September 2, 2012 7:17 pm

China banks – feel the squeeze

Slowdown in profit growth has left lenders trading near five-year lows

China’s banks have done their national service. Now they are paying for it. Although their non-performing loan ratios look to be under control at an average 0.9 per cent, asset quality is in fact still deteriorating. Under China’s enigmatic loan classification system, delinquent loans were up 80 per cent at Shanghai Pudong Development Bank in the first half; up almost two-thirds at Minsheng Bank. Rolling over local government debt means that this problem will get worse.

There is little the banks can do to offset this trend. The economic slowdown has flattened loan demand – tough when net interest income accounts for three-quarters of bank revenues. The days of guaranteed healthy interest margins are also disappearing. Long overdue interest rate liberalisation, which started when the central bank cut interest rates in June, will squeeze lenders’ net interest margin further. It already slipped almost 20 basis points at China Merchants Bank in the second quarter of 2012.

The prospects for non-interest income are also dwindling. Last year, banks profited handsomely from the pricing power that came with state-imposed credit tightening. And the fast developing trust industry – based on repackaged loan portfolios – boosted the sale of wealth management products. Fee and commission income at Industrial and Commercial Bank of China, the sector behemoth, rose almost a half in the first six months of 2011. In the first half of this year it was flat.

The resulting slowdown in profit growth – Bank of China’s was just 8 per cent in the first six months, half last year’s pace of growth – has left China’s banks trading near five-year lows on 1.1 times book value.

That also reflects a political reality: there is no guarantee they will not be called upon again to do the honourable thing and lend China out of its economic slowdown.

Email the Lex team in confidence at lex@ft.com

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