Mainland bank stocks fell in Hong Kong yesterday, reflecting the potential drag on profitability after the People's Bank of China abolished on Saturday the floor for lending rates.
Banks are now free to set their lending rates, but the intensified competition is likely to drive down interest income and cause them to lower credit standards, raising risk, analysts say.
"The PBOC's action is credit-negative for banks because it is another move towards interest rate deregulation that will narrow their net interest margin," Bin Hu, a senior analyst at Moody's Investors Service, wrote in a report.
Net interest margin is a measure of loan profitability and declines if interest earned on loans falls while interest paid on deposits remains unchanged.
Until Saturday, the floor for lending rates was 70 per cent of the central bank's benchmark rates. The PBOC still caps deposit rates at 110 per cent of the benchmark.
Targeting a market-based interest rate as the main monetary policy tool could lower the profitability of banks, especially the smaller ones, Standard & Poor's Ratings Services said in a report.
Banks that focused on small and medium-sized enterprises, such as China Minsheng Bank and China Merchants Bank - the stocks of both fell 0.77 per cent - face more competition for high-quality borrowers, Moody's said.
That is because they will expand into more profitable businesses, such as loans to these enterprises, to try to offset rising pressure on margins.
Moody's expects the impact on profitability to be greatest on the Big Four banks, as they have relatively large exposures to big state-owned firms that are able to secure lower lending rates.
In the first quarter, less than 12 per cent of new loans were priced below benchmark rates, Deutsche Bank said in a report.
If the rate on those loans was cut by 1 percentage point, the impact on the net interest margin of Hong Kong-listed banks would be a decrease of 0.031 percentage point, it said.
Smaller banks were hit hard on the stock market yesterday, although their losses were cut in the afternoon. China Citic Bank fell 3.04 per cent to HK$3.51 while Chongqing Rural Commercial Bank dropped 2.48 per cent to HK$3.14.
Among the Big Four, Industrial and Commercial Bank of China fell 1.22 per cent to HK$4.86, China Construction Bank fell 0.91 per cent to HK$5.44 and Agricultural Bank slipped 0.65 per cent to HK$3.06. However, Bank of China rose 0.32 per cent to HK$3.15.
HSBC economist Qu Hongbin said the PBOC's next move would be to widen the floating range for deposit rates, but this would require the introduction of deposit insurance first.