayers, in China it's a different story.

At issue is the relatively low interest rate the mostly state-controlled banks pay to captive depositors. The banks, in turn, lend those funds at much higher rates and pocket the spread, the so-called net interest margin. Last year, that spread at the Big Four state banks averaged 2.5 percentage points.

Because deposit rates are set by the government, smaller players can't compete by offering higher deposit rates, guaranteeing the big banks a secure and low-cost source of funds. Lending rates, in contrast, are open-ended so big banks are free to charge their borrowers as much as they can. Consequently, the banks have become highly reliant on their lending business and its steady margins.

Also fattening profits are their large-scale operations, relatively low overheads and reserves against potential bad loans that are arguably too small, says James Antos, a senior analyst at Mizuho Securities.

Last year, the Big Four - Industrial & Commercial Bank of China, Agricultural Bank of China, China Construction Bank and Bank of China - racked up 623 billion yuan (HK$763.29 billion) in net profit, or 1.7 billion yuan a day. What's more, those banks averaged more than 20 per cent returns on equity, a record, despite being forced to meet tighter capital requirements. By comparison, European banks' return on equity, a key measure of profitability, averaged 5 per cent in 2011.

While the fat profits are good news for global shareholders of the Chinese banks, which are all listed in Hong Kong and Shanghai, it's stirring trouble at home. Premier Wen Jiabao recently called for measures 'to break the bank monopoly' and let other smaller players in. That was followed by a repeated warning from the China Banking Regulatory Commission that banks will be 'severely punished' for charging excessive fees on basic services such as opening and closing accounts. And it all comes as China's leaders evaluate whether to legalise so-called underground banks that have sprung up to feed credit-starved entities including small- and medium-sized enterprises (SMEs). It was estimated they accounted for 4 per cent of total credit outstanding as of June 2011.

Public anger against banks has been rising. In December, ahead of China Minsheng Banking reporting a 59 per cent increase in profit, Hong Qi, the bank's president, remarked at a financial forum that Chinese banks made so much money that 'we are sometimes embarrassed to announce it'.

His comment drew waves of criticism from internet users on Weibo - China's equivalent of Twitter - likening mainland banks to robbers. Moreover, depositors are growing increasingly concerned about their meagre interest income being ravaged by inflation. For instance, the benchmark one-year deposit rate is 3.5 per cent, while inflation last year was running at 5.5 per cent.

At the same time, SMEs have been caught in a credit crunch, partly because big state banks favour lending to state-owned enterprises, which are considered to have an implicit government guarantee and are therefore deemed less risky.

The upshot is that it skews the allocation of capital and increases the clout of the state-owned enterprises, which dominate everything from energy and resources to telecommunications.

The People's Bank of China (PBOC), the country's central bank, has been calling for deposit interest rates to be liberalised as part of a move to overhaul and modernise the financial system. PBOC governor Zhou Xiaochuan said last month that conditions were ripe for interest rate liberalisation given the strong state of Chinese banks.

Deposits are at the heart of his concern. Already, depositors are starting to shift out of low-yielding bank deposits and into more attractive so-called wealth management products. Attracting deposits might become more acute in the future as other innovative higher yielding investment products become available.

Currently, the big state-owned banks account for 53 per cent of outstanding loans, according to calculations by analysts at Sanford C. Bernstein.

The call to break the big banks' hold on the economy comes ahead of the leadership shuffle, which is likely to complicate matters and raises the question why Wen, who has tried unsuccessfully to overhaul other sectors of the economy during his eight-year tenure, has broached the issue when he is less than a year from retirement.

'Wen is conscious about his reputation in history and how he will be judged,' said Liu Shengjun, deputy director of the China Europe International Business School's Case Centre in Shanghai.

He said that as a lame duck, Wen could ask the bank regulator to come out with guidance and rules while he was still in position, setting the stage for them to be applied in the two years after his retirement.

'It's just a few months before he retires. He's just saying this for fun,' contended Zhang Xiaoji, research director at the development research centre of the country's cabinet, the State Council.

'The notion of breaking the monopoly of big banks in China has been mentioned for years, and Wen himself has even approved related documents several times. But it is not just up to him because the bank sector is a system.'

It's a system with vested interests, including the big banks themselves, which are already bridling at being bashed for what they contend is partly their role to carry out government directives.

Other players also aren't likely to be supportive, including the state-owned Assets Supervision and Administration Commission of the State Council, which oversees enterprises' assets and has advocated that state-owned enterprises play a larger role in the economy.

Michael Pettis, associate professor of finance at the Guanghua School of Management at Peking University, said the problem was that having only a few big banks and many small banks created little competition. He noted that this was the case in the US 20 to 30 years ago before a wave of consolidation took place. If the mainland allowed more mergers among smaller banks and formed more national banks, for example 15 to 20, that would inject competition and make the whole capital allocation process much more efficient, Pettis said.

Others argue the government should allow private investors to hold bigger stakes in banks at the city and county levels, and allow private investors to set up more non-state-owned banks like China Minsheng.

Still, while all the noise has rattled some mainland bankers, analysts who track the big listed banks aren't worried about the status quo being upended.

'We do not expect the state-owned banks' dominant market share position will be at risk, nor will the banks be subject to a government sponsored break-up,' said Michael Werner, a senior analyst at Sanford C. Bernstein. But large banks could lose market share as a result of new government policies to make the market more competitive for deposits and loans, he said.


The number of banking institutions on the mainland, including foreign banks, car financing firms and private banks, in 2010